China’s previously red-hot, double-digit growth rate is expected to be merely warm in 2009, as the world’s most populous country suffers the effects of the global slowdown. Nevertheless, China is expected to lead Asia and the world’s developed economies out of the slowdown this year, as massive government spending on infrastructure and expansionary monetary policies provide domestic relief from the contracting export market.

As a result, most money managers investing in China are choosing investments that will benefit from infrastructure spending, such as construction and cement companies, and avoiding export-sensitive industries.

As well, Chinese consumers are expected to be cautious, and companies whose products will be in demand despite the slowdown are considered the best bets. Favourite defensive sectors in the country include utilities, telecommunications, consumer staples and health care.

“If China can maintain growth of 7% to 8% in 2009, it will keep the engine going,” says Lambros Piscopos, senior vice president of global equities with Natcan Investment Management Inc. in Montreal. “And that is the most likely scenario. The government is willing and able to do whatever it takes to maintain jobs.”

With foreign-exchange reserves of US$2 trillion, China has the money to finance its ambitious spending plans. In a determined effort to keep the globe’s fourth-largest economy moving at a good clip, the government of China has devised a US$586-billion stimulus package that, over the next two years, will put unemployed factory workers to work in construction jobs.

This package includes infrastructure spending on roads, airports and railways, as well as on education and health care. The investment amounts to about 20% of China’s gross domestic product spread over two years.

“The fiscal stimulus will be significant,” says Chuk Wong, vice president of Toronto-based Goodman & Co. Investment Counsel Ltd. and portfolio manager of Dynamic Far East Value Fund, sponsored by Dynamic Funds Ltd. of Toronto. “Unlike the U.S., which is broke, China will easily be able to fund spending without raising taxes or borrowing.”

About one-third of China’s economic growth comes from exports, while another third comes from infrastructure and the final third comes from consumer spending. Over the past few years, exports had been growing at a rate of 20%-30% a year. That growth rate is expected to drop significantly in 2009, and there has already been a wave of factory closures.

Figures for November show a decline of 2.2% in China’s exports, the first slip in seven years. Along with slower sales growth, China’s factories are struggling with higher labour costs and tougher environmental regulations.

“The Chinese are entering a slowdown, but with extremely strong fundamentals in place,” says Eng Hock Ong, Singapore-based managing director of AGF Asset Management Asia Ltd. and portfolio manager of AGF Asian Growth Class Fund. “The banking system is functioning well, and high foreign-exchange reserves put the government in a strong financial position.”

Inflation — a serious concern a year ago, when it peaked at 8.7% — has fallen to a year-over-year rate of 2.4%, thanks to lower food and energy costs. Inflation now stands at its lowest level in two years, giving China’s government the freedom to stimulate spending without fear of boosting prices.

The main risk to this scenario is that the global slowdown will be longer and deeper than expected, lasting past the middle of 2009. In that case, China’s exports could dry up further, with the malaise spreading to the Chinese consumer and leading to a pullback in consumer spending and deflation.

“China’s growth is driven directly and indirectly by export growth,” says K.C. Lee, Hong Kong-based portfolio manager of Fidelity AsiaStar Fund, sponsored by Toronto-based Fidelity Investments Canada ULC. “It needs a turnaround in the economies of the U.S. and Europe, which are its major trading partners.”

The worst is not over for Chinese corporate earnings, Lee says; he is maintaining a cautious stance until he sees hard evidence of a global turnaround. About 30% of Fidelity AsiaStar Fund is in cash.

Another risk is U.S. protectionism. As the new Obama Democratic federal government struggles to prop up the anemic U.S. economy, the U.S. may put up some fences to protect its own manufacturing base, at the expense of competing Asian products.

But Gavin Graham, director of investments with BMO Asset Management Inc. of Toronto, feels that risk is slight. “There may be some protectionist measures,” he says, “but the U.S. will probably be careful, as the Chinese are the biggest buyers of its treasury bonds.”

@page_break@Here are the fund managers’ picks for China:

> Agnes Deng, portfolio manager with Hong Kong-based Baring Asset Management and manager of Excel China Fund, sponsored by Excel Funds Management Inc. of Mississauga, Ont., expects China’s GDP growth to average 8% in 2009. The Excel fund is underweighted in consumer discretionary and in industrial and shipping stocks that are export-sensitive. But Deng sees opportunities in Chinese companies that will benefit the government’s infrastructure spending plans.

Deng likes energy producers China National Offshore Oil Corp. and China Coal Energy Co. Ltd., as well as Anhui Conch Cement Co. Ltd. and China Sinoma Inter-national Engineering Co. Ltd.

> AGF Asia’s Ong also sees opportunities in industries that will benefit from the stimulus package, and is adding to the AGF fund’s holding of coal-power generator China Shenhua Energy Co. and cement company China National Building Materials Group Corp.

Ong is optimistic about finan-cial services firms, including China Merchants Bank and China Construction Bank.

Property stocks will come out of their slump later in the year as the global economic pace quickens, Ong says. He likes developer China Resources Land Ltd.

> Tim Leung, head of Asian equities for I.G. Investment Management (Hong Kong) Ltd. in Hong Kong and lead manager of Investors Greater China Fund, favours China’s financial services sector, including the Industrial and Commercial Bank of China, which, he believes, will benefit from looser monetary policy and loan growth.

Leung also likes China Resources Power Holdings Co. Ltd., an infrastructure play.

China’s strong finances, he says, put it in a position to shelter itself from a global downturn.

China Mobile Ltd. is a popular holding due to its potential to grow, even in a tough economy. With 40% of China’s 1.3 billion people owning cellphones, mobile-phone market penetration has room to expand.

> Natcan’s Piscopos likes Hengan International Group Co. Ltd., a manufacturer of tissue products such as toilet paper and baby diapers.

> Mark Lin, vice president of international equities with Toronto-based CIBC Global Asset Management (Asia) Ltd. in Montreal, sees opportunity in high-end exports that are less vulnerable to global slowdown.

He likes Mindray Medical Inter-national Ltd., a company that sells medical diagnostic and ultrasound imaging equipment in Asia, the U.S. and Europe. He expects Chinese demand to increase for instruments such as heart monitors and blood-pressure monitors because of plans for more government spending on health programs.

“I’m staying away from companies producing discretionary or luxury products,” Lin says, “that are reliant on a strong economy.” IE