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Study: Chinese Economy Heading Toward Downturn

China’s surging economy is due for a slowdown or an outright crash from an investment bubble fueling the country’s phenomenal growth.

SAN FRANCISCO — China’s surging economy is due for a slowdown or an outright crash from an investment bubble fueling the country’s phenomenal growth, according to the conclusions of a report released Wednesday by the UCLA Anderson Forecast.

This story first appeared in the December 9, 2011 issue of WWD.  Subscribe Today.

“Both scenarios are equally likely,” according to the report’s author, economist William Yu.

China’s economic imbalance can be measured by how investment growth accounts for 56 percent of the country’s economic growth, in contrast to the 40 percent seen as tipping points in earlier economic booms gone bust elsewhere in Asia over the last two decades, according to the report.

While investment engenders economic growth, too much of it raises the risk of loans going unpaid when a slowdown occurs, threatening a domino effect throughout China’s economy.

This could happen with a potential downturn in demand for Chinese exports, a key component of the country’s economy and employment base, led by sales from the European Union and U.S.

“With the ongoing European debt crisis and the bleak U.S. employment market, it is hard to predict that these two major markets will have a favorable appetite for Chinese export goods in the near future. A lukewarm export market will directly hamper China’s GDP growth,” Yu said.

Investment in China’s fixed assets includes financing of manufacturing — accounting for 34 percent of total investment — and real estate, equaling 25 percent, the report said.

Underpinning these investments are low-cost loans that have fueled China’s growth as it’s transitioned from an economy of state-owned enterprises. Aside from bank loans, private loans have grown in popularity, such as letters of credit, which are excluded from corporate balance sheets to avoid government rules and scrutiny.

There’s also been an escalation in real estate prices, another bubble that threatens loan repayment and a slowdown of China’s overheated economy, which has led the world by growing at an average annual rate of 8.6 percent over the last 30 years. In contrast, the U.S. has seen annual growth of 1.6 percent, typical of developed countries.

However, Yu notes that a real estate crash wouldn’t be widespread but rather more likely would affect developers, as opposed to consumers whose residential mortgages require large down payments.

On the other hand, consumer consumption in the nation of 1.5 billion people can’t be relied on to counter an economic slowdown, since their savings rate is 52 percent of GDP, in contrast to the U.S., where it’s 11.2 percent.

Likewise, the Chinese are frugal consumers in good and bad economic times, as they husband money since there isn’t a social safety net to fall back on like unemployment insurance or welfare. Additionally, with consumer credit in short supply, it takes time to save for big-ticket items, Yu said.

With such an economic equation facing China, “depressed consumption and overinvestment is not a sustainable way to grow an economy,” Yu concludes.

Todd Lee, senior director in global economics for IHS Global Insight, agreed with the Anderson Forecast report that it’s difficult to predict how the Chinese economy will unfold.

“For the first time, China is facing a potential scenario where the economy is getting squeezed externally and domestically,” he said.

“The question is whether or not the crisis in the EU will escalate to the degree the financial crisis in the U.S. escalated in 2008 and dragged down the whole global economy,” Lee said. “If that doesn’t happen, Chinese exports can still muddle through.”

While Chinese consumers will continue their unwavering but modest consumption in a mild economic slowdown, “if there is a hard landing, you are looking at a concurrent real estate collapse and banking crisis,” he said. “It’s highly unlikely consumption will hold up in that scenario.”