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Why China's Growth May Slow

Can China navigate around short-term obstacles to growth?

Bearemy Glaser, 07/14/2011

We got news this week that China's blistering growth rate slowed slightly in the first quarter of the year. The Chinese economy "only" expanded 9.5% in the first quarter, down from 9.7% during the last quarter of 2010. Given the developed rest of the world's seeming inability to grow at all, these numbers remain impressive. Indeed, many are hoping that the expanding emerging-markets countries (notably China) will help keep the global economy going as austerity and slow growth become the buzzwords in the west. But are these hopes for endless growth justified?

The long-term growth prospects for China are notable as the country carves out an enormous new middle class and begins shifting from a low-value-added export-driven economy to one that serves domestic consumption and tries to move higher up the value chain. But I think in the short and medium term there are real risks of a slowdown in Chinese growth. Here are a few things that could short-circuit the economy.

Inflation

The rapid expansion of the Chinese economy has gone hand in hand with a rapid expansion in price levels. According to official statistics, inflation currently sits at 6.4% with food prices pushing higher the fastest. And it's quite possible that inflation is running even higher than the official government statistics show.

Getting inflation under control is going to be very difficult without slowing down the broader economy. The Chinese government has repeatedly raised the reserve requirements for banks and hiked interest rates in an attempt to rein in lending and tap the breaks on the economy. This is a delicate maneuver, however. Tightening up monetary policy too fast could make it hard for businesses seeking access to capital for expansion purposes, and leaving policy too fast could let inflation get out of control, threatening the underlying strength of the economy.

So far, the government has erred on the side of letting inflation run at a contained but reasonably fast level. It isn't inconceivable that policymakers will get this balance wrong and that the economy could slump because of it.

Housing Bubble?
One of the questions that has been the trickiest to nail down is if China is experiencing a housing bubble that is on the verge of popping. Housing prices have certainly risen at a very impressive clip during the last few years, particularly in the major cities. Home prices that defy gravity naturally conjure up comparisons to those in Ireland or the United States, where housing prices seemingly could never fall, until they did in spectacular fashion.

There are a few things to keep in mind about housing in China. First, lending standards are much tighter than they are in developed countries. Would-be homeowners have to put a tremendous amount of money down, and loan terms aren't overly generous. Secondly, there are restrictions on buying second homes or speculating in properties, so most units are actually owner-occupied. You also have to consider that there is real growth in wealth and the middle class that is driving up demand for these homes in desirable areas.

Bearish markets editor Bearemy Glaser is the worry-prone alter-ego of markets editor Jeremy Glaser. Each week, Bearemy will share what's topping his list of concerns and invites you to reply or add your own in the comments section below.

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