ISI’s Straszheim: China’s interest rate hike is “tapping the brakes”

“China raised interest rates and everybody is all upset about that,” said Donald Straszheim at the start of his Oct. 19 presentation on “China’s Growth Prospects and Risks” to the CFA Institute’s “Investing in Emerging Markets Conference.” Earlier on Oct. 19, China raised borrowing and deposit rates by 0.25% (25 basis points).

Perspective on Oct. 19 Chinese rate hikes

But Straszheim, the head of China research for ISI Group didn’t seem upset by China’s rate hikes. Instead, he presented it as a reasonable way to “tap on the brakes” to slow China’s economic growth. Looking at the history leading up to the rate hikes, Straszheim said that China implemented a big stimulus following the 2008-2009 economic meltdown. This led to China overheating later in 2009 and into 2010. Although attempts to slow the economy to engineer an economic “soft landing” were  having an effect, inflation was at 3.5% and rising too quickly. Food, which makes up more than 30% of China’s consumer price index, could potentially boost the country’s inflation to 5% as a result of weather issues, said Straszheim. Also, the economy is still strong and the housing market is booming. Hence, the rate hikes.

“I don’t think this is the beginning of the end,” said Straszheim. “I don’t think this is the beginning of another major tightening cycle,” although more rate hikes may follow.

China is heading for a “soft landing” and is likely to experience 3%-4% inflation and 8% growth in 2011, added Straszheim.

Slower growth is coming

China’s fastest economic growth is behind it, said Straszheim, for the following reasons:

1. Demographics. China’s “one child” policy will hurt it. The average growth of China’s labor force had been 12 million per decade. Growth will fall to four million for this decade and then shrink by two million in the next decade, said Straszheim.
2. Technology. The technology gap between China and the rest of the world has narrowed dramatically.It can still make gains, but they won’t be as big.
3. China’s key export markets. The U.S., Europe, and Japan will grow more slowly than in previous decades.
4. Scale effects. The economy has grown a lot. It’s harder to grow quickly off a big base.

Straszheim’s predictions for China’s economic growth are

• 2010-2014: 8%
• 2015-2019: 7%
• 2020-2024: 6%
• 2025-2029: 5%

Chinese challenges: Housing shortage, bank loan problem, yuan vs. dollar

China faces some challenges:

• China needs almost twice as many housing units as are being built.
• Its banks hold many nonperforming loans.
• There is tension between China and the U.S. over exchange rates. What goes unnoticed in the U.S. is that the Chinese currency has fallen vs. most key currencies other than the dollar. The main risks to his forecast are in the areas of trade and currency, he said.

Despite the challenges, Straszheim expects China will grow faster than much of the rest of the world for a long time to come.