Four challenges facing China in Year of the Dragon

Asia fund managers have warned China’s economy faces a series of challenges despite its meteoric rise to global superpower status.

The country’s rate of growth has prompted the IMF to predict China will overtake the US as the world’s largest economy within five years.

Since the Chinese government relaxed regulation to allow state-owned enterprises to list on stock exchanges in the mid-1990s, growth has averaged 9.5% per year.
However, rapid inflation, tightening monetary policy and a recent slowdown in growth have led investors to question whether China has lost its shine.

Soft or hard landing?

The major talking point over the past year has been whether China will experience a hard landing, which would see government attempts to control inflation also curbing growth.  

Aberdeen Asset Management’s group head of equities Hugh Young expects China will experience a soft landing as GDP growth has gradually fallen from 9.7% in Q1 2011 to 8.9% in Q4.

“Looking at it economically, I think China will experience a soft landing as it has lots of reserves at its disposal, and to experience a hard landing there would have to be a property bubble. I think these fears are overstated, as China has not geared itself up to the hilt,” said Young.

“The danger of a hard landing will intensify if property prices continue to climb, as the wealth effect will be felt on the economy.

“China is just going through a transitional phase, it has had the early stage of a surge of growth and is now focusing on infrastructure to build up the domestic market – but in doing this it will not be an out and out disaster.” Richard Sennitt, manager of Schroder Asian Income fund, is also in the soft landing camp.

He warned the risk of European banks withdrawing credit from Asia has increased, but this will not be enough to drive down the growth rate. “China will have a soft landing as its government has the firepower to help the economy,” added Sennitt.

Excess liquidity

Liquidity is an issue for managers investing in China. First State’s Martin Lau, manager of the top performing First State Greater China Growth fund, said he is concerned about excess liquidity in the property market driving up prices.
In 2008 China introduced a very large stimulus package following the global financial crisis, which has since contributed to rising inflation.