With the US economy in trouble, everyone’s looking to China to deliver the world from its economic woes. But like the US in 2007, China may find itself grappling with a burst bubble.
Global investors in the last few months have embraced China: No less an investing guru than Burton Malkiel showered praise on its economy in an interview this month. With a $586 billion stimulus launched in the middle of a worldwide recession last year, an equity index that climbed at least 75% this year, and growth at 7.1% in the first half of 2009, the Middle Kingdom invited the world’s envy.
Illustration: Jayachandran / Mint
That envy may soon turn into apprehension, with China’s central bank finally admitting this week what economists have known for some time: that inflation is a danger. Stock markets in Shanghai and Hong Kong fell heavily on Wednesday.
But how could a bubble arise in the middle of a slowdown? That’s easy, if the reaction to the slowdown is unprecedented fiscal and monetary expansion.
First, China has been digging its own grave. It is not the only country on a spending binge, but most of the money winds up in construction, manufacturing or, reportedly, in stock market speculation. So China continues to privilege investment over consumption, leading to excess capacity. Add to that the $1 trillion-odd banks have lent this year and, presto, you get asset bubbles.
Second, central banks and governments worldwide have primed their pumps that, among other things, have contributed to a resurge in commodity prices. China’s central bank has noted that much of the inflation is imported.
Third, the same investors who have been attracted to China as a stable source of profits may be making its monetary conditions unstable. Foreign exchange reserves crossed $2 trillion this month, mostly owing to “hot money” or short-term capital. We can’t exactly tell what happens to this “hot money” when it enters China, but surely a lot of it finds its way into, say, real estate stocks. What’s Chinese for “subprime”?
Reports this week suggest banks may start to limit lending. They may start showing more non-performing assets, too, while the liquidity in the system dramatically decreases.
Investors are bound to realize this sooner than later, if they haven’t done so already. That will mean portfolio capital leaving China, hungry for another destination. And whom should this capital find right around the corner but India, possibly stoking a similar bubble? It will be interesting to see how Indian regulators and policymakers respond then.
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