China: Can the rabbit bound free of the forces of destruction?

There is a Chinese proverb about cunning that runs: "A sly rabbit will have three openings to its den."

Few would argue against the wisdom of having good contingency plans in place, but on the flipside, the saying leaves open the possibility that even the slickest bunny could be caught out by a determined three-prong attack.

And China according to several leading economists is facing just such an onslaught. The attacks come from a shaky Wall Street and slower US economic growth, a tighter domestic money supply and, longer term, developing world cutbacks in investment. This unhappy trio of factors is expected to lead to a significant slowdown in the Chinese economy in 2008-09.

As the new year gets underway with the markets mired in a global credit crunch, the question being asked is whether the Chinese rabbit will be able to shake free from these threats in 2008 and continue to bound forward, or whether it will find itself trapped in a hole.

China is now a crucial part of the world economy even international investment banks such as Morgan Stanley have turned to it for funding in the form of a $5bn (2.5bn) cash injection from sovereign fund the China Investment Corporation. So the reverberations are likely to be felt globally and the signs are not looking good.

At the end of last year, the Asian Development Bank cut China's GDPgrowth forecast to 10.5 per cent from 11.4 per cent in 2007. Several economists, such as Mingchun Sun, senior China economist at Lehman Brothers, go further, predicting that growth in 2008 will drop below double digits for the first time in six years. Mr Sun is forecasting Chinese GDP growth of 9.8 per cent this year.

"If it slips below 8 per cent and I am forecasting 8.8 per cent in the fourth quarter this year that will hit China very hard. There will be a negative output gap that would hit jobs. For China, growth of around 9 per cent is necessary for the economy to remain healthy," says Mr Sun.

Most of the economic fears in the People's Republic spring from concern about the slowdown in growth from its biggest source of demand: America. "While the US may not be China's biggest trading partner now that is Europe by a whisker it is still the lynchpin of the global economy" says Stephen Green, senior economist at Standard Chartered.

"We have already seen export growth to the US from China slow from 35 per cent year-on-year to around 6 per cent. The forecasts for lower growth in China stem from expectations about falling exports." Mr Green adds.

Combined with an expected slowdown in European growth along with domestic measures designed to tighten Chinese banks' lending, rising interest rates and a strengthening currency against the dollar China is heading for some challenging times.

Fears are also growing that slowing exports will pop China's investment bubble.

"So far, global growth and exports have masked the fact that there is severe overcapacity in China. Less exports, and inventory stockpiles could lead to aggressive price cuts, potentially hitting companies' profitability and ability to repay bank loans," says Mr Sun.

By the time China hosts the Olympic Games in August, the boom times within the current economic cycle could just be coming to an end. As China is the world's second-largest economy and, according to the World Trade Organisation, is expected to overtake Germany as the world's largest exporter this year, the global impact is likely to be marked.

Although its stock market had fallen back by around 15 per cent from its peak of 6,124.04 in mid-November, 2007 was still a record for flotations in China.

Chinese companies raised around $100bn through initial public offerings (IPOs), with an estimated $65m raised by A-share listings in Shanghai or Shenzhen and the bulk of the remainder via H-share listings in Hong Kong. By contrast, companies in the world's other hot econ-omy, India, which also enjoyed a record year for IPOs, only raised a combined $7.7bn.

Despite the worries about the global economy, bankers expect a broader range of Chinese companies to try and tap the capital markets this year, after Petro China and China Shenhua Energy raised almost $18bn between them last year. However, they will not find it as easy as it was in 2007.

As reported on Xinhua, the state news agency, the primary task of China's 2008 fiscal pol-icy is "to prevent the economy from becoming overheated and to guard against a shift from structural price rises to evident inflation". Inflationary fears stemming from China's yawning trade surplus (of around $280bn) prompted the central bank to raise interest rates for the sixth time in a year in December. In the previous month, inflation was running at 6.9 per cent, the highest for 11 years.

But if the forecasters are right, lower exports, a smaller trade surplus and a tighter money supply could quickly dampen any inflationary anxiety.

"Although last year there was concern about inflation, let's not forget that not long ago China suffered several years of deflation. If the global slowdown takes hold and there is over-capacity, it is possible we could see deflation again in China in 2009," says Mr Sun.

Last year, one of the biggest inflationary pressures was rocketing pork prices which were up more than 50 per cent at their peak after a disease called Blue Ear devastated herds. Food accounts for more than 30 per cent of China's consumner price index basket the collection of goods that is used to measure prices compared with around 10 per cent for the UK.

"Pork prices fell back quite sharply after October. But they started to climb again at the end of December," says Mr Green.

Property prices have shown an equally runaway tendency, up 30 per cent over the past year in hotspots such as Shanghai.

Soaring asset prices have prompted Beijing's central planners to implement tighter monetary policy, not only by raising interest rates but also by boosting the ratio of reserves that banks must set aside as deposits.

While the Chinese authorities and the People's Bank can do very little to prevent the widely anticipated American or global slowdown, the challenge facing them in 2008 will be to strike the right balance between reining in the econ-omy so it does not overheat, and not pulling back so hard that growth is stopped in its tracks.

As the US splutters, the world is hoping that this is a rabbit China can pull out of its hat.