Reforms will enhance growth potential

Since the beginning of December, the MSCI Emerging Markets Index has declined 13 percent. The sell-offs in many emerging markets, especially Turkey, Argentina and Brazil, were triggered by their sharp currency depreciation as a result of the United States' tapering of its quantitative easing, as well as market fears of an external debt crisis, for example in Turkey; the negative impact of local rate hikes, for instance in Brazil and India; inflation in Argentina, Brazil, India, Russia, South Africa; and potential economic contractions, as well as political instability in Turkey and Thailand.

Interestingly, the Hang Seng China Enterprises Index has also dropped by a significant 16 percent during the same period. This decline was close to the fall in the country equity indices of Turkey and Argentina and a little sharper than that of Brazil. It appears that the market believes that China's economic situation has deteriorated as much as those in Argentina and Turkey in recent weeks. Some investors are now asking when Chinese government will ease its macroeconomic policy to stimulate the economy.

However, this is a question no one in the Chinese government is talking about, simply because there is no need to.

This market perception of China is wrong. China's economic fundamentals are much healthier than most other emerging markets and China is one of the least vulnerable emerging economies to the US' tapering.

First, compared with other emerging market currencies, China's currency has been the most stable in the past weeks, and it will likely remain stable. Based on past experience, the renminbi should remain one of the currencies that is most resilient to external shocks this year, given that its capital account is still largely controlled for portfolio flows and the macro fundamentals are very supportive of the currency. The renminbi is likely to appreciate by about 2 percent against the US dollar this year, although a modest increase in its flexibility is possible.

Second, the macro fundamentals are much stronger in China than in many other emerging economies. China's GDP growth was 7.7 percent in the fourth quarter of last year, higher than the 7.5 percent annual target, and its volatility was within 0.2 to 0.3 percentage points on a year-on-year basis in the past few quarters. Its consumer price index inflation was 2.5 percent in December and will likely remain around 2.5 percent for the coming few months, representing the most stable period in history. Its current account maintained a healthy surplus of about 2 percent last year and will almost certainly stay in surplus this year. External debt is 8.8 percent of GDP. These data compare very favorably with many other emerging markets that experienced significant growth deceleration, large current account deficits, and higher inflation.

Third, China's political situation has become more stable since the change of leadership, partly due to the success of the anti-corruption program, while other emerging economies, such as Thailand, Turkey, South Africa, India and Brazil, are now either experiencing serious political challenges and/or facing uncertain election outcomes.