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Monday, October 13, 2003

China: The Speeding Bullet?

Eddie's weekly Straits Times column. This week its the China syndrome, going up, or coming down with a bang? Eddie plumps for the former:

ASIAN stock markets are booming, finally. Since the end of May, the Nikkei and the Straits Times Index have both soared by 28 per cent. Hope abounds that their economies will follow. And yet, Asia's fastest-growing economy finds its own stock market in a slump. The Shanghai Composite Index has slipped 13 per cent since May, even though China's economy is expected to grow 8 per cent this year.

Chinese investors are learning the stock market truism: What goes up inevitably comes tumbling down. Chinese stocks have sky-high valuations and dubious disclosure. As one investor told Reuters: 'What's the point in buying any more? You might as well say goodbye to your money. It's frightening.'She added: 'Isn't it ironic that the economy is doing so well and stocks so badly?' Irony indeed. The Chinese economy just eclipsed the United States as the world's top destination for foreign direct investment, pulling in US$52.7 billion (S$91.4 billion) last year. This year, China became the largest trading partner of Japan and South Korea.

But perhaps the economy is growing too quickly. As a senior Chinese minister warned two months ago, the world's fastest-growing economy is in danger of overheating as expansion outstrips power supplies, threatens production quality and raises the risk of oversupply. Mr Ma Kai, the minister for national development, told China Daily: 'If it is not cooled, the investment fever in some industries will affect China's robust economic growth heavily. 'Financial authorities have also warned of a real estate bubble. Since China introduced home mortgages in 1998, the property sector has taken off rapidly. Both new projects and sales have risen by 24 per cent a year in terms of square metres, or three times the GDP growth.

Mr Andy Xie, economist at Morgan Stanley, estimates that the property sector has accounted for at least a fifth of China's growth since 1998. By the end of this year, Mr Xie reckons, 1.2 billion sq m of property could be under construction, financed by 2.3 trillion yuan (S$487 billion) worth of loans. He warns: 'If the property sector were to grow three times as fast as the GDP for a further two years, this could cause a financial crisis.' The government signalled its intention to rein in credit growth when the central bank raised the reserve requirement on bank deposits to 7 per cent from 6 per cent a month ago.

Investors are understandably nervous: Everybody knows the economy is being driven on a faulty engine, but the fear of rising unemployment deters the government from stopping for repairs. Hence the economy careens at breakneck speed. As economics professor Hu Angang of Tsinghua University told the Financial Times two weeks ago, 'sustainability is the key issue now'. China surely needs banking reform if its economic engine is to work better. The core of its banking problems is the lack of market mechanisms to allocate resources efficiently.

One consequence is that excessive credit formation in China tends to lead to more deflation rather than inflation, as it stems from excessive investment rather than consumption. In the meantime, officials are still grappling with a mountain of bad debts. Officials say non-performing loans in the banking system account for just over 20 per cent of total loans, but independent observers such as Standard & Poor put the figure at 45 per cent of GDP. The Chinese are making a start. But progress is at a snail's pace. Over the next few months, Chinese financial institutions plan to put up about US$6 billion in non-performing assets for sale: hardly earth-shattering when compared with an estimated US$375 billion to US$750 billion worth of problem loans sitting in the big four state banks.

This week brings another reminder that the road ahead looks very long indeed. A landmark scheme that would have opened the Hong Kong stock market to mainland investors looks likely to be postponed, probably until next year. The concern is that opening the Hong Kong market would divert funds away from Shanghai's languishing bourse. Still, China is a large economy, and looks destined to grow. In a way, there's no great mystery about it: economic growth has historically come from utilising excess population. In the case of the US, it was derived from Europe's surplus population. In China, it's from the masses that people the interior and the coastal towns. Investments follow from an enormous catch-up potential.

The head of a well-known European company told ChinaBiz that he would spend 'the remainder of (his) career closing factories in Europe, and opening new ones in China'. The North American customers of a well-respected European engineering company now require them to manufacture 30 per cent of their output in China, and to benchmark the remainder against Chinese prices. For China, there is enough growth in the pipeline to absorb a few glitches.

Take housing in Beijing for example. The Business Times reported last week that there is some overheating in mid-range housing projects, such as one in eastern Beijing which is finding it hard to market its second phase because there are plenty of choices for homebuyers. But even as this project is having difficulty attracting buyers, down on the fourth ring road, Beijing residents queued patiently overnight for seven days for a chance to buy low-cost flats. Mr Xie thinks that if the government manages to deftly cool some of the overheated investments, investors could become even more enthusiastic about China, and a larger investment cycle might follow, leading up to 2008 when China hosts the Olympics. I would bet on Mr Xie being right. With the Western and Japanese economies limping along, China is increasingly playing an important dual role as both market and low-cost supplier. It would be good news for all if the Chinese can steer their speeding bullet.
Source: Eddie Lee, Straits Times

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