Country Updates

For the month ending February 2010

China/Hong Kong

Chinese stocks rebounded modestly in February. For the month, the MSCI China Index gained 2.19%, Hong Kong’s Hang Seng Index gained 2.43% and China’s domestic A share index rose 2.42%. China's currency, the renminbi (RMB), ended the month at 6.83RMB/USD.

In January, China's new loans reached US$204 billion, up 29.3% from a year ago. Property prices also rose 9.5% from the same period last year. For the second time this year, the central bank took swift measures to try to address the potential for an asset valuation bubble and risks of overheating, and raised the reserve requirement ratio for banks by 50 basis points (or 0.5%) in February. Major Chinese banks are now required to keep 16.5% of their deposits on reserve.

The Purchasing Managers' Index (PMI) decelerated to 52.0% in February from 55.8% in January. The market had not expected such a decline, which was partly due to seasonality factors resulting from the Chinese New Year holiday. In addition, the PMI may also reflect the impacts of macro tightening and risk in the recovery of the manufacturing sector.

In January, the consumer price index increased 1.5% from a year ago, compared to 1.9% in December. The producer price index rose 4.3% in January, up from 1.7% in December. Exports expanded 21.0% in January, while imports jumped 85.5%. China's automobile sales reached their highest level ever in January at 1.7 million, more than double the same period last year. Of that figure, 1.3 million were passenger vehicles, which also reached remarkable record highs in sales.

India

As India’s central government presented its fiscal 2011 budget in February, Indian markets remained flat amid mixed expectations of a sustained recovery and stimulus withdrawal. The Bombay Stock Exchange (BSE) 100 Index grew by a modest 0.7% during the month, even as industrial production grew by its highest rate in a single month over the last 20 years. According to the most recent data available, the Index of Industrial Production (IIP) grew by 16.8% in December on the back of strong growth in the manufacturing and capital goods sector, compared to 11.7% for November. Even though growth appears to be recovering, inflation in February increased to 8.56%, the highest level in 15 months. While the combination of growth and inflation could present a case for monetary tightening, the government has signaled its intention for fiscal moderation through its budget statement, making more capital available to the private sector.

Overall, the budget remains focused on consumption rather than on investments, but it also proposes to take some forward-looking steps. The government aims to reduce the central fiscal deficit from the 6.5% level it was at last year to 5.5% in fiscal 2011, and 4.8% in fiscal 2012. It hopes to achieve this through better tax collection and higher asset sales. The government has already increased the price of many commodities, including those that consumers are sensitive to, such as fuel and fertilizers. It has also set an ambitious target to divest assets worth US$8 billion in the next year. India’s tax policy, however, appears to favor consumption. While excise duties for the corporate sector were increased, the tax brackets for personal income taxes have been raised. On a positive note, higher allocations have been earmarked for building social and rural infrastructure and more licenses may be awarded to qualifying non-banking financial firms.

Japan

In February, the Tokyo Stock Price Index gained 1.04% in U.S. dollar terms, slightly underperforming the 2.85% gain by the S&P 500 Index. Sovereign debt issues in Europe kept markets subdued for the first half of the month, but as prospects of a European Union-led bailout for Greece grew stronger, equity markets edged higher. On the other hand, the yen has again strengthened to levels below 90 yen/US$1, limiting the advance of export companies.

Toyota’s automotive quality problems took center stage as a massive global recall announced in January was followed by another global recall of the company’s popular Prius hybrid car. Toyota’s sales declined sharply during the month amid intense media coverage, including a televised U.S. congressional hearing with its company president. Toyota is Japan’s largest corporation and, along with its affiliates, forms the largest manufacturing group in the country. A decline in Toyota’s competitiveness over the medium-term seems inevitable and could have a negative impact on Japan’s overall economic recovery.

Ironically, Toyota’s woes come at a time when Japan’s macroeconomic indicators show a stronger sign of recovery. Fourth quarter GDP growth in 2009 came in at an annualized 4.6%, well ahead of consensus estimates of 3.5% growth. January retail sales rose 2.6% from a year earlier, the first increase in 17 months. Other indicators such as industrial production and the country’s unemployment rate also continued to improve.

At a parliamentary budget hearing, Japan’s finance minister stated that “a 1% rise in the consumer price index would be desirable to overcome deflation,” effectively urging the Bank of Japan (BOJ) to adopt inflation targeting policies. This was encouraging considering that deflation is one of the primary economic problems Japan faces today. Mounting political pressures may force the BOJ to adopt increasingly easy monetary policies to combat deflation.

Korea

During February, Korean financial markets remained largely unchanged. The Korea Composite Stock Price Index (KOSPI) dipped just –0.43%, and the Korea Securities Dealers Automated Quotation (KOSDAQ) rose 2.11%. While the market reacted negatively during the month to news of Greece’s sovereign debt issues, it recovered quickly. There was also speculation that the outgoing Bank of Korea governor, who takes a conservative approach to his monetary policy, would raise interest rates before the end of his tenure in March. However, Korea’s Monetary Policy Committee maintained its 2% policy rate in order to sustain the current economic recovery effort and to cope with potential problems stemming from Europe. Given that President Lee Myung Bak will appoint the next Bank of Korea governor, and is expected to choose someone with the same expansionary policy stance, it seems unlikely that the Bank of Korea will tighten monetary policy anytime soon.

During the month, Korea’s economic sentiment, consumption and trading data were healthy. Business and consumer sentiment remained nearly unchanged from the previous months. Retail sales and overseas travel figures also showed strong rebounds from pent up demand that had been depressed by concerns over the H1N1 epidemic as well as the recent global economic downturn. Many domestic consumer companies launched marketing campaigns to help sales by leveraging two major sporting events: the Winter Olympics and the World Cup games.

Exports in February rose 31% backed by strong demand from emerging markets. Exports to developed countries also showed strong double-digit growth, though exports to Europe were down slightly.

February 2010

As of December 31, 2009, Matthews Asia Funds held no positions in Toyota Motor Corporation.

The views and information discussed in this article are as of the date of publication, are subject to change and may not reflect the writer's current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investments vehicles.