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China puts the brakes on credit-driven growth

Slower economic growth in China means less demand for raw materials from Canada.


China's growth strategy is exhausted, its economy headed for a markedly slower pace.

Trade numbers released Wednesday suggest a downshift in growth while policy makers pull off an eventual shift to consumer-driven activity.

Exports, expected to climb at a year-over-year pace of 3.7 per cent in June, instead fell 3.1 per cent. And imports, projected to rise by 6 per cent, slipped 0.7 per cent.

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It is now safe to conclude that the bull-vs.-bear debate has been won by the skeptics. A shift is under way that will mean less credit-driven, infrastructure-based economic growth in China and, by extension, slower growth for countries such as Australia and Canada that have previously benefited from China's expansion.

China's central government is now taking concrete steps to limit credit growth and the unprecedented infrastructure development that underpinned the country's three-decade-long growth miracle.

Growth is set to slow as a result, limiting demand for commodities that have driven Canadian resource stocks higher.

Economists have taken note of China's new growth path and were fast to trim their forecasts for economic expansion next year to 7.6 per cent.

Capital Economics, for example, forecasts gross domestic product will grow 7 to 7.5 per cent this year and again in 2014, with a decline to 6.5 per cent in 2015, sharply lower than the double-digit pace before the financial crisis and a scenario it describes as "relatively optimistic" at that.

Barclays Bank PLC recently warned of the increasing risks of a severe slowdown that would see China's economic growth revert to a path of about 3 per cent annually.

"China's policy makers finally seem willing to tackle the economy's structural imbalances," Mark Williams, the chief Asia economist at Capital Economics, said in a recent report.

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"This reduces the threat of an abrupt slowdown in GDP growth further down the line, but it also means that China's growth is likely to be far weaker over the next few years than most currently expect."

The Shanghai composite climbed 2.1 per cent Wednesday and the Hong Kong market gained 1.1 per cent despite the disappointing trade data. Investors were hoping that the indications of a weaker economy would force the central government to reignite growth with stimulus.

But in recent months, the government has appeared more interested in limiting investment growth while it sorts through credit issues. The reluctance of the People's Bank of China (PBoC) to alleviate a recent interbank credit crisis is perhaps the best example of this new hardline stance.

When rumours that medium-sized bank China Everbright Group had failed to repay a loan, interbank lending rates surged to 10 per cent, a level that made it impossible for borrowers to profit. The PBoC merely noted that the financial system had "adequate liquidity" and that the banks were on their own.

Senior officials have also signalled that expansion in manufacturing capacity is likely to slow. According to Reuters, China's State Council made the blunt announcement Friday that it would halt credit for industries like shipbuilding and steel, where capacity was far beyond demand, in an effort to force consolidation.

In addition, China's leadership noted concern with regional government debt used to finance infrastructure. Vice finance minister Zhu Guangyao recently stated that "a very important task for this administration is to clearly determine the level of local financing platforms."

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Official acknowledgment that the local government debt picture is difficult to assess – estimates of the loans outstanding range between $1.5-a trillion and $3-trillion (U.S.) – is another sign the government is serious about reform that ensures more efficient but slower growth.

China is the world's second-largest economy (for now, at least – Japan may give it a run for its money in the next few years) and still has substantial potential for growth in the coming decades.

The current growth strategy, however, has come to an end. Canadian investors who have taken China's insatiable demand for raw materials for granted will sooner or later be forced to change course.

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About the Author
Market Strategist

Scott Barlow is The Globe's in-house market strategist. He is a 20-year veteran of Canadian investment banks, including Merrill Lynch Canada, CIBC Wood Gundy and Macquarie Private Wealth (MPW). He was a highly ranked mutual fund analyst for 10 years and then, most recently, the head of a financial adviser support team at MPW. More


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