FOR INVESTORS FOLLOWING the China story, Sars is now a fading memory. Their fears that the People's Republic's economy would be knocked sideways by the virus have proved unfounded. GDP growth this year is back on track and will break through the 8% barrier again. Other figures for the year to July are equally impressive. Exports are up 34%, investment in fixed assets jumped 32%, foreign investment has risen 34%, and both bank loans and money supply have risen by 20%.
It would seem that after briefly slowing in the spring, China's economy is now once again at full tilt.
But such impressive numbers are themselves causing concern. Instead of doctors whipping out their thermometers every few minutes, it's now economists who are checking for signs of overheating. Some believe that in certain sectors China could be a bubble waiting to pop. Eddie Wong, ABN Amro's chief strategist for Asia, is in this camp. "This is an over-investment bubble. And I think it's a fairly serious one," he says
Others are uneasy in a vaguer way. They are sure there is trouble ahead, but not too sure exactly where. Dong Tao, CSFB's chief economist for Asia, says: "This is not a normal overheating so there's a big debate about whether the economy is overheating or not. My argument is that you can check the body temperature but just because that may be normal doesn't mean that everything is fine. The best indication is investment and credit growth, and on that score I believe China has already entered a phase of overheating."
Optimists point to the consumer price index, which shows an inflation rate of just 0.5%, as a sign that everything is fine and under control. But more fearful economists reckon they are ignoring other vital information. As Tao says, the CPI is not the best indicator of whether China is about to boil over. "The CPI is heavily weighted by food because two-thirds of the population lives in the rural sector. But it's not an adequate benchmark given that two-thirds of activity is in the industrial sector."
Another reason, Tao believes, why the problem may be hidden is because investment rather than demand is driving the economy. "It's creating new capacity, which will lead to price wars and lower prices," he says. "And this is where the problem is. If it's not handled well, we will see another round of non-performing loans."
China's banking sector is already burdened by a non-performing loan ratio of over 40%, and it's not clear how many more bad assets the banking sector can bear before its back breaks. "Every industry seems to be over-invested and there will be a crunch at some time," says Tom Byrne, a sovereign analyst with Moody's Investors Service. "But at the moment it will just add more to the government debt."
A reprise of the Asia crisis?
The figures are enough to cause alarm in the Chinese establishment. The country's leaders are only too aware of the problems that arise when bubbles burst. As one economist says: "We last saw what is happening in China in the rest of Asia in 1997. And the Chinese economy may go that way too. There are tremendous domestic imbalances and too much investment in crummy assets. There will be a crash, the money will go pouring out and you have a reprise of the Asia crisis."
Ma Gai, minister for the state development and reform commission, last month warned that if things are "not cooled the investment fever in some industries will affect China's robust economic growth".
The industries that Gai was alluding to include steel, iron, building materials and the auto sector.
Iron has experienced a spike in investment of 130% in the first six months of this year alone. In the auto sector investment is set to double over the next two years and car production had already rocketed by 83% year on year to June 2003. Steel received an extra 21% injection of capital.
China's progression from communist economy has demanded strong pro-growth policies for the past 20 years. Now the country is spewing out exports so fast that it would seem that any slack from the possible oversupply that Gai talks about would soon be taken up overseas anyway, especially if the US economy recovers.
It's a premise that Wong of ABN Amro wholly rejects. "China now invests more than 42% of its GDP into fixed-asset investments," he says. "And it's totally wrong to assume that just because China is believed to be the world factory they can afford this capacity ratio and will export the excess."
He notes that last year's foreign direct investment was an impressive $50 billion, but points out that this was only 10% of China's $500 billion of fixed-asset investment. And if FDI for asset acquisition is discounted, FDI accounted for just 4% of the $500 billion that went into capacity investment. Yet foreigners still accounted for 52% of the country's exports.
Hong says: "No matter how inefficient the investment is, total domestic investment that's related to exports is no more than 10%. [So] 96% of fixed-asset investment is done by locals and 90% of that fixed-asset investment is not related to exports. And while domestic consumption is growing it still only accounts for 45% of the GDP."
That, says Wong, is not enough to soak up oversupply. "There is a lot of talk about why China can have such a high investment ratio. But we have heard it many times in Asia. We heard that they could have current account deficits of 10% and investment ratios of 40% without causing problems, but then the Asia crisis came."
For now, though, the problems seem distant. If China continues this type of investment, demand will, in the short term, also remain strong. After all, the Chinese need a lot of steel to build steel plants. "But," says Wong, "once the steel plants are finished, the demand will disappear. And problems like this, if they don't solve them, will be big. The problem is that there is no guarantee that it's not too late."