China knows that her past breakneck growth rate is unsustainable, economically, socially, and ecologically. Hence the about-turn to go for a slower and more sustainable growth model in the lastest Five Year Plan (2011-15).

But any drastic drop in growth rates would be convulsive (job losses, social instability etc) especially in a precarious global environment. As China's bank reserve requirements have been increased 11 times since 2009, inflation has somewhat subsided, and house prices are comind down hard, there is room for some easing of credit, especially for hard-hit SMEs.

According to Paul Schulte, Hong Kong–based global head of financial strategy and Asia banks research at CCB International Securities, a subsidiary of China Construction Bank Corp.,"in the past 12 months Chinese regulators have removed 4.4 trillion yuan in liquidity from the financial system—well in excess of the original stimulus spending—through tightening," according to a report by Allen T Cheng in Institutional Investor of 4 January, 2012 – "Beijing Preps for a Soft Landing" Click here

China has therefore been cleaning up its local debt drastically and the general prognosis doesn't support a doomsday scenario. So a measured easing of credit is unlikely to lead to a credit implosion.

As for the economy, while China's export sector is cooling, consumption is showing robust rising trends. KFC is now opening 500 restaurants a year. According to the World Luxury Association's 2010-2011 annual report, China is expected to become the world's largest luxury market this year.

The rising middle class is growing in China's rapidly expanding cities. According to McKinsey Global Institute, by 2025, China will be adding 350 million more urbanites in 221 new cities each with a population of over a million (compared with only 35 such cities in the whole of Europe at present). This rapid urbanization often gives outsiders an impression of "empty shopping malls and roads to nowhere", a refrain of some "China shorters". But there is no mistake the massive urbanization, the largest in human history. This is likely to offset some of the downturn caused by falling exports.

China's latest PMI rebounded to 50.3% in December, suggesting a soft rather than a hard landing. Click here

For now, relatively better equipped with financial resources, China is counting on maintaining at least 7-8% growth this year. This is supported by most forecasts, including those of the World Bank (8.4%), IMF (9%) and the Conference Board (8%). Click here

According to a report "What's in store for China in 2012?" Download McKinsey Quarterly – What’s in store for China in 2012 – February 2012 by Gordon Orr in the McKinsey Quarterly of February 2012, "Despite food price inflation and a stagnant housing market, China should maintain a rapid rate of growth". The balance of his prognosis is based on the following assessments

1. Government policies will spur consumption and investment.
2. Dominant models will emerge for reforming rural land ownership
3. Real estate will stagnate.
4. The fundamentals will cause further inflation in food prices.
5. Chinese investment in green tech will spike upward.
6. Accounting scandals will continue.
7. Private-equity and venture capital funds may go ‘walkabout.’
8. Chinese acquirers will be bolder.
9. The automobile segment will be slow.
10. Hospital reform will accelerate.

Nevertheless, as China is re-balancing the economy away from excessive export dependence, the process is likely to be painful.

In a report on 6 February, the IMF warned that China's economy could drop by half this year in the event of a sharp recession in Europe. According to the IMF, while China could sustain economic growth by repeating the massive stimulus package in the global financial crisis, remaining concerns about its lingering problems of bad loans and credit quality may limit the scope of this palliative. Click here

As Europe is China's largest market (ahead of the US), an European Armagedden would be very bad news for China indeed.

Best regards,

Andrew