China's rapidly expanding role as the prime driver of global economic growth implies that continued policy inertia in Beijing, or missteps, would pose a major risk to global economic and financial stability. That means that all businesses in the developed world, whether directly trading with or investing in China or not, will be impacted by China’s performance in 2008/09 and beyond.

Business Monitor International's newly published Special Report, China - What If We’re All Wrong? evaluates the key risks posed over the next five years to China's economic growth and social stability by environmental degradation, banking sector vulnerability and food and asset price inflation. In particular, we highlight the asymmetries of China’s current exchange rate policy, and the manner in which these exacerbate key downside risks. This discussion is set against BMI’s assessment of political stability in the event of a hard landing, and our 5-year independent macroeconomic forecasts, in turn underpinned by our global assumptions for world growth, investment and trade.

BMI's China View

While we are retaining our positive headline growth projections for China to 2012, based on the continued process of urbanisation and China’s export-driven growth model, China – What If We’re All Wrong shows how the Chinese authorities, and particular their currency policy, are facing gathering headwinds.

To anticipate what lies in store for the yuan, we used our in-house econometric model to forecast the impact of the monetary policy options avaiable to the Chinese authorities for currency revaluation or appreciation on economic growth, the trade account, inflation and interest rates. We explain in the Report why the potential shock to GDP growth of an unexpected one-off revaluation strongly implies the authorities will avoid this course of action in favour of a sustained appreciation, in line with the pace of gains since Q4/07. (See below for further extracts from the Report.)

CONTENTS

Chapter 1 - China: What If We're All Wrong?

  • The Risk Trilemma: Banking Sector, Environment, Inflation
  • Currency Policy At The Core
    • Chart: Merchandise Trade, US$bn
  • The Banks
  • The Environment
  • Price Pressures: Agflation
    • Chart: CPI (% change y-o-y)
  • Where Next For The Yuan?
  • What About Inflation?
    • Chart: Exchange Rate Scenarios, CNY/US$
    • Chart: Inflation Scenarios, % chg y-o-y
    • Chart: Real GDP Growth Scenarios, % chg y-o-y
    • Chart: Loan-Dposit Ratio (%)
  • Regulatory Obstacles Impede Long-Term
  • Pragmatic Approach To Skills Transfer
    • Chart: Correlation Between Deposit Loan Growth And Shanghai Composite
    • Chart: Non-Performing Loan Ratios (%)
    • Chart: Rural Deposits (as a proportion of total and household deposits, %)
  • Second-Tier Banks Hold Untapped Potential
  • Environment: Weak Link In Economy
  • Air: Coal Power Is The Main Offender
  • Water: Too Little, Too Toxic
    • Chart: China - Car Ownership Figures
    • Chart: China - Urbanisation Patterns, 1950-2030
  • Land: From Agriculture To Cities
  • Health Consequences Could Stymie Labour Force
  • Centre-Periphery Rivalry Hampers Solutions
  • China Facing Rising International Criticism
  • Some Possible Solutions
  • Clear Downside Risks To Growth
    • Chart: Baltic Dry Index And Shanghai Composite Index

Chapter 2 - The Political Implications Of A Hard Landing

  • Slowdown Would Trigger More Unrest Rising Discontent
  • Unrest Would Exacerbate Intra-Elite Schisms Left Turn
    • Chart: China - Incidents Of Unrest
    • Chart: China - Leading 'New Left' Intellectuals
  • The 'D' Word

Chapter 3 – GDP Data Highlights External/Domestic Trade Off

  • Focus Still On Inflation
    • Chart: Real GDP (change % y–o–y)
    • Chart: Baltic Dry Index And Shanghai Composite Index
    • Chart: Consumer Price Inflation (% change y–o–y) & Producer Price Inflation (% change y–o–y)

Chapter 4 – Global Assumptions – Q2 2008

  • Global Outlook
  • Down But Not Out In 2008
    • Chart: Global – Real GDP Forecasts (%)
  • United States
  • The 'R' Word Comes Into Play
    • Chart: US – Real GDP Growth
  • The US's Medium–Term Prospects
  • Europe
  • Strong Euro Will Sting Exporterts
    • Chart: US – Unemployment & Private Sector Earnings (inverted)
    • Chart: US – Initial Jobless Claims ('000s) and 2s–10s UST Spread
  • Japan
  • Economy To Weaken In 2008
  • Weaker Global Economy May Weigh On Exports
    • Chart: Exchange Rate – US$/EUR
    • Chart: Japan – Quarterly Real GDP Growth (% chg, annualised rate)
  • Japan's Medium–Term Prospects
  • China
  • Momentum To Slow Only Gradually
    • Chart: Japan – Central Gov't Debt, Outstanding Bonds & Borrowings
    • Chart: Consumer Price Inflation (% change y–o–y) And Producer Price Inflation (% change y–o–y)
  • Commodities
  • Oil – Crude Will Remain Costly
    • Chart: Exchange Rate, CNY/US$
  • Metals – Base Metals To Move Steadily Lower
  • Risks To Outlook
  • Agricultural Commodities
  • Grain Complex To Buoy Softs
    • Chart: Brent Crude Oil (US$/bbl)
    • Chart: Goldman Sachs Industrial Metals Index
  • Supply Shocks
    • Chart: Corn – USc/bsh (top) & soy – USc/bsh (bottom)
    • Chart: Goldman Sachs Agricultural Index
  • Risks To Outlook
    • Chart: Domestic Usage Of US Corn (millions of bushels)

Key Benefits of the Report to your business

  1. Use BMI's 5-year independent macroeconomic forecast to benchmark other public and private sector views of China's growth outlook through end-2012
  2. Identify and evaluate adverse political and economic trends in China, to facilitate risk mitigation strategies
  3. Assess critical shortcomings of China's business environment that pose hidden barriers and costs to corporate profitability
  4. Evaluate external threats to doing business in China, including currency volatility, the commodity price boom and protectionist policies

Extracts from China - What If We're All Wrong?

The environment is a major threat to growth, stability and international standing - BMI believes that China is now reaching a tipping point, whereby deterioration in the quality of life is starting to undermine the economic benefits of fast expansion. We assess the likelihood of the authorities failing to take concerted action over environmental degradation, and the consequences for social unrest. Does the legitimacy of the Chinese Communist Party (CCP), which rests on delivering rapid economic growth, inevitably condemn China to continued environmental degradation? We examine the main environmental offenders, including coal, water, and the impact of urbanisation on land, and the broader problem of center-periphery relations (the failure of Beijing to rein in local authorities and runaway growth).

The banking sector is vulnerable to a shock - Once considered the Achilles heel of the economy, China’s banking sector has made remarkable progress in recent years. However, if robust GDP growth and profit growth were to slow, the wide deposit/lending rate spread narrow, or if the equity market underwent a sustained correction, the negative impact on a fragile banking sector could seriously complicate economic reform efforts. Given this reality, how able are the authorities to further liberalise banking regulations, and expand the current undersized pool of management talent and financial expertise?

We also highlight business opportunities in the banking sector: owing to the cost of foreign banks entering China’s banking sector, foreign banks must compete in areas such as quality, service and expertise (such as the rapidly growing and lucrative wealth management industry); since limited skilled labour is drawn to high salaries in the bigger banks, the second-tier smaller banks present an opportunity for foreign investors.

There is an urgent need to diversify capital markets - We show how the lack of depth in Chinese capital markets is contributing to equity volatility, as the lack of alternatives to depositing money with a bank leaves domestic savers with little option beside the stock market - hence the 99.2% gain in 2007 in the Shanghai Composite Index (SCI). Continuing tight regulations and state control over the sector, combined with a shortage of skilled labour, preclude any overnight solution, and the need for diversification of banking products will therefore remain a major downside risk in the financial sector.

Agflation is threatening China’s food stability - Income growth and changing food consumption patterns (meat demand is surging), urbanisation and reduction in farmland have combined to push food prices to dangerous levels, while domestic supply and productivity improvements cannot keep up.

BMI's Affiliates and Partners in Asia

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