While it may look to the world as if the growth of the eastern giant's economy is unstoppable, there are mounting concerns, says Heather Stewart
Barely a week goes by without yet another stunning fact from the Chinese economy. Last Friday brought news that despite spending billions on the world's largest fiscal stimulus package to help escape the global downturn, China's vast foreign exchange reserves shot up by another 23% in 2009, to a stunning $2.4tn (£1.4tn) – almost twice the GDP of the UK. Official figures this week are expected to show that while the rest of the world was struggling to emerge from recession, Chinese growth was running at a rampant annual rate of more than 10% in the final three months of the year.
With China barely breaking stride during the Great Crash, and set to surpass sickly Japan as the world's second-largest economy by the end of 2010, it would be easy to see the turmoil of the past two years as setting the seal on the inexorable rise to dominance of the eastern giant.
However, dark clouds are gathering on the horizon. First, there are mounting fears over China's dramatic bounce-back – bubbles are inflating in the stock market and housing that could burst, with catastrophic results.
Capital controls protecting the currency from a financial exodus mean it's hard for domestic investors to send their surplus funds abroad – so with banks directed to pump up lending, cheap cash is pushing up asset prices at home. Bank lending in December was more than 95% higher than a year earlier, according to the People's Bank of China.
"Ample liquidity and capital controls, having protected China from the worst of the global financial crisis, now threaten economic and financial stability," said Ben Simpfendorfer of RBS in a note last week. "Investors are searching for yield, but are limited in their choices. Higher inflation and the state council's reluctance to raise interest rates may only accelerate the rush into equities, property, and, increasingly, into repackaged loans."
The Chinese authorities are well aware of the risk of a bubble, and have taken a series of steps in recent weeks, including increasing banks' reserve requirements, to try and cool things down. "They've got very scared that they can't control it," says Mark Williams, senior China economist at consultancy Capital Economics.
With China battling to secure enough raw materials to feed roaring growth, inflation is also a considerable risk, and analysts believe the authorities will raise interest rates by the end of this year to prevent it running out of control – though with rates so low in the battered western economies, that risks attracting an unwanted influx of foreign funds. "These problems are big, they're real," says Gerard Lyons, the chief economist at Standard Chartered, who travels to China regularly.
Second, even if fears about financial and economic instability prove unfounded, there are political obstacles on China's path to permanent prosperity.
Google's contretemps with the Chinese government last week underlined the fact that Beijing has achieved its extraordinary economic rise without playing by the west's rules. But the spat over business ethics is likely to be dwarfed in the coming years by the bubbling tension over China's trading relationship with the US and Europe.
Williams, of Capital Economics, believes that China will escape the risks of overheating or out-of-control inflation, but that its growth will create increasing political confrontation. "It's obviously good if incomes are going up; that's good for hundreds of millions of peasants, you can't begrudge that – but it's throwing up all these challenges; there's a lot of frictions," he says.
Even before the credit crunch, congressmen in America's rust-belt states blamed China for "currency manipulation" – fixing the yuan at an artificially low exchange rate against the dollar, so that it could benefit from cut-price exports, and get a leg up the world economic league tables.
Now, with the Asian recovery in full swing, exports of goods from China are exploding, stealing market share from the traditional manufucturing powerhouses of Germany and Japan, both countries desperate to use their traditional export-led growth model to restore their economies to health.
There have already been a series of protectionist moves against China since the downturn began. The US has invoked World Trade Organisation rules to slap tariffs on Chinese tyres, paper and steel products; the EU has done the same to exports of aluminium wheels and steel products, as their producers struggle to compete with the Chinese juggernaut. The chorus grows ever louder from politicians around the world calling for Beijing to allow the yuan to appreciate. Japan and the eurozone in particular are likely to feel that China is growing at their expense.
Not every analyst agrees that the right solution for China is to float its currency, cross its fingers and hope for the best. Its enormous trade surpluses and mountainous foreign exchange reserves partly result from weak demand at home – because Chinese consumers save so much of their income, around 35%.
That forces the government to keep exports surging ahead to maintain rapid economic growth, and avoid the social and political crisis that could result if the economy slowed down and millions of jobs were lost. Solving that problem and generating domestic-driven growth could arguably do as much to tackle the "global imbalances" of vast surpluses in China and deficits in the US, as a depreciation.
Stephen Roach, chairman of Morgan Stanley, Asia, backs Beijing's insistence that the best way to tackle its sickly consumer demand is not to unleash the forces of the foreign exchange markets on the yuan, but to use domestic policy. The Chinese authorities have recently announced plans to improve social safety nets, so that families don't feel the need to salt so much of their income away for a rainy day, and switch spending from shiny new construction projects that may never be occupied, to education and health.
"There is good reason to believe that China gets it – and is about to take dramatic steps in rebalancing its domestic economy in a fashion that would provide a sustained and meaningful reduction in its current account surplus," Roach says.
Qu Hongbin, HSBC's China economist, agrees that what he calls "China's New Deal" will help to boost consumer spending, so the country can continue expanding without overheating. "We believe the jump in government spending on the social safety net, combined with surging consumer credit, will encourage consumers to loosen their purse-strings and lower their savings rate by five percentage points over the next three years," he says.
Lyons says: "If you're going to pick an economy that's going to come out of this well, it's China – but if anyone thinks it's going to be a smooth path, with no bumps along the way, they're wrong. The west has to realise there's a business cycle in China."
Copyright Speakers Corner 2016