Asia Economy

China's still growing, but fears are rising that it won't last

Kyle Bass: China must recapitalize its banking system

China delivered growth right in line with estimates at 6.7 percent for the third quarter, suggesting that the government's fiscal stimulus continues to support the world's second-largest economy.

But the growth also heightens worries around the government's spending habits and raises questions as to how long officials can continue to allocate large sums of capital into the economy to sustain these growth rates.

The International Monetary Fund recently warned that China's debt problem is becoming unsustainable and should be addressed sooner rather than later by Beijing. China's debt to GDP ratio is at 250 percent.

"Growing levels of Chinese debt are one of the biggest risks to our mostly positive outlook," said Sameer Samana, global quantitative strategist at the Wells Fargo Investment Institute. "The most recent numbers on aggregate financing and new yuan loans were 24 percent and 22 percent above consensus estimates, which shows that policymakers are still choosing debt-fueled growth over reforms and that is unsustainable because it creates a lot of excess capacity and inefficient growth,"

Influential hedge fund managers also have been voicing their concern around China's debt problem. Hayman Capital's Kyle Bass told CNBC's "Power Lunch" that he wasn't confident in China's growth story specifically when it pertained to the country's banking system.

Investors talk in front of an electronic board showing stock informations at a brokerage house in Kaifeng, Henan Province.
China Daily | Reuters

"They have to recapitalize their banking system ... what I'm saying is you have to be very careful studying how fast and how recklessly they built their assets," Bass said.

Distressed investors have been looking at China's banks and the nonperforming loans they are sitting on as a potential investment opportunity, sources told CNBC.

"Unfortunately, it all comes back to timing and when this will become a larger issue and how it will be resolved, and it may be less of a short-term issue than a long-term issue," Samana said. "I think there is some hope on the part of investors that with the in-line [GDP] report last night, they will get some breathing room to go back to enacting reforms, but we'll have to wait and see if they follow through on that."

One sector that has benefited from China's large stimulus efforts is the property industry, which makes up about 15 percent of China's GDP.

Home sales have been rising due in part to this larger migration from smaller cities to metropolitan cities that offer better pay and more promising opportunities. But the good times may be ending.

"The government is now seeking to shift down a gear in the property market," said Duncan Wrigley, head of research at NSBO. "Home sales are expected to slow after over 20 cities tightened home sales policy, in terms of mortgage terms and restricting the maximum number of properties each individual can buy. Developers will keep building the properties that they have already sold off-plan (as the majority of home sales in China are). But this points to a drag on growth going into 2017."

Despite worries about China's growth story, emerging markets have been outperforming this year. The MSCI Emerging Markets Index is up 17 percent in 2016 while the Shanghai composite is down 12 percent during the same time frame.

Whether EMs can continue to recover may depend on China's ability to rebound.

Capital Economics is not confident in these markets rallying writing to clients "there are growing risks of a downturn in China in the medium term."