Over-heating China

BS OPINION

According to Morgan Stanley, bank lending to the non-financial sector increased by a staggering 50 per cent between the first quarter of 2002 and the third quarter of the current year. Investment in fixed assets in the first three quarters of the current year is up 31.7 per cent.

Imports are growing at 25 per cent, so that trade with China has been a major source of growth for many economies, including India's. Driven by a combination of foreign investment and massive state spending, the red-hot Chinese economy has been sucking in imports from all over the world, sending commodity prices soaring and lining the pockets of aluminium, steel, iron ore, copper and cotton producers.

Last year, China consumed 21 per cent of the world's traded aluminium, 24 per cent of its zinc, 28 per cent of its iron ore, 17 per cent of its copper and 23 per cent of its stainless steel. The turnaround in the Indian steel sector owes much to Chinese demand.

The Chinese have been building roads, shopping malls, dams, office blocks, residential complexes and Olympic stadia at a furious pace. Real estate prices in the premium office blocks of Shanghai have doubled in a year.

How long can this dream run last? Not very, is becoming the informed view. Many China watchers anticipate a sharp slowdown in that country's economy next year. The investment-to-GDP ratio is reaching unsustainable levels (at last count it was over 42 per cent).

Overcapacity is building up in many industries, as are inventories. Property prices have simply shot up too fast, and prices in general have begun to edge upward. These signs of overheating have worried the Chinese authorities, who have reacted by trying to slow the pace of credit creation, even as the country is likely to slip into a current account deficit some time next year.

The Chinese monetary authorities are also looking for ways to reduce money supply by sterilising part of the FDI inflows. Two months ago, the central bank raised reserve requirements, while lending to commercial property developers was frowned upon.

More recently, the National Development and Reform Commission put in place new restrictions on inward investments, in an attempt to check the addition of new capacities.

Although these measures are yet to have any appreciable effect, the fear is that once the central bank achieves its objective of cooling the economy, Chinese imports will slow down. The great fear is that failure by the authorities to achieve a soft landing may result in a hard landing that means trouble for everyone.

In 1993, for example, China imported 33.5 million tonnes of steel. After the business cycle turned, steel imports fell by a third in 1994, and by another third in 1995. What happens to Chinese demand will be critical for Indian exports in several sectors. Commodity prices too may fall from their peaks, with finished metal prices being the most affected.

The silver lining, however, is that the US economy shows fresh momentum, and the impact of a slowing China may be more than neutralised by American demand. Nevertheless, Indian businesses need to keep a wary eye on the signs of a downturn in China, and trim sails accordingly.