CHINA: OVERINVESTMENT AND DOWNSIDE RISK

INVESTMENT OVERHANG SPELLS TROUBLE FOR CHINA

Persistently high levels of investment are producing diminishing returns and may signal a correction.

Nick Ferguson

Finance Asia, February 5, 2013

You can’t keep a good China bull down. After a brief flirtation with notions of a hard landing, the conventional wisdom now has it that China is poised to resume its inexorable rise to global superpower.

It is not entirely clear why the mood has changed. China has a new deck of leaders, as nobody could have failed to notice, but they are hardly very different from the old ones — and, in the meantime, the country’s other problems haven’t gone away.

Questionable accounting, unaffordable housing, tainted food and corrupt officials are all proving hard to resolve. There is also the small issue of Beijing’s hazardous “fog”, which has become a very visible example of a negative externality. But all these problems would fade into insignificance if China’s tentative recovery were to falter.

There are reasons to fear that may be the case. China continues to run the highest investment-to-GDP ratio in the world and, despite the cooling effects of the global financial crisis, its economy may be suffering from a serious investment overhang.

Indeed, Standard & Poor’s estimates that China’s overinvestment poses a downside risk of $800 billion. The rating agency has conducted a study of investment levels in 32 countries in the run-up to two crises — the Asian financial crisis and the most recent global financial crisis — and concludes that China is at the highest risk of an investment-induced correction.

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