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GM! Lombard Research: ‘China overheating’, warns economist

19 July 2010 | By Adam Lewis

Lombard Street Research, an economics consultancy, has dismissed the threat of a house price bubble in China but warns the economy is overheating substantially.

Diana Choyleva, an economist at Lombard, warns in the firm’s latest Monthly Review, that at some point over the coming year China’s expansion is likely to be cut short. It is likely to be restrained by cyclical barriers amid a sizable relapse of global growth.

“The longer the economy continues to boom and inflation is left unchecked, the worse the necessary growth correction is set to be”
“The longer the economy continues to boom and inflation is left unchecked, the worse the necessary growth correction is set to be,” Choyleva warns.

She says: “With the level of output in China well above its trend level, real output growth actually needs to go sufficiently below trend to close the positive output gap and get rid of the overheating.

“On our estimates real quarterly GDP growth was above trend at 5.2% in Q2 or an annualised rate of 22.4%, which further fuelled the economy’s overheating.”

With overheating being the main policy challenge for China at present, Choyleva argues the Chinese authorities are likely to attempt managing inflation expectations by “massaging” the official data.

However, she says “the longer they refrain from restraining China’s red hot economy, the worse the necessary growth correction would be.” She adds: “The more inflation expectations get out of control the harder it will be for the People’s Bank of China to rein in inflation.”

Despite the threat of the economy overheating and the knock-on affect it will have on slowing growth, Choyleva argues that China does not have a property bubble growing.

“A bubble is underpinned by an excessive accumulation of debt vis-à-vis both the ability to service the debt and wealth,” she says. “The surge in Chinese demand for property has been driven by investment motives.

“China’s ultra-easy monetary conditions helped spur it on. But on our estimates, 40% of the properties bought in 2009 were being financed entirely with savings, not borrowed money. This, and the fact that mortgage debt is such a low share of output, makes it difficult to argue that China’s housing market is a bubble.”

http://www.fundstrategy.co.uk/markets/asia/%E2%80%98china-overheating%E2%80%99-warns-economist/1015389.article