While the extent of the damage inflicted by the Sichuan earthquake is being assessed, we expect the impact on the macro-economy should be limited, as the quake's epicenter was in a mountainous area, which is amongst the less developed regions of the country.

Financial markets have remained calm so far, as evidenced by the muted performance of the domestic A-share market. The CSI 300 Index was relatively unchanged versus pre-quake levels while the disaster has very limited, if any, impact on our China portfolios.

However, Sichuan province, which accounts for about 20 percent of the country's total hydro-power and natural gas output, will be affected in the short term and result in temporary supply disruption.

While the direct impact on production of grain, livestock and poultry should be manageable, the disruption of transportation and agricultural infrastructure, for example, irrigation systems, could revive upward pressure on food inflation near term.

The Chinese government will face continued challenges to balance its policy tools. On one hand, they have to reduce credit control on infrastructure investment and conduct salvage operation in disaster areas; while on the other hand, they continue to face high inflation pressure driven by rising input costs.

We expect the Chinese authorities to adopt easing fiscal policy for post-quake reconstruction demand, while they are likely to continue to sterilize excess liquidity to control money supply growth.

Major natural catastrophes such as the 1998 floods and the severe snowstorm earlier this year showed that inflation or disruption of economic activities tends to be temporary. We expect the earthquake will be no exception.

We believe reconstruction in the aftermath of the disaster will pick up significantly, and sectors like medical, cement and construction-related materials will be beneficiaries.

As we have long been focused on the domestic consumption and infrastructure investment themes in China, our portfolios should benefit from the increase in demand for domestic infrastructure-related industries.

That said, we expect Chinese equities to remain volatile given the lingering concerns over the negative earnings impact of persistent inflation pressure and slower global growth. Despite the higher-than-expected inflation figures at 8.5 percent in April, China's National Agricultural Price Index continues to trend downward post the peak in early February, suggesting sequentially easing CPI pressure.

Hence, we expect the CPI reading to trend lower post April with a high base effect since May 2007.

The Producers Price Index (PPI), nonetheless, may continue to stay at high levels.

Therefore, we expect industrial companies to face continued cost inflation as it takes time to pass on cost increases to sustain margins through industry consolidation.

Also, we expect the slowdown in global economies, coupled with a strong renminbi, will remain an overhang on exporters and commodities/cyclical plays though prices of selective commodities could be supported by a weak US dollar and supply disruption/uncertainty.

The author is the head of Investor Communications at JF Asset Management.

(HK Edition 05/23/2008 page3)