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China Strong Long Term

Fund managers give mixed reviews on China's short-term prospects but say problems are surmountable.

Sunny Ng, 11/30/2011

It's amazing how much things have changed. To be sure, the days of believing that China's robust economic growth and rock-solid fiscal position could bail out the economies in the West are clearly over. Morningstar equity analyst Daniel Rohr tackled the big picture of the problems associated with China's economic imbalances. Runaway inflation, a looming real estate and credit bubble, the shadow banking system, and rapidly declining exports are just some of the problems we think might plague the Chinese economy.

Headwinds

Scarier terms have rarely been associated with a single country:

Runaway Inflation
Inflation for August remained stubbornly higher than the targeted 4% for the year, coming in at 6.1%. The inflation rate has been on an upward trajectory since 2010. In particular, there is a fear that a vicious cycle of wages chasing prices and prices chasing wages will push prices ever higher.

Property Bubble
Driven by the rapidly growing middle class and population urbanization, Chinese property prices have risen by more than 140% since 2007 and as much as 800% in some major cities. Affordability, as measured by price to income, is five times the international average.

Shadow Banking System
In an effort to curb inflation and rein in credit, the People's Bank of China has raised reserve requirements seven times since January 2010 and imposed a quota on new lending by the banks (CNY 7.5 trillion; $1.18 trillion). These policies have limited regulated lending to all but the largest and most creditworthy companies. They've also created a host of unregulated lenders reportedly charging exorbitant rates up to 5% per month to smaller companies looking for credit. Some estimate the size of the shadow banking industry to be CNY 15 trillion ($2.4 trillion).

Declining Exports
The most obvious threat to the Chinese economy are declining exports fueled by the poor economic climate in Europe and the United States, wage inflation in China, and the upward pressure on the yuan (albeit only slightly because of strict government currency and capital controls).

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