China Stimulus Will Have Little Global Impact: JP Morgan

China's $587 billion stimulus package should aid the domestic economy, but it may have little global impact, says a JPMorgan analyst

By Anette Jönsson

The Rmb4 trillion ($587 billion) stimulus package announced by China this past weekend is large enough to cushion the downturn in the domestic economy and ensure that the country's economy continues grow above 8% a year, but its impact on the global economy and even the rest of Asia is likely to be much smaller than initially anticipated, according to Frank Gong, J.P. Morgan's head of China research and strategy.

"This package alone will not be able to turn the global commodities markets around," he said at a press briefing yesterday. "For infrastructure spending you probably need steel, cement, heavy machinery and a lot of cheap labour, but China is still going to see a big slowdown in exports and industrial output. Also, infrastructure doesn't need much energy or industrial metals like aluminium, nickel, tin, copper etcetera and cement is a commodity that is made locally so the increase in demand will have no global significance."

Having had a few days to take a closer look at the two-year package, Gong estimates that the incremental infrastructure spending as a result of this fiscal stimulus—on top of what is already included in the current five-year plan for 2006-2010—will be about Rmb2 trillion to Rmb2.5 trillion, translating into 8%-10% of GDP in total or 4%-5% of GDP per year. While smaller than the Rmb4 trillion headline number (as most commentators have argued it would be) the planned spending dwarfs all previous monetary and fiscal measures and shows that China is serious about maintaining strong economic growth. Or in the words of Gong: "This is really China's Big Deal."

Academic research shows that the positive impact on GDP from Chinese government spending is about 1.3 times the amount actually spent, which means that Rmb2.5 trillion of incremental spending could add 6.5 percentage points worth of annual growth. And since China would "easily" grow at 3%-4% per year without this package, this should ensure that the economy will continue to expand at an 8% plus pace.

That said, the domestic beneficiaries too will be limited to a few key sectors, Gong argues. With a large part of the money expected to go towards the expansion and upgrade of China's railway system, infrastructure companies like China Railway Group and China Railway Construction Corp, both of which have listed in Hong Kong in the past 12 months, should be definite winners. The cement sector should also get a boost as demand will increase and the supply-demand situation in the industry is currently quite balanced. Cement is also quite energy-intensive which means the decline in oil prices is an added positive on the cost side.

The other key commodity for railway construction is steel, but China's steel industry is already facing 20%-30% of overcapacity because of weakening of external demand which means prices in the domestic market (which has to absorb this extra capacity) are likely to be pushed down significantly. At the same time, the Chinese steel companies locked-in iron ore deliveries for one year at a price equal to a 97% increase in the iron ore price in June/July—almost at the peak of the cycle. As a result, the steel manufacturers are likely to see a huge margin squeeze and almost the entire sector will be loss-making, Gong says. Consequently, he advises investors to stay away from steel stocks.

"My position is that if there is a good bounce in commodities—sell," he says. "The only beneficiary in commodities these days is cement."

Meanwhile, banks are likely to benefit as the government usually only puts up 20%-30% of its infrastructure spending upfront, while the rest is typically financed by bank loans. This, according to Gong, should help to cushion the slowdown in loan growth and since these loans will be guaranteed by the government, it should also improve the risk profile of the banks' loan portfolios. And if the increased fiscal spending does help to stabilise the financial markets, then insurance companies—which are large holders of listed securities—may also benefit. China Life, which is often regarded as a proxy for the A-share market, is one name to watch, Gong says.