David Morris
INVESTORS have placed considerable faith in China over the past few years. Many remain convinced that the country’s growing middle class (estimated to be around 300m people) is ready to step in and take up the slack as US and European economies slow. But while China’s economic growth is likely to continue to outstrip that of developed countries for years to come, it still has significant problems to deal with.

Its manufacturing base is tied closely to its export market with its biggest customers being the US and Europe. Given the ongoing European debt crisis, austerity measures, high US unemployment and moribund housing market, consumers in the US, Europe and UK are likely to be cutting their spending for the foreseeable future. So until domestic demand in China increases significantly, its manufacturing base is likely to come under severe pressure. Meanwhile, there is evidence that Western manufacturers are experiencing a sharp slowdown in Chinese sales. Although luxury brands have done spectacularly well over the past few years, many are now scaling back expansion plans. This is hardly surprising considering that despite recent wage growth average Chinese per capita personal income is roughly 20 per cent of that in Europe.

Last week, the latest update on the Chinese trade balance was released. The surplus narrowed to $14.5bn in September from $17.8bn previously. Growth in both exports and imports slowed significantly. On Friday, we heard that both CPI and PPI fell for the second consecutive month. But underlying the headline inflation numbers was the unpalatable fact that food prices rose 13.4 per cent year-on-year. This remains a major issue for the Chinese administration, as do concerns of a bursting real estate bubble and a possible banking crisis due to bad loans made to over-indebted local governments.

Looking at the iShares FTSE China 25 ETF, back in August there was a sharp break of the downward-sloping trend line which had held as support since the summer of 2009. The index has since snapped back following the announcement that the domestic arm of China’s sovereign wealth fund is buying shares in its four largest banks. But the trend line is now acting as resistance, and buying pressure so far hasn’t been strong enough to get a close above 35. It is worth keeping an eye on this over the coming weeks.