The earthquake, measuring 7.8 on the Richter scale that struck Sichuan province on May 12, is the strongest to hit China in more than three decades. Although the quake has caused untold devastation in terms of human losses, the market believed that the economic impact will be minimal and even less than the snowstorm damages in January and February. Hence the market reaction has been limited.

The CSI 300 index was down 1.3 percent on the following day of the earthquake, and it was quickly recovered by positive market sentiment to push the index up more than 3 percent the next day.

Obviously, the insurance stocks were hard hit as claims are likely to be high on both human and investment losses while the construction and building materials stocks were the major gainers as they will benefit from rebuilding the cities.

It is understandable why the quake's economic impact will be less. Sichuan is a less-developed province in China, and it only accounts for around 4 percent of China's GDP. International trade and foreign direct investment (FDI) in Sichuan are also small: the province's trade is less than 1 percent of the national total and the FDI in the province is less than 2 percent of the overall FDI into China, so the province's direct impact on the national economy is limited.

However, the quake's actual impact on the nation's economy could be deeper than the market concensus. Sichuan's economic importance is mainly in natural gas extraction, mining and agriculture. The province is currently estimated to produce more than 20 percent of China's natural gas output and has more than 40 percent of China's natural gas reserves.

Although there was no significant damage to the energy companies operating in the area, the government has ordered to close down most of the plants temporarily in order to access the damage.

Furthermore, Sichuan produces around 7 percent of China's agricultural output, including rice, while more than 10 percent of the country's pork originates from the region. Since both the energy and agriculture commodity supplies are likely to be disrupted, in an already inflationary environment, the inflation problem could be extrapolated in the coming quarters.

Overall, we do not expect a change in the broader economic response following the earthquake. We believe the impact on GDP growth is likely to be limited, with disaster relief and re-building expenditure likely to offset the halted economic activities. However, inflation problem is unlikely to die down in the coming quarter as we estimated early in the year.

Hence we continue to see more hikes in reserve requirements and a stable trend for currency appreciation to narrow the trade surplus and slow inflation as raising interest rate is not the option.

The author is the director at Convoy Asset Management Limited.

(HK Edition 05/20/2008 page3)