A new look at the Chinese economy

chinese economyAs one of the world’s most populous nations, it is hardly surprising that China is a global economic force. 

The Chinese economy was certainly growing at a phenomenal rate in the last decade, as much as 12% per annum according to some observers. But things are no longer going as smoothly as Beijing may have planned.

China’s growth is built on debt. The price of its growth it has been debt ballooning to almost 250% of gross domestic product (GDP).

A debt crisis

Internally, China is seeing a debt crisis, with business defaults and bankruptcies, low industrial profits, and a slowdown in the real estate sector. There is only so much the country’s big state owned banks can do to continue to prop up the economy.

China’s credit rating has been downgraded by Standard & Poor’s amid fears rising debts are adding to economic and financial risks. Admittedly, the downgrade was just one notch, from AA- to A+. China is still on the same level as countries such as the United States and Austria, but any downgrade marks international concern, chiefly at the way the total debt quadrupled to £22trillion by the end of last year.

What is going on?

It looks as though China has become trapped in a dangerous economic cycle.

The Chinese economy growth has been fueled by a demand for low cost exports, and readily available credit. When external demand weakened because of the financial crisis ten years ago, the initial spur to growth faltered.

The Chinese government pumped in credit, and strong growth resumed, only to fall again for a few months. This cheap credit has become the answer every time there is another drop in demand from overseas, or even an internal crisis – such as a loss of confidence in the country’s property market and construction industries, or as in 2015 when the Chinese Stock markets crashed, twice.

Standard & Poor’s pointed to the prolonged credit growth as one of the key reasons for the credit rating cut. While it has contributed to strong growth and higher asset prices the ratings experts believe it is now leading to diminished financial stability.

Things could be set to get even more difficult for China.

During his campaign, Presidential Trump pledged a 45% tax on all Chinese products. Though he shows no signs on following through on the pledge, even targeted tariffs on specific goods could do real damage to China’s economy.

The other and even more frightening threat is that of North Korea. If war comes, the influx of refugees across the border alone could further destabilise China, quite apart from the cost of any military involvement.

Why this all matters

If the Chinese bubble bursts, the impact would affect different regions in different ways. In countries dependent on commodity exports to China, a reduction in demand could have a negative impact on GDP.

On the other hand, the fall in commodity prices could be beneficial, for other countries that import commodities, such as the United States and Europe.

But any slowdown could affect the global economy as a whole. China has been the single largest contributor to global economic growth over the last decade, according to the IMF, contributing 31% on average between 2010 and 2013. A weakening of the Yuan would remove one of the factors powering growth and could even prompt global deflation.

Positioning portfolios for a slowdown

If you have international investments, you may want to look at ways to brace them against a slowdown in China’s economy. Reducing your exposure to commodities would be one step you might want to consider. You might also want to ensure that your portfolio is properly diversified, with holdings in stable economies like the United States and regions like Europe.

To discuss any aspect of international or domestic investment please call the experts at Continuum.

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