Why Investors Should Remain Cautious of China

China has hit its economic growth target of 7.5%, up from the previous quarter, but Schroders economist Craig Botham says investors should remain vigilant

Schroders Investments 16 July, 2014 | 4:58PM
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This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Craig Botham, Emerging Markets economist at Schroders, comments on why he remains cautious on China.

The downward trajectory of economic growth in China was reversed in the second quarter, as real GDP grew 7.5% year on year, against growth of 7.4% the previous quarter. The small rebound comes on the back of a string of mini-stimulus packages as the government’s rhetoric on growth has changed. While at the start of the year the government seemed to be priming markets for growth below the target of “about” 7.5% growth for 2014, recent months have seen stauncher support for the goal.

Stimulus measures have included targeted cuts to the reserve requirement ratio, relending by the central bank, tax cuts, and most recently changes to the loan-to-deposit ratio calculation designed to incentivise lending to small and medium sized enterprises. The combined impact has been to stabilise most measures of activity, with industrial production, investment, credit growth and exports (also helped by robust European and US demand) all halting their recent declines. Even the property sector managed to taper its rate of decline, which was far less precipitous in the second quarter than in the first.

Looking ahead, the new policy stance would suggest continued mini-stimulus efforts to support growth at current levels. However, we find it difficult to be overly optimistic on this; to us this growth rebound denotes a disappointing volte-face from the government and a retreat on the previous commitment to rebalancing and sustainable growth.

Resorting continuously to credit stimulus will only exacerbate financial fragilities and raises the likelihood of financial crisis in future years. In particular, expanding credit by loosening criteria for the loan to deposit ratio seems guaranteed to lead to a worsening of asset quality, and the move to exclude foreign denominated loans and deposits from the ratio seems tailor-made for generating a currency mismatch problem.

Overall, the strengthening of Chinese growth gives us little cheer, given its roots. The change of tack from policymakers prompts increased misgivings about China’s economic future. It could all too easily be a case of short-term gain, long-term pain.

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Schroders Investments  manages more than £200 billion on behalf of institutional and retail investors, financial institutions and high net worth clients from around the world. 

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