Should investors be worried by China’s slow down?

24th May 2012

"Downward pressure on the economy is increasing," the government said in a statement issued after a cabinet meeting led by Premier Wen Jiabao. It added: "We must proactively take policies and measures to expand demand and to create a favourable policy environment for stable and relatively fast economic growth."

A slow down in China

There can be little doubt that Chinese growth is slowing. The export sector, one of the biggest drivers of growth, has been hurt by falling global demand and Chinese manufacturing contracted in May, according to the HSBC Purchasing Managers' Index. As such, theoretically, talk of stimulus should be welcomed by markets. Growth from any major power can help to counterbalance the weakness coming from the Eurozone and China's strength was certainly contributory to the (albeit anaemic) recovery from the crisis in 2008.

But it is not quite so clear cut. The credit expansion in China has been worrying investors for some time. Fitch recently issued a warning on the pressures facing Chinese banks. The report points out that China has experienced a credit boom since 2008 and highlights a number of pressures now emerging in the country's banking system.

The number of non-performing loans (NPLs) and special-mention loans reported by banks has been rising since the fourth quarter of 2011, Fitch says. The size of these problematic loans is low but "vastly understated", the group adds.

At the heart of this is the weakness in the property sector. A recent report by the rating agencies found strains in funding and sales: "China's property developers face rising risks of default, according to the latest stress tests conducted by Moody's and Standard & Poor's. The two rating agencies published reports on Thursday that suggest the sector will continue to deteriorate over the coming months because of falling sales volumes and dwindling funding options."

The Lewis Turning Point

A number of high profile commentators have argued that China is subject to a phenomenon called 'the Lewis Turning Point', identified by Arthur Lewis in the 1970s from research done on the economic history of Japan. This is when wage inflation starts to rise and countries start to lose their competitiveness. As this report in the Guardian shows, the central bank is aware of the dangers: "As the Lewis turning point approaches, domestic labour supply is tightening and the price of labour-intensive agricultural products, the service industry, and resource-based products will tend to rise further," the bank said, referring to a stage in a country's economic development when the economy fully absorbs rural surplus labour that keeps wages from rising. As demand climbs, it will drive a resurgence in prices. Moreover, imported inflationary pressures due to international commodity price volatility still exist."

Many believe that China is over-expanding credit in an attempt to maintain impossibly high long term growth rates. Any further stimulus would only exacerbate this problem.

Is 'anti-China' really a contrarian view?

The positive for investors is that the risks in China are now being widely discussed. Although being 'anti-China' may still be against the grain, it is no longer a niche view. James Weir, Asia investment specialist at Guinness Asset Management believes that the risks may have been overplayed. He believes that there are always casualties in a growing economy and Chinese growth should continue to tick along at around 8%.

"If you look at the scale of what is happening in China, there is a danger that people don't see the wood for the trees. 1bn mobile phones were sold last year, more cars than in the US. The Government is trying to drive a middle course. For the time being, it has tightened monetary policy and the policies it put in place have worked. it has had a V-shaped recovery. The issues with the property market are not really new…there is a strong demand for new housing and they are trying to meet it."

He suggests that it might be a good thing if a number of property developers went bust, taking excess capacity out of the market. He also points out that the last two years have not been great for Chinese equities, so there doesn't appear to be any significant 'exuberance' in the market. He adds: "Sometimes people have a tin ear in relation to China. The Government has said for some time that growth will slow to 7-8%, yet most economists are still predicting higher rates."

At the moment, the details of any stimulus are only lightly-formed, but if there was a significant expansion in credit, it may be worrying for investors in the region. However, the worries around China are already being widely discussed and, as such, any weakness may already be in asset prices.

 

More on Mindful Money:

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Will Japan collapse under its public sector debts?

Infographic: How China Manipulates Its Currency

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The Financialist

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