Asia Economy

‘Perfect storm’ to hit China economy in 2016

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Recent positive data from China may have allayed some doubts about the state of the economy, but PNC Financial Services Group is staying cautious, warning of a "perfect storm" that could surface in two years' time.

"Several problems long on China's back burner are likely to come to a head by 2016," Stuart Hoffman, chief economist at Financial Services Group wrote in a report this week, citing challenges including a weakening credit market, a slowdown in corporate reinvestment of earnings and a correction in the all-important housing market.

These headwinds could slow Chinese real GDP (gross domestic product) growth to around 6.0 percent in 2016, the slowest since 1990, the firm noted.

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China's economy expanded 7.5 percent in the second quarter, a touch above expectations of and rising from 7.4 percent in the first three months of the year, as the government's targeted stimulus measures began to pay off.

The so-called perfect storm could unfold with a dramatic slowdown in the flow of credit for investment, especially from non-traditional lenders like trust companies, as corporate credit quality deteriorates, the report said.

"If trust credit does indeed dry up, Chinese borrowers will struggle to roll over their loans and could be pushed into default, throwing even more sand into the gears of financial intermediation," Hoffman said.

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Reduced credit would then reinforce a sharp slowdown in capital expenditures, PNC said, noting that spending in labor-intensive manufacturing sector has already slowed amid rising labor costs and an appreciating currency.

"And Chinese private businesses with idle funds are unable to invest in more attractive opportunities in the domestically-oriented service sector [because] regulatory barriers protect state-owned business from private competition," he added.

Housing sector on shaky ground

Any major correction in the country's housing market, an important pillar of the economy which affects more than 40 other sectors, could exacerbate events, PNC adds.

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Already, the signs are pointing to a softening sector. In June, average new home prices in China's 70 major cities fell 0.5 percent on a month-to-month basis, marking their second consecutive monthly drop after May's 0.2 percent decline, according to Reuters calculations based on data issued by the National Bureau of Statistics.

"China's real estate and construction sectors are sagging as falling prices discourage housing construction and purchases," said Hoffman. "The real estate correction will likely continue and reinforce a slowdown in general business investment."

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Citigroup has warned that average selling prices in the physical market could fall around 20 percent in tier one and two cities and 30 percent in tier three and four from their levels at the end of 2013.

Slowdown will be managed

To be sure, no everyone's equally bearish. John Zhu, China economist at HSBC doesn't foresee a dramatic deceleration to 6-percent growth levels.

"A lot of economic analysis tries to extrapolate micro-level analysis to the macro-level. There are so many other variables and policy levers that could be pulled," said Zhu, who expects growth will hover above 7 percent over the next couple of years.

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Infrastructure investment by the government or private sector will likely offset the drag from a slowdown in housing construction, he said.

"There's a lot of useful infrastructure that is still needed in China, from railroads to elderly care facilities," he said.

In addition, as the recovery in U.S. and Europe gains traction, demand for China's exports will continue to strengthen, he said. China's exports have been gaining steam in the past few months, rising 7.2 percent in June after 7 percent rise in May.