China is trying to keep ‘three plates spinning’ on growth argues Neptune

7th May 2014

Exposure to China is unlikely to be a winning strategy over the next few quarters given the extent of the challenges facing the country argues James Dowey, investment director & chief economist at Neptune Investment Management.

Mr Dowey says although exposure to the Chinese economy can be tactically profitable during short periods of relief in sentiment, it is unlikely to be a winning strategy over the coming quarters.

He lists the three challenges below

1.       First, it is trying to manage the legacy of its credit boom from 2009 to 2012. This means containing the effects of rising default rates on the economy by absorbing losses where necessary.

2.       Second, it is undergoing a major liberalisation of the financial system. This means radically overhauling the credit supply mechanism so that credit is allocated by market mechanisms at market prices, rather than under government quota and preference. Crucially, the rise of market based credit supply channels must not occur under conditions of excessive moral hazard, which would lead to a market under-pricing of risk. Therefore, regarding the first spinning plate, the government must be wise enough to identify where it is absolutely necessary for it to absorb losses associated with bad lending during the past five years and where, in contrast, it should let market discipline prevail.

3.       Third, since the economic growth rate in China is strongly determined by the growth of credit, via its role in fixed asset investment, the first two plates must be tended to without allowing any major discontinuity in the rate of credit growth. This is a political imperative because the government has staked its reputation on sustained growth.

He adds: “Can China keep all three plates in the air? In short, although our view is that China’s chances of avoiding a serious disruption are better than the bears think, there is no way that these issues can be resolved and anxieties eased quickly. From here, China’s financial system must pass the test of time.”

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