Delivering Alpha 2011

Is China Headed for a Crash? Not Yet, Say Observers

Alex Frew McMillan, Special to

China continues to post some of the fastest rates of growth in the world. But even that may not be enough to prevent the world’s second-largest economy from running into trouble. A nation that has raced forward with double-digit gains in gross domestic product in recent years now threatens to shift into neutral, economists say.

The prospect of a hard landing is what concerns many China watchers. Though most say that’s not imminent, it’s a definite risk as global growth shudders to a halt, with demand for China’s exports likely to fall.

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“There will be some viable concerns about China drifting towards what would be considered stalling speed,” Joseph Lau, the senior Asia economist at Société Générale, says. “Like an aircraft, the risk is that it doesn’t go fast enough, and crashes, resulting in a hard landing.”

The country will likely risk verging into that territory over the next couple of years. Lau anticipates growth moderating to 7 percent to 8 percent in that period, after growing at an adjusted 10.3 percent last year, according to the International Monetary Fund (IMF). “As you drift towards 7 percent in the next year, that will raise those risk concerns,” he says.

Many countries would be thrilled with that kind of growth, but with millions of people moving from the countryside to the cities each year even that level might not match the demand for new jobs.

Lau is more pessimistic than most. He says the rate of growth would need to keep above 6 percent to avoid such a crash. Anything lower than that would result in what Lau calls a “positive-growth recession.” Although the country would be posting economic growth, it wouldn’t be enough to sustain a nation that is undergoing serious structural changes as it matures.

The irony is that the slowdown in growth may spell good news for China’s economy in the long run. It is partly a product of the nation shifting away from rapid export-driven growth to a more mature industry makeup that’s based on domestic consumption.

“That fast growth creates other structural imbalances,” Lau says. “A more moderate pace of growth would help shift away from inefficient resource allocation or overcapacity to more productive areas. It will be healthy. It won’t seem healthy in the next year or two, but in five or 10 years it will definitely be positive for the structure of the economy.”

China is not slowing at anywhere near the rate that people expect over the longer term.
Senior Economist, Commerzbank
Ashley Davies

The IMF continues to predict strong growth of around 9.5 percent per year through 2016, and other economists are more optimistic about China’s prospects. Ashley Davies, the senior economist for emerging markets in Asia at Commerzbank, has raised his forecast for 2011 growth to 9.2 percent, from an initial 8.7 percent, after a strong start to the year.

“China is not slowing at anywhere near the rate that people expect over the longer term,” Davies says. “The question is when do you reach that turning point when the economy does slow substantially?”

He believes Beijing, with $3 trillion in foreign currency reserves, still has the firepower to boost growth if necessary.

That ability could be constrained by China's dramatic response to the global financial crisis, when the country rolled out a massive, 4 trillion yuan ($627 billion) stimulus package. That stimulus sent the economy into overdrive, and fueled credit and capacity excesses that Beijing is now trying to address. “They can’t take their foot off the throat of the economy,” Davies says.

“The West is suffering from the “pushing on a string” argument—if people don’t borrow you’re not going to get growth. But in China if you increase lending it’s taken up very quickly,” he said.

Still, rising wages and the consistent appreciation of the Chinese currency have spelled bad news for equities. Chinese stocks have underperformed for some time, with the MSCI China index essentially flat over the last three years, showing an average annual gain of just 0.04 percent. They’re down 11.2 percent over the last year, through late August, one of the worst emerging-market performances as concerns emerged that local governments were overburdened with debt.

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Estimates of the size of local debt range from the official 10.7 trillion yuan to an unofficial figure of 14 trillion yuan. With more than half that debt due to mature by the end of next year, Beijing will need to restructure local debt and prevent a major bank default, HSBC chief economist for greater China Qu Hongbin wrote in a report in August.

But the problem is still manageable, Qu believes, with total government debt in China still at just over half of GDP. That’s considerably lower than the developed world and most emerging countries.

Beijing’s continued credit tightening and higher interest rates will curb growth, but aren’t destroying it, the economist believes. “Bottom line: growth in China is moderating, not collapsing,” Qu wrote in a report on the country’s manufacturing figures, which showed a slight pickup in August over July. “Inflation, not growth, remains the top near-term macro risk for policy makers.”

With such big-picture concerns, though, stock analysts have deeply divergent views on which way the Chinese market is headed. John Tang, the China strategist at UBS, has said that Chinese stocks could still plunge to their 2008 lows, which would imply another drop of 25 percent to 30 percent.

But other market watchers have suggested China could be a bargain or even a safe haven.

“Our macro call on the Chinese economy is that it will have a ‘sluggish landing’ due to the over-investment and over-extension of credit in the past few years,” a team of Credit Suisse analysts wrote in a market briefing on Aug. 9. “So, growth will be relatively subdued but not really a ‘hard landing.’ So investors should consider some bottom-fishing at the current level.”

How reliable are the numbers?

Shanghai A shares had only an 8 percent potential downside, compared to their 2008 lows, Credit Suisse concluded. Price-to-book ratios have corrected 30 to 40 percent in China since 2009, compared with only a 20 percent correction in Hong Kong, where shares also have a significant downside of 15 to 20 percent.

Vincent Chan, a research analyst and one of the authors of the report, notes that the strong growth of last decade also created inefficiencies that are now being corrected.

“Strong export growth helped drive a lot of excess capacity in China as well,” he says. With both credit and investment tougher to come by, “the likelihood is that the growth of China will weaken—the old growth model is more difficult to sustain.”

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Chan notes that official GDP figures are not reliable, with China not following the international standards of breaking down GDP by expenditure. He also calls the official unemployment figures “useless” since the jobless rate always hovers around 4.5 percent, whatever the condition of the economy.

But he believes moderately slower growth will not threaten China too much. Although some China watchers have suggested growth below 8 percent could lead to social unrest, he doesn’t think that’s too much of a risk. 

“The country’s level of tolerance for lower growth has become higher—I think that’s pretty important,” he says. “Growth was a much more important variable five to 10 years ago. Now you don’t really have an unemployment problem, so slowing growth will have a lesser impact.”

And even at a slower pace in the next decade, any growth is good when the developed world is in turmoil and moving sideways at best.

“It is likely that China will slow, but at a rate that is enviable for other countries,” Davies says.