10 threats to Chinas economy - Citywire Money

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10 threats to Chinas economy

by Chris Marshall on Oct 18, 2011 at 17:18 Who knows how Europes crisis will pan out. It could,in the end,turn out to be a side show, distracting attention from the main event,and thats China. Chinas economy is in flux. The government is attempting a shift away from cheap exports and towards an economy fuelled by Chineses growing ranks of consumers. In fact, the economy is already domestically driven, but its being propped up by government investment spending uncertain foundations even for a country as cash-rich as China rather than consumers themselves. The Chinese authorities are now looking for quality growth. This means the decade of 11% GDP growth is over; today we learnt that growth decelerated to 9.1% in September. But a controlled slowdown of Chinas economy is proving an almighty juggling act, made more difficult by the global economic crisis. The threats are many.

1. Inflation
Having risen to worrying levels and though it remains uncomfortably high for the authorities consumer prices inflation (CPI) appears to have peaked at 6.5% in July (and fell to 6.1% in September). If inflation rises significantly again, then there will be a furious re-writing of City forecasts: the gentle soft landing scenario (where growth slows as expected, but not below about 7%) will be scratched out and replaced with a hard landing' doomsday forecast. The thing that would scare me most would be if inflation started rising again then authorities may have to tighten further. If inflation moved up to 7, 8 or 9% then a risk of a hard landing is substantially higher, said Brian Coulton of Legal & General. But, this is still not the emerging market strategists central scenario.

2. Europe and the US in crisis

How much of a threat does the growing economic downturn in Europe and the US pose to China? While the threat of a further weakening in Western demand was enough for the International Monetary Fund to downgrade Chinas growth prospects, opinions over the future impact of a global slowdown diverge sharply. Maarten-Jan Bakkum of ING says the Chinese are very worried about Europe. He adds that if a French bank went bust, for example, that could be the signal for Chinese to ease their policy, which in turn could be inflationary.

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But Coulton reckons Chinas authorities are squarely focused on their own domestic problems. Im not sure China is responding to external fluctuations in risk appetite. And as HSBC economists said in a note today, even if western economies slip into renewed recession, the impact on Chinas growth should be much smaller than three years ago as a result of Chinas continued shift away from export dependency.

3. Reliance on spending
Here we see a clash between Chinas long-term aims of shifting towards a consumer-fuelled economy, which requires less dependence on investment spending, and the shorter term need to avert a hardlanding, which currently requires investment spending - or at least a well-managed slowdown. While stats today showed investment growth remains strong, investment to GDP should decrease but if it goes down very fast if might be difficult to keep growth high enough, says Bakkum. Perhaps the most downbeat of China watchers, Nouriel Roubini, say the path of least resistance is the status quo, ie, continuing this high investment. But once increasing fixed investment becomes impossible most likely after 2013 China is poised for a sharp slowdown, Roubini wrote recently.

4. Local government debt

Some are waiting patiently for bad debts held by local governments in China to explode. But this doesnt make it to the top of economists worry list; they say the authorities will muddle through what is not a systemic economic risk. 'We think the central government will yield to pressure and step in to help,' commented Yao Wei of Societe Generale.

5. Property bubbles
Chinas frothy property market is central to its economy. Housing investment accounts for about 10% of GDP, and is crucial for economic growth. Again, the government must balance the need to cool the market, clamping down on speculative activities, while not damaging economic growth. It has already started this process and after stats today showing a slowdown in residential housing sales, economists say September may have marked the beginning of a correction. We believe that risks to the Chinese property market remain manageable for now commented, said Brian Jackson of RBC Capital Markets. If the market does eventually go pop and analysts have been predicting this for years then it could trigger social unrest, require bank recapitalisations and have repercussions around the world. A big question mark remains here

6. Unhealthy banks
which makes the prospects for Chinas banks difficult to gauge. In fact, there has been widespread concern about Chinas banks, not just because of their exposure to its property market. There is also a lack of transparency and concerns over governance, as well as the risks over losses they may face.

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These concerns are so grave that last week Chinas sovereign wealth fund bought shares in the countrys banks to stem their sharp share price declines. Western investors in China, such as Aberdeens Hugh Young, have said they are avoiding the banks, as they are uncomfortable with them. But Bakkum adds that the Chinese authorities have the cash to recapitalise the banks if need be. The Chinese state has a lot of money to spend and can move quicker than European politicians if its needs to, Bakkum says.

7. Inaction
Now that inflation appears (tentatively) to be better under control, there are hopes the authorities will take smart, steady, and targeted stimulus measures to help the economy where necessary. Beijing can and will respond to external shocks, albeit on a smaller magnitude, say the HSBC economists. Steps to relax credit controls and cut the requirements on how much banks must hold in reserve (a measure used to stimulate the economy), along with a loosening of property market controls, should allow the economy to keep growing at 8.5% or so next year, commented Mark Williams of Capital Economics today. The consensus among economists is for Chinas GDP to grow by 8.5% next year. Others aim much lower, including Bakkum with a forecast of 7.9%. But he agrees that the authorities will still need to take measures to help the economy. If they dont act I think there is a lot of downside growth. There is a need for both monetary and fiscal easing, says Bakkum.

8Or too much action

If things get that bad elsewhere in the world if Western demand for exports really sinks these efforts could all be thrown out of kilter and the Chinese authorities will again be forced to take action to bolster the economy. Then the inflation threat could return and so does the risk of a hard landing.

9. Social unrest
Inflation rears its ugly head again. Chinas growth success is not shared equally among its huge population, with rising food and property prices among the conditions making life difficult for Chinas poor and leading to growing social tension and protests against the government. According to an annual survey of social attitudes, reported in the Wall Street Journal, inflation shot to the top of the list of problems in 2010, up from fifth place in 2009.

10. Change of leadership

Added to all this uncertainty, next year succession plans will be put into place when Chinas current crop of leaders, including president Hu Jintao and premier Wen Jiabao, will begin to hand over power. It is important for Chinese politicians to be seen to be handing over a healthy Chinese economy. It probably makes them more likely to ease policy to keep growth going than otherwise, says Coulton, though he emphasises that this is not his base scenario.

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