By Lawrence Carrel

China’s local governments are facing a massive mound of debt that needs to be refinanced soon. The People’s Bank of China prefers not bailout the local governments, and the Ministry of Finance has yet to find a plan acceptable to local banks and other players in the Chinese bond market. Despite this, some experts feel China is making the right moves to address the problems and will soon find a solution.

“I’m pretty sanguine about China taking air out of the credit bubble and taking the risk of a hard landing right out of the market,” said James Barrineau, Schroders’ co-head of emerging market debt relative. “Growth is definitely slowing compared to recent Chinese history, but that is a good thing because they are moving from this investment-led, credit-fueled growth to a more sustainable level of growth.”

Barrineau manages the Schroders Emerging Markets Multi-Sector Bond Fund (SMSNX), which has a year-to-date return of 5.66% as of May 5.  The fund, which has $28.3 million in assets, seeks the best values in emerging market debt across sovereign, corporate, and local currency bonds. The fund has a structurally lower correlation to U.S. Treasury movements than major emerging market debt indices and most emerging market debt funds. Thus, the interest rate risk is lower. It has a turnover rate of 380% and charges an expense ratio of 0.9%.

In New York as part of Schroders’ U.S. media conference, Barrineau made the following comments in a private interview with the Asia Times.

The People’s Bank of China is trying to create demand for local bonds by intervening in the market, he said. “And we think they will eventually be successful. Local government debt is one the sore points in the market. But the PBOC is becoming more aggressive in using monetary policy to address the bad debt issue in local governments.”

China’s problem is obviously growth, but the portfolio manager said he had zero worries about China because it is such an engine of growth. The central bank is trying to create more demand for debt by pushing the risk to private sector entities, who are willing to buy into the risk. This will open capital markets and lower interest rates to stimulate growth.

“We thought there would be some defaults, but that’s not necessarily a bad thing because it introduces some rigor into the credit markets, which has not been the case,” he said. “Ultimately, they understand what the problems are and they are addressing them.”

Barrineau said there is currently a school of thought that says China is undervalued in much the same way the U.S. was in 1982. This philosophy provides an argument to stay involved in the Chinese markets because it believes current investors are getting in at the bottom of a sustainable upturn and broadening of the equity market.

He says the growth in emerging markets is in Southeast Asia. Outside of China, the emerging markets in Asia that he likes include Indonesia, Thailand, Malaysia and the Philippines. Schroders considers South Korea to be a developed market.

He thinks Indonesia with its new president is a nice reform story and the country has been a big beneficiary of lower oil prices. His team at Schroders thinks Indonesia will do some pro-growth measures that will be well received by the market.

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