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PIMCO Asia vice president and portfolio manager Chia-Liang Lian is in charge of the Asian trading desk and is a member of PIMCO’s emerging markets team. In an interview below, Chia-Liang discusses the economic outlook and investment opportunities in China.

Q: With the U.S. either in, or falling into, a recession, the world is looking to China as a provider of both demand and capital. What is PIMCO’s view on China’s economic outlook for 2008?
Lian: At PIMCO, we spend a lot of time thinking about China’s growth prospects, both on a cyclical horizon as well as on a secular timeframe. China’s GDP growth has held up at over 10% annually in recent years, easily the fastest pace of expansion since the mid-1990s. Indeed, this above-potential pace has been nothing short of spectacular. In nominal GDP terms, China is now roughly the size of Germany, having recently surpassed the U.K.

Fixed investment continues to be a key contributor to growth, and now accounts for over half of GDP. This upward fixed investment trend can be seen in other parts of Asia, and presents a stark contrast to the situation in the U.S. What is more, in China, the scope for further spending on infrastructure remains huge. According to Beijing’s five-year plan, for the current period ending 2010, public spending on public transportation is poised to double from the previous decade.

Household consumption provides an additional boost to domestic demand. Along with steady gains in income, consumer spending has been underpinned by the stock market, which rallied sharply up to the end of 2007. One secular development is the emerging dominance of a middle class, something that was practically non-existent in earlier years. This has served to bolster demand for high-end consumer products, such as personal computers and cars.

The gradual emergence of China as a source of final demand is underscored by the increased role it plays in the region’s export markets and with its trading partners, including Taiwan, Korea and the ASEAN (Association of Southeast Asian Nations) countries.

For the year as a whole, in 2008, GDP growth will probably moderate toward a still-healthy 9-10%. This is despite some fallout from the severe snowstorms in January-February, and more recently, severe earthquake in the Sichuan province. Remember, this is the year of the Olympics and that should provide additional support to growth in the short term.

Q: Does this mean China is decoupling from U.S. growth? Is the decoupling theory a myth or reality in Emerging Asia?
Lian: I am a firm believer of the decoupling story over the secular horizon. It is important to stress at the outset that decoupling does not imply immunity. What it does mean though is that Emerging Asia as a region is now more resilient to a global slowdown than it has ever been before. And this has a lot to do with China and India, the two large economies in the region.

Historically, in both countries, GDP growth has been less affected by the vagaries of external demand than smaller, more open economies. In the IT-led downturn at the turn of the decade, swings in exports had less direct impact on their GDP growth.

At the same time, increased import substitution underscores the emergence of domestic demand. In growth terms, China’s imports have consistently lagged exports since 2005. This is in contrast to a tighter relationship between both aggregates in earlier years, and is one major factor that drove the trade surplus wider.

Q: Are you concerned that China’s breakneck pace of GDP expansion may slow toward a hard landing, especially after the Olympics?
Lian: Interestingly, our constructive macro view on China is shared by market economists. In the last quarter of 2007, PIMCO’s Asia forum team conducted a survey of economists from sell-side firms. A resounding 80% of them do not envisage a scenario of a hard landing over the next twelve months. With social stability as a key objective, policy makers want, and have more than enough ability, to avoid it.

Again, I want to stress that the Chinese economy is unlikely to be immune to a U.S. slowdown. However, China’s macro performance should be well supported by domestic demand and fiscal stimulus, if necessary. Policy makers have both the “will and wallet” to pump-prime if necessary. This would suggest a certain degree of economic “de-synchronization” between China and the rest of the world.

Q: Is China really “different”?
Lian: One factor behind this optimism is China’s unique economic structure, which creates flexibility and diversification, as well as challenges. The Chinese economy can be broken down into three distinct components - coastal, mid-tier and hinterland. These regions are at varying stages of development, and with dramatically different features and needs. This suggests a still-significant scope for infrastructure investments, including railroads and airports.

Q: With urbanization creating demand for housing and services, what investment opportunities has PIMCO identified?
Lian: The ongoing urbanization is both a cyclical and a secular theme. with just 40% of the total population in cities, urbanization still has a long way to go in China. The outlook for consumption is supported by favorable demographics. China, with a population of 1.3 billion, or four times that of the U.S., has the largest economically active population in the world. Household demand for goods and services should underpin the housing sector. While bubble-like features have emerged in the real estate market of coastal cities like Shanghai, Shenzhen, and Guangzhou, there is still substantial price differentiation across lower-tier cities.

Consumer prices have been alarming, as they have recently spiked sharply higher across the region, not just in China, due to higher costs of food and energy.

Importantly, core inflation in China has been relatively modest. Demand-pull factors are countered by the still considerable slack in the labor market, as shown by the high unemployment rate resulting from layoffs and retirement of workers at state-owned enterprises.

Due to the paramount goal of preserving social stability, job creation and price stability will be the key areas of policy focus. The government will likely provide fiscal stimulus to sustain growth performance and, with the objective to curb inflation pressure, the authorities are expected to show greater acquiescence to a stronger yuan, allowing its value to be determined by the market. Since currency strength has had little impact on the export sector in the past three years, policy makers may be more comfortable about a stronger exchange rate.

We think that higher-quality credits that stand to benefit from the secular rise in domestic demand in China present interesting opportunities.

Q: Outside China, is there value in Asia?
Lian: Against a backdrop of improving credit fundamentals, the ongoing maturation of Emerging Asian markets will provide a growing range of investment opportunities.

Recent market volatility in certain Asian currencies and credits partly reflects a tug-of-war between technical factors and fundamentals. Still, the long-term fundamentals of this region continue to look solid. Countries with consistent external and fiscal surpluses continue to attract our attention. At the same time, evolving domestic political developments bear monitoring.

The Singapore dollar remains a compelling defensive play amid current market uncertainty and rising inflation concerns, and continued yuan strength should have a salutary effect on the Malaysian ringgit.

Q: Thank you, Chia-Liang.