Is China hot or overheating?

Runaway inflation, a looming real estate and credit bubble, the shadow banking system and rapidly declining exports, are just some of the potential problems which many believe plague the Chinese economy.

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It’s amazing how much things have changed.  To be sure, the days of believing that China’s robust economic growth and rock solid fiscal position could bail out the economies in the West are clearly over.  Runaway inflation, a looming real estate and credit bubble, the shadow banking system and rapidly declining exports, are just some of the potential problems which many believe plague the Chinese economy.  Scarier terms have rarely been associated with a single country.  On the other hand if you talk to business owner, residents and even the majority of investors in the region you will find that for the most part, optimism still prevails.  Are we missing something or is this wishful thinking?

 

As a global organization, we are fortunate to have 100 fund analysts on the ground in 12 countries, who speak to thousands of investment managers about their respective investment strategies and views on the global economy. In many cases the conversation turns to China, so we thought we would share some of their insights with you.  It appears that although there is little visibility into China’s economic situation in the short term, on the whole managers are still relatively bullish about the country’s long-term prospects.  To provide some context to the manager views, which follow, we summarize below the potential headwinds that the Chinese economy is facing.

 

·            Runaway inflation: Inflation for August 2011 remained stubbornly higher than the targeted 4% for the year, coming in at 6.1%.  The inflation rate has been on an upward trajectory since 2010.  In particular, there is fear that a vicious cycle of wages chasing prices and prices chasing wages will push prices ever higher.

 

·            The property bubble: driven by the rapidly growing middle-class and population urbanization, Chinese property prices have risen by more than 140% since 2007, and as much as 800% in some major cities. Affordability, as measured by price to income, is five times the international average.

 

·            The shadow banking system: in an effort to curb inflation and reign in credit, the People’s Bank of China has raised reserve requirements seven times since January 2010 and imposed a quota on new lending by the banks (7.5 trillion yuan for the year).  These policies have limited regulated lending to all but the largest and most credit worthy companies, and created a host of unregulated lenders reportedly charging exorbitant rates up to 5%/month to SMEs looking for credit. Some estimate the size of the shadow banking industry to be 14 to 15 trillion yuan.

 

·            Declining exports: the most obvious threat to the Chinese economy are declining exports fueled by the poor economic climate in Europe and the US, wage inflation in China and the upward pressure on the yuan (albeit only slightly due to strict government currency and capital controls).

 

 

 

Sunny Ng, CFA is Director of Fund Research with Morningstar Asia

 

Editor’s note: Through conversation with various fund managers in the region and overseas, Sunny Ng, Director of Fund Research, outlines the principal risks to China’s economic growth, and provides a summary what the bulls and bears are saying. Want to know more details about what the various managers are saying about China? Look out for the follow-up article: “Is China hot or overheating? -  What fund managers are saying.


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