What Puts China's Growth at Stake? - Analyst Blog

The International Monetary Fund has reduced its forecasts for China's growth to 7.75% for this year. Speaking at a press briefing in Beijing on Wednesday, first deputy manager of the IMF David Lipton said the IMF was revising its initial forecast of 8% downwards. This initial forecast was released in April along with predictions for an 8.2% increase for 2014.

The writing has been on the wall for some time now. Last week, the "flash" HSBC Purchasing Manager's Index for May slumped to a seven-month low. Not only did the figure come in below expectations, this was the first time that the flash PMI index declined below 50 since October. This is a matter of deep concern for the nation, since a level below 50 indicates that the manufacturing sector is contracting.

Though official PMI data is to be released tomorrow, there have been several indications for some time now that the economy is slowing down. The economy expanded by 7.7% in the first quarter, falling behind the 7.9% recorded in the last quarter of 2012-13.

And now after the PMI numbers, leading investment bank economists have also been forced to reduce their estimates. To add to the gloom, the Organisation for Economic Co-operation and Development has also reduced its growth estimates for China from 8.5% to 7.8%.

The "flash" PMI report caused substantial turmoil across international markets. Most significantly affected was Japan, the Nikkei dropping 7.3% to close at 14,483.98. It was only natural that China ETFs felt the heat as well. The iShares FTSE China 25 Index Fund ( FXI ) dipped over 1% last Thursday. The ETF had fallen below its 50-day and 200-day simple moving averages as well.

The majority of China ETFs had started the year on a low note, despite the fact that they are attractively valued. ETFs with attractive valuations include the iShares FTSE China 25 Index Fund and the SPDR S&P China ( GXC ). More focussed options in this segment include the Guggenheim China Small-Cap ( HAO ) and the Guggenheim China Technology ( CQQQ ). Both of them have turned in impressive performances, outpacing the iShares FTSE China 25 Index.

The primary culprit seems to be slowing exports due to the economic situation in Europe and the U.S. This is being compounded by the lack of sufficient domestic demand, which was cited as the OECD as the rationale behind reducing its estimates. One of the reasons why domestic demand has declined is because there is now an effort to reduce government spending in many areas.

In fact, the IMF has said that China should make sustained efforts to reduce its social financing. Total social financing amounts to 7.9 trillion yuan ($1.27 trillion) for the first quarter compared to around 4.9 trillion yuan for the same period last year, which is a substantial increase. In April, the former commerce minister said that the country's general government debt had crossed the 30 trillion yuan mark, nearly $4.85 trillion.

Government debt has now increased to nearly 50% of GDP, though the international lending agency feels that it is still under control. Lipton said that the deficit was still manageable since part of it was managed through land sales and "augmented" debt was at manageable levels. Even so, it was necessary to bring down the level of deficit over time so that deficit levels were sustainable.

However, many market watchers believe that a lower level of growth may not be a completely negative development. This could give the country an opportunity to increase domestic demand in order to decrease its dependence on exports. Additionally, economic disparities have increased sharply, leading to fears of possible social unrest.

In any case China has already adopted monetary policy as its primary tool to spur on growth. Interest rates remain low, with little chances of them going up in the future. However, the country runs the risk of overheating the economy by giving rise to asset bubbles. This is why the IMF has urged the nation to aggressively pursue reforms. This could happen only through further liberalisation of financial markets, leading to more efficient allocation of resources.

President Xi Jinping has also spoken about the risk to the country's environment due to unbridled growth. Urbanisation and strident economic reforms are important steps which the nation seeks to undertake. What direction the current dispensation wishes to take will go a long way in determining the economic future of the world's second largest economy.

GUGG-CHINA TEC (CQQQ): ETF Research Reports

ISHARS-FT CH25 (FXI): ETF Research Reports

SPDR-SP CHINA (GXC): ETF Research Reports

GUGG-CHINA SC (HAO): ETF Research Reports

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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