Hamish McRae: When you look at China all you see is growth, but a bumpy road lies ahead

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The Independent Online

The annual Davos symposium – that extravagant annual meeting of business leaders, politicians and academics in the Swiss resort – has a younger sibling. It starts today in the Chinese port city of Dalian. But, rather than collect together the heads of the world's largest companies, it seeks to bring together those from the fastest-growing.

Such a meeting could, in theory, take place anywhere but it is happening in the world's fastest-growing country, China, and in what I am told is China's fastest-growing city. Dalian is a pretty place, a commercial centre but also a seaside resort and, if having this new "summer Davos" happen here does nothing else, it will at least open the eyes of the visitors to China's astounding growth story.

That story – growth running at more than 11 per cent, the economy about to pass Germany in size – has been told so often that it is now widely appreciated. But what I, at least, had not appreciated until the past few days is the extent to which China seems immune, at least so far, from the financial woes that have rumbled away elsewhere in the world. You might expect, after five years of the fastest global growth ever experienced, that it would be the fastest chunks of the world economy that would show most signs of strain.

There are indeed some signs of strain in China but this does not seem to have shown through in the financial markets. In the past few weeks, while markets around the world were shuddering, the Shanghai stock exchange has been hitting new highs. This raises an intriguing question. Will China take over from the US as the global economic locomotive, helping to sustain this long expansion, or is there some sort of financial bubble a-brewing in China that will eventually have to be pricked?

One obvious pressure gauge of strain is inflation, and here the warning light is flashing amber. Inflation in China is running at more than 5 per cent, with most of the increase coming from food prices, which is particularly painful for the urban poor. However, it is not clear how much this reflects a rise in global commodity and energy prices, how much it is the effect of environmental problems (China has suffered a lot from flash floods) and how much it is one-offs, such a disease affecting pigs that has pushed up the price of pork by 75 per cent from what it was a year ago.

The pessimist could argue that global energy and commodity prices are in fair measure the result of the surge in Chinese demand and are likely to rise further. The optimist would point to the fact that inflation for most items has remained subdued and that monetary growth has remained quite modest (see first graph). Insofar as monetary growth is a causal factor in inflation, it has now become quite restrictive.

There have been four increases in interest rates this year, with more expected. At any rate, inflation will almost certainly fall in the coming months – the issue being whether it will fall enough to set fears at rest. The government is, understandably, very concerned and there are rumours that it might impose price controls. If it did, it would be troubling: better to let inflationary forces out in the open because you know what you are dealing with, rather than try to conceal them. Actually, I would be more concerned about the surge in asset prices than the rise in inflation. Beijing, at least, is witnessing a property boom that beats the British one hollow. Flat-buyers in the capital talk of prices doubling within two years, despite a huge surge in the supply of new homes and a mortgage regime which requires a one-third deposit. At least China does not have a consumer debt problem, because having a credit card is still considered unusual. Where the bubble, if it is indeed one, is most evident is in share prices. The two Chinese markets – the main one in Shanghai and the more speculative one in Shenzhen – have not been affected by recent events. Let us focus on Shanghai, for it is in the process of transforming itself from a tiny market trading a handful of pretty odd shares into a market reflecting China's economy. We are in the very early stages of mass privatisation, with the first state-owned companies gradually being floated on to the public markets. Three of the four large state-owned banks now have quotes – but they are quoted in Hong Kong, where there is an established market, rather than Shanghai.

Meanwhile, their shares have shot up. China Construction Bank, for example, is trading at double its float price. The company is reportedly about to launch on Shanghai too, which will be a transforming experience.

Indeed, if things go ahead as reported, it will raise about $7.5 bn, which will be the second-largest share sale in the world this year. Think about that: a share sale in still-communist mainland China will be the world's second-largest. That is a measure of the shift of financial power the world is now seeing. You can get a feeling for the rationale for floating in Shanghai in the last two graphs. Using the conventional price-earnings measure, Shanghai is pretty expensive (Shenzhen has been all over the place). Global markets trade in the teens. All right, profits are growing massively in China, and you could rationally justify a higher rating than more established markets, but p/e ratios of 40 plus are reminiscent of the dotcom boom. We know what happened then. It is also striking how steady the rise in Shanghai has been when compared with the more bumpy performance of Hong Kong, as shown in the final graph.

One way of putting this is that, rationally, there should be no contagion between the US sub-prime fallout and what is happening to share prices in China. Another way of putting it would be to say that Hong Kong reflects experience of global markets, whereas Shanghai does not. Either way, it is a no-brainer for a gigantic Chinese bank to choose Shanghai as the place to float its next tranche of stock.

The broader point here is that the shift of financial power is taking place very quickly. There may well be a financial bump (let's not call it a crash) on the way. You could say that there needs to be because, otherwise, Chinese investors will start to believe, like their Japanese neighbours did in the late 1980s, that markets went only one way. That would truly end in tears.

But, having spent a week now travelling round China, it is hard not to believe that the economy has so much momentum that it will be able to push through the next downturn in reasonable shape. Some way in the future, China will become a normal economy. But, as the leaders of these growth companies gather in Dalian, all they see is growth. You can understand investors, particularly inexperienced ones, thinking pretty much the same way.