China Business Forecast Report Q4 2009

Outlook Brightening, But Concerns Persist Stronger than expected real GDP growth in Q209 has forced us to revise up our 2009 growth forecast. Driven primarily by government-led investment, real GDP staged an impressive rebound in Q209 to expand by 7.9% y-o-y, as compared to 6.1% growth registered in the previous quarter, and with the global economy forecast to continue on the path to recovery in the second half of the year, we are now expecting real output to expand by 8.1%, having previously forecast a 6.8% expansion. Meanwhile, we have also revised up our 2010 growth forecast for China, from 7.6% to 8.8%. having said this, we continue to caution that runaway liquidity growth poses a significant downside risk to growth going forward.

The violent riots that took place in the province of Xinjiang on July 5 has once again underscored the rising threat of political instability in China. With no outlet for citizens to voice their grievances under one-party rule, the threat of further violence remains firmly on the cards, particularly given the country's ongoing economic woes. This would have significant implications for both social and economic policy, and could have a bearing on the long-term political outlook for China. Indeed, China faces myriad economic, social and environmental challenges over the coming decades that could seriously test the Chinese Communist Party (CCP)'s ability to govern.

China registered its first increase in fiscal revenues since October 2008 in May, with government income rising by 4.8% y-o-y. However, expenditure continued to rise at a rapid pace, climbing 14.5% y-o-y, having risen by 24.5% in the previous month. With expenditures expected to continue soaring throughout 2009 as the government seeks to prop up economic growth, and revenues forecast to remain weak amid ongoing economic weakness and an expansionary fiscal policy, we are forecasting China to record a budget deficit equal to 2.6% of GDP in 2009. Although we recognise upside risks to both the country's budget shortfall and its debt position, we retain a sanguine outlook for both.

Foreign investment inflows into China continue to suffer at the hands of the global recession, with foreign direct investment falling for an eighth consecutive month in May - declining by 17.9% y-oy to US$6.4bn - to bring the year-to-date total to US$34.0bn, some 20.6% lower than compared with the first five months of 2008. However, with a vast supply of cheap labour and anticipated rapid economic growth, China will remain the top destination for FDI in the developing world.

Moreover, the long-term outlook remains positive, as the Chinese government increasingly gives more protection and encouragement to the burgeoning private sector.