Chinese Bubble Hard Landing Possible in A Few Years

Gene Linn  |

Hong Kong stocks rebounded strongly on Friday because the U.S. dollar softened due to below expectation economic figures that were released. The blue chip Hang Seng Index jumped 1% or 217 pts, closing at 23,118 pts. Energy stocks and cement stocks led the rally.

Petrochina (0857:HK) surged 4%. Its parent company will raise its equity interests in A share by 2% in coming 12 months. Coal sector gained 2.5%. The preliminary draft of the industry’s “Five-Year Plan” was announced. Central government plans to develop coal mines in the Western region intensively. Cement stocks also rose 3.3%. Investors are optimistic on cement demand driven by construction of economy houses. In addition, the elimination of outdated production facilities would contain market supply. Lenovo (0992:HK) advanced 5.3% as the company’s 4Q bottom line beat market expectation.

Today, I will give you my long-term view on China’s economic development. I am sure many of you have read about a possible hard-landing scenario of the Chinese economy written by many world renowned economists. I agree to their view points, a hard landing is not unimaginable, but timing is extremely hard to gauge. I tend to believe that it will not happen in the next 1-2 years, later rather than sooner.

The cause is easy to identify, the relentless pursuit of economic development has created magnificent short-term results in the expenses of long-term benefits. Social discontent is at the highest today as in the past decade. Wealth gap is widening at an alarming rate and lower-income group enjoys little of the economic achievement.

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Property prices in large cities are well beyond the affordability of the ordinary people, many of the apartments were sold a few years ago but remain unoccupied today. Price of a 100 sq m apartment in Beijing has soared by 4 - 5 times in the last 10 year, while wages of a managerial grade worker have only risen by 2.5 – 3.5 times. “Real demand” is not that large considering the low affordability but “investment demand” is huge given the lack of other investment tools and the rich people have to find ways to park their money.

I might sound pessimistic but I think this is reality. When, and if, the “crash” happens one day, this may not be a bad thing at all, this will actually clear away excess capacities, change the way people (especially the leaders) look at things, and set the country on a more “correct” path for growth.

I believe the impact will be tractable as the middle- and upper-income classes constitute only c.25% of total population, the lower-income class has nothing to lose. Recovery will certainly be swifter than many developed countries. Yet, it is only realistic to assume that 3-4 years of recuperation period is necessary. I am reasonably confident in the long-term, but mid-term China does face the risk of a hard-landing.

Chinese leaders do have the capability to limit the negative impact of such crash if they carry out effective reforms duly. But do not expect any drastic reform will be introduced in the next 1-2 years.

Existing leaders will retire and successors will take their offices in November 2012. There are only 18 months left and surely not enough time for any new reform to implement. Existing government will tend to maintain status quo and may fine tune economic policies without any major changes. In conclusion, I think a major correction is possible a few years down the road but long-term prospect remains fairly optimistic.

Benny Wong, head of research at a Hong Kong-based Chinese company, is on leave today. His associate, Albert Yip, contributed this comment.

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