As China Rolls Ahead, Fear Follows
For nearly two years, Chinas turbocharged economy has raced ahead with the aid of a huge government stimulus program and aggressive lending by state-run banks.
But a growing number of economists now worry that China the worlds fastest growing economy and a pillar of strength during the global financial crisis could be stalled next year by soaring inflation, mounting government debt and asset bubbles.
Two credit ratings agencies, Moodys and Fitch Ratings, say China is still poised for growth, yet they have also recently warned about hidden risks in its banking system. Fitch even hinted at the possibility of another wave of nonperforming loans tied to the property market.
In the late 1990s and early this decade, the Chinese government was forced to bail out and recapitalize these same state-run banks because a soaring number of bad loans had left them nearly insolvent.
Those banks are much stronger now, after a series of record public stock offerings in recent years that have raised billions of dollars from global investors.
But last week, an analyst at the Royal Bank of Scotland advised clients to hedge against the risk that a flood of cash into China, coupled with soaring inflation, could result in a day of reckoning.
A sharp slowdown in China, which is growing at an annual rate of about 10 percent, would be a serious blow to the global economy since Chinas voracious demand for natural resources is helping to prop up growth in Asia and South America, even as the United States and the European Union struggle.
And because China is a major holder of United States Treasury debt and a major destination for American investment in recent years, any slowdown would also hurt American companies.
Aware of the risks, Beijing has moved recently to tame its domestic growth and rein in soaring food and housing prices by raising interest rates, tightening regulations on property sales and restricting lending.
At the end of the Central Economic Work Conference, a high-level annual economic policy meeting that concluded on Sunday, Beijing promised to combat inflation and stabilize the economy. Those pledges came just days after the central bank ordered banks to set aside larger capital reserves in a bid to slow lending, the sixth time it has done so this year. And the government reported on Saturday that the consumer price index had climbed 5.1 percent in November, the sharpest rise in nearly three years.
Analysts say more tightening measures are expected in the coming months but that the challenges are mounting.
There are so many moving pieces, said Qu Hongbin, the chief China economist for HSBC in Hong Kong. It wouldnt be honest to say things arent complicated.
Optimists say China has been adept at steering the right economic course over the last decade, ramping up growth when needed and tamping it down when things get too hot.
But this time, Beijing is not just struggling with inflation, it is also trying to restructure its economy away from dependence on exports and toward domestic consumption in the hopes of creating more balanced and sustainable growth, analysts say.
China is also facing mounting international pressure to let its currency, the renminbi, rise in value. Some trading partners insist China is keeping its currency artificially low to give Chinese exporters a competitive advantage.
Beijing contends that raising the value of its currency would hurt coastal factories that operate on thin profit margins, forcing them to lay off millions of workers.
The most immediate challenge appears to be inflation, which some analysts say may be even more serious than the new figures suggest. Housing prices have skyrocketed. And prices for milk, vegetables and other foods have soared this year.
The money supply is too large, said Andy Xie, an economist based in Shanghai who formerly worked at Morgan Stanley. They increased the money supply to stimulate the economy. Now land prices have jumped 20 times in some places, 100 times in others. Inflation is broad-based. Go into a supermarket. Milk is more expensive in China than it is in the U.S.
In Shanghai, where the average monthly wage is about $350, a gallon of milk now costs about $5.50.
Wages have also risen sharply this year in coastal provinces amid reports of labor shortages and worker demands for higher pay. Many analysts expect more wage increases next year.
That may be good for workers, analysts say, but it will also change the dynamics of the Chinese economy and its export sector while contributing to higher inflation.
Beijing is now under pressure to mop up excess liquidity after state banks went on a lending binge during the stimulus program that got under way in early 2009. Analysts say a large portion of that lending was diverted to speculate in the property market.
In addition to restricting lending at the big state banks, Beijing recently moved to close hundreds of underground banks and attempted to restrain local governments from borrowing to build huge infrastructure projects, some of which may be wasteful, according to analysts.
Some economists say the real solution is for Beijing to privatize more industries and let the market play a bigger role. After the financial crisis hit, the state assumed more control over the economy.
Now, state banks and big state-owned companies are reluctant to surrender control over industries where they have monopoly power, analysts say.
Inflation is not the most serious problem, says Xu Xiaonian, a professor of economics at the China Europe International Business School in Shanghai. The most fundamental problem we have to resolve is structural. We need more opening up and reform policies. Look at the state monopolies in education, health care, telecom and entertainment. We need to break those up. We need to create more jobs and make the economy more innovative.
Zhiwu Chen, a professor of finance at Yale, agrees.
The state economy and the local governments will be where the future problems occur, Professor Chen said in an e-mail response to questions on Sunday. They will be the sources of real troubles for the banks and the financial system.
Though no economist is forecasting the end to Chinas decades-long bull run, many have turned more cautious. And Fitch Ratings recently released a study it conducted with the forecasting consultancy Oxford Economics that examined the effect a slowdown in China would have on the rest of the world.
Fitch expects Chinas economy to grow at an annual rate of 8.6 percent next year, down from about 9.7 percent this year. But the report, which was released a few weeks ago, said that if growth slowed to 5 percent, the economies of many other Asian nations would suffer seriously. Steel, energy and manufacturing industries around the world would also be hard hit, it said.
Fitch analysts are careful not to forecast a sharp slowdown in China. But if one comes, they say, it is most likely to stem from a combination of property crash and banking crisis.
