Eight Big Risks in China

01/24/2008 12:00 am EST

Focus: GLOBAL

Carlton Delfeld

Editor, The La Jolla Letter and Pacific Gains

Carlton Delfeld, editor of Chartwell Advisor Global ETF Report, says investors need to understand the potential down side of the Chinese economic miracle.

Before you get too carried away with the China growth story, take a quick look at the liability side of China's balance sheet:

1. Valuation Risk. Many companies listed on the Shanghai market but appear to be trading at 50x-plus multiples to earnings. In addition, a significant percentage of Chinese companies' profits are from investments in other Chinese bubble stocks. This reminds me of Japan in the late 1980s before it imploded.

2. Banking/Credit Risk. No one really knows the extent and depth of China's debt problem. Suffice it to say that $1 trillion is probably at the low end of possible scenarios. We won't know until the Chinese economy slows down a bit and the problem loans surface.

3. Resource Price Risk. China's economy is heavily dependent on imported natural resources. As the price of these resources escalates, it could lead to acute shortages, extreme inflationary pressures, and an economic slowdown. 

4. Taiwan Risk.  For the leadership of the Chinese Communist Party, Taiwan is a constant irritant and most likely an obsession for some hard-line factions determined to bring Taiwan back into the fold of the motherland. With the Taiwan presidential election, tensions may ease but the risk will remain significant.  (The Kuomintang party, which favors closer ties with Beijing, won by a landslide in recent parliamentary elections -Editor.)

5. Trading Partner Risk. Given China's persistent bilateral trade imbalances, it would not be surprising if several of its trading partners unilaterally imposed quotas or other trade restrictive manners. If these sort of measures spread, it would have a sizable impact on China's economic growth.

6. Inflation Risk. Chinese inflation reached an 11-year high of 6.9% in November, a level that will harden Beijing's resolve to tighten monetary policy and probably further delay energy price reform. The annual inflation rate is driven primarily by food prices, which rose by 18.2% from a year earlier. These numbers are disconcerting, especially since China has lifted interest rates five times and reserve ratios ten times this year, with little impact on the pace of economic growth or inflation.

7. Beijing Olympics Risk. Many analysts see the summer games in Beijing as a big positive, but what if things go wrong? The pollution problem is attracting more media attention (and the government has announced stringent limits on traffic in Beijing during the Games-Editor). Another issue is the spotlight on the hundreds of local protests that occur each month but for the most part are kept out of the press.

8. Political Risk. Some investors favor China over India, because they believe that its authoritarian government can get things done without a lot of debate. The reality is that the central government is not as much in charge as it appears: there is considerable tension and disagreement which simmers just below the surface. If economic growth should slow, these fissures will move to the forefront.

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