Latest News Illustrates Riskiness of Chinese Investments

“Calling the Trend” Column, by George Leong, B. Comm.

The Shanghai Composite Index fell 3.45% on Tuesday after news that the China Banking Regulatory Commission had warned the domestic Chinese banks to shore up their capital adequacy requirements or face fines. This is a warning flag. The reality is that China has been on a superlative growth path over the last decade, driven largely by government support and easy access to capital. The Chinese banking sector has been long rumored to be facing some issues and this news validates it. Make no mistake about it, as the risk is high. Bank failures in China could spook stock markets not only in China, but also overseas, as it would threaten the stability of the country’s banking system and dampen the chances of a strong recovery.

You can be rest assured that the Chinese regulators will deal with this potential problem, as the last thing they would want is a collapse of the banking system, like what we have seen in the United States. The threat in China is not the same as the problems in the U.S., which were largely driven by speculation and greed, along with mistakes. Increasing the capital requirement is not major problem and can be dealt with.

Yet, at the end of the day, no matter how you look at it, China is one of the top major growth areas for investors looking for opportunities to make profits. If you were to visit any one of the tier-one cities, like Beijing or Shanghai, you’d immediately notice an astounding amount of development. The growth is also quickly spreading to the tier-two cities that are smaller but have above-average business growth.

The World Bank recently increased its economic growth forecast for China in 2009 to 8.4% versus the previous 7.2% estimate in June. The increase was attributed to the company’s major economic stimulus plan that has helped to drive infrastructure spending across the country and build more capacity. China’s GDP growth is predicted to rise to 8.7% in 2010 by the World Bank. Yet the World Bank also said that sustainable growth will need to be driven by “more emphasis on consumption and services and less on investment and industry.” This makes sense. Traditionally, the Chinese are savers, but for the country to grow, consumers will need to increase their spending habits. Only about 20% of China’s GDP is due to consumer spending, versus about 70% in the U.S. As consumers spend more, it will help to drive economic growth.

The country’s President, Hu Jintao, wants to increase the country’s domestic consumption and cut its dependence on exports. Think about it; China currently needs buyers for its goods, otherwise growth suffers. The U.S. has been a major trading partner, but the decline in consumer spending has reduced the demand for Chinese- made goods. So what you have are plants with excess capacity and that are idling waiting for foreign demand to rebound. This is dangerous and is a key reason why the country wants to boost its domestic consumption of Chinese goods. Longer-term, this will help China in its pursuit to become a dominant world economic power.