The five threats to China

Crisis? What crisis? Judging from the Chinese government's revelation that it plans to target GDP growth of around 10 per cent in 2010, you wouldn't know there'd recently been a major meltdown in global financial markets. But while it is more than likely that China will post healthy growth levels next year, there are five main threats emerging that investors should be watching carefully, as China tries to keep the precarious balance in an economy threatening to overheat.

China's economy managed to grow by around 8.5 per cent last year, according to preliminary indications from its government. This far exceeded the more bearish forecasts at one time hitting around 6.5 per cent growth for the year. These started to be scaled upwards in the first half of 2009, thanks in part to a massive government stimulus, with the government pulling out all the stops to keep growth ticking over and avoid major economic destabilisation.

Stimulus exit, cooling measures

This year, the goalposts have shifted and the government must focus on a new strategy – balance. To demonstrate how closely the world is watching China's efforts in this regard, you only have to look at the first step, last week, to start the cooling process, which entailed raising the interest rates on three-month treasury bills for the first time in five months.

China's consumer price index rose in November, after almost a year of deflation and heightening concerns that inflation could become a problem should Beijing fail to start tightening monetary policy in coming months.

While the move isn't as severe as increasing the official interest rate on bank loans, which probably won't happen until later this year, it came hot on the heels of a recent warning about inflation by Premier Wen Jiabao, fuelled by property prices, and sent serious jitters through Asian stockmarkets.

The government is only about half-way through its stimulus package, but has reiterated on several occasions its commitment to spend the entire $US173 billion it pledged to spend before the end of 2010. While you cannot leave a railway half built, there are fears that the stimulus isn't being wound back quickly enough.

Stockmarket and property bubble

An emerging property bubble is probably the most pressing threat facing the Chinese economy and one that has been subject to no end of dire warnings and analysis. While the rest of the world suffered from liquidity shortages, China suffered a cash glut, leading to spiralling property values.

In November, property prices grew at their fastest rate in 16 months, up 5.7 per cent year-on-year – though this figure masks a complex market which saw prices double in hot-spots like Beijing and Shanghai in less than four years (see China's house of cards, January 8).

The government is moving to tighten land sale rules for developers, as well as bank lending practices – any Chinese family buying a second home must make a down payment of at least 40 percent. But many say the government isn't acting swiftly or aggressively enough and the bubble is still going to be the number one threat in 2010. Even Zhang Xin, CEO of Soho China, one of the country's leading property developers, has voiced his concern about an emerging property bubble.

Former Morgan Stanley chief economist for Asia Andy Xie says China's property market is heading for one huge bust that will take a year and a half to unfold. He also describes China's asset markets, including the stockmarket, as Ponzi schemes. Morgan Stanley analyst Jerry Lou concurred, writing in a recent note that Chinese stocks are headed for a 'boom and bust' in 2010. "We see a temporary window of high growth and low inflation in the first half of 2010 followed by rising inflation worries in the second half. This means an equity market boom and bust in the same year,” his team writes.

The Chinese stockmarket has long been volatile, influenced by the number jittery retail investors and, some say, a lack of full transparency. But even if you ignore the market as a risk to itself, uncertainty in areas like property are simply adding to its unpredictability, as China's leading property companies, such as China Vanke, take a rough and tumble ride.

If either, or even both, of these bubbles burst in 2010, China's domestic demand growth will take a serious hit. With subdued demand from the US, China is relying on domestic demand to fuel a large component of its growth (see Has China peaked too soon? January 11).

Meanwhile, as Australia breathes a sigh of relief that commodity prices, including copper and iron ore, have seemed to recover some of their lustre, the increased demand for input materials could represent another risk on Chinese soil, with the threat of industrial over-capacity. It is an issue the government has noted on several occasions, moving to stop approving new projects in certain industries and avoiding duplicate construction. It has also tightened credit control and lending practices, being more selective about what projects to fund.


Currency and trade

Bridging the gap between the internal and external risks to China's growth is the debate raging about its currency, the renmenbi (yuan). While China sees the issue of its currency as domestic, international economies are exerting more and more pressure on the Chinese government to remove the yuan's peg and allow the currency to appreciate, even going so far as to say that the manipulation of the currency is at the heart of the imbalances that caused the global financial crisis in the first place. But China remains firm that it must keep the yuan low to ensure demand for its exports – analysts say China will allow appreciation when inflation and export growth revive, which is likely to be in spring 2010.

This has led to a number of diplomatic stoushes and claims of protectionism. Trade disputes at the highest level of the World Trade Organisation are also becoming more heated, with US President Obama making it clear that he has no qualms standing up to China, pushing for the removal of dozens of Chinese subsidies that promote its exports and implementing his own penalties, including a 35 per cent tariff on Chinese-made tyres and a 10 to 16 per cent tariff on steel tubing. Expect more of these disputes in 2010.

Australia's government and business community will be closely watching the outcome of an investigation into Rio Tinto China executive Stern Hu. The Chinese government announced on Monday that it's investigation was complete and referred the case to the Shanghai People's Procuratorate, which will make a final decision as to whether or not Hu and his co-accused will stand trial. While this is of importance to our government and community, there are more pressing matters for China to attend to on the home front.


Carbon reduction

Also likely to be a thorn in the side of China's key relationships is emissions trading and an agreement on international climate change measures. As we saw during Copenhagen, China is prepared to stand up for what it believes is its rights as a developing nation in negotiations and not just play second fiddle to the demands of the US, and this is likely to lead to continuing tension during international negotiations.

However, it is also facing increasing pressure to be more transparent with its own emission numbers and the state of its environment. The FT.com points out that while official guidance sometimes shows pollution is reducing, other sources show that pollution in China's biggest cities is not necessarily showing improvement. The US is likely to start applying pressure this year to sign legally binding agreements on emission reduction.

In a side-bar to these talks, the world is watching green technology development in China, which is being encouraged by the government. The country's 863 Program has been massively expanded in the area of new energy technology research, with the government establishing targets for installing wind turbines, solar panels and hydro-electric dams. And while the world's second largest energy consumer woos oil-rich states like Nigeria to secure energy supplies, it also taking small steps towards fostering development of green energy supplies at home. In December last year the government amended its renewable energy laws to require electricity grid companies to buy all power produced by renewable energy generators.

But there are mixed messages. It was confirmed this week that China's passenger vehicle market ended last year with a 59 per cent year-on-year sales increase to overtake the US as the world's biggest car market. While some say this points to higher emissions, some argue that the more revenue the car companies can secure, the faster the development of affordable hybrid or electric technology.


Social instability

There have been a number of destabilising social movements within the Chinese domestic political landscape, including more protest activity in the energy-rich Xinjiang region, as well as a strengthening of the democracy movement, sparked in part by the imprisonment of the country's leading dissident, Liu Xiaobo, for 11 years, in a trial that took just three hours, despite his pleading not guilty to charges of "inciting subversion". Hong Kong democracy activists have also been more vocal, holding protests and demonstrations.

These are just some of the threats facing China 2010, although many more could emerge and some may ease. While external factors, such as China/US relations are important, both in China's international standing and economically, China's leaders will primarily be looking in their own back yard to maintain the balance it needs.