The unstoppable force of China's growth story may come up next year against the immovable barrier of a US-led global economic slowdown. But it isn't necessarily bad news.

China, factory to the world and an economy-on-the-go growing at a furious 10+ per cent - with scorching asset markets and a banking system awash in liquidity - seems unstoppable.  But, 2008 might bring in a change…

Unlikely as it may seem, slowing global consumer demand in the coming year could accomplish what the Chinese authorities themselves have had very limited success in doing these past few years - cooling the dragon economy.

The coming US slowdown (recession?) is going to impact China not only in the consumer goods exports sector, but in investment goods, exports of machinery, tools and base metals as well. Some analysts feel China has reached the peak of its growth cycle this year.

The other side of the mountain?
The Asian Development Bank (ADB) has cut China's gross domestic product (GDP) growth forecast for next year from 11.4 per cent to 10.5 per cent. The adjustment suggests that the most straightforward segment of China's growth cycle may now be over. This has fundamental implications for stock market investors.

Some analysts believe China's growth has peaked in the third quarter of 2007, and is set for a cyclical downturn next year. Their forecasts say that many of the staple investment favourites, from cement to auto shares, may well be among next year's losers.

So how do investors insulate themselves from these threats? One way is to avoid cyclical sectors. But beyond sector-bound concerns, there is the larger fear that exports generally will slow down, and threaten to pop China's entire investment bubble. How likely is this?

Beware the bubble
A broader export-led slowdown would expose the overcapacity in Chinese industry, leading to an inventory build-up. This could mean aggressive price cuts in the second half, which could undermine the profitability of industrial houses and their ability to repay bank loans.

Worse, slower profit growth among Chinese stocks which trade at high price-to-earnings (PE) multiples could be a possible trigger for a prolonged market correction.
The Beijing Summer Olympics, to be held in August, is another key but unknown piece in China's jigsaw puzzle of growth.

The planned wrapping up of the country's heavy infrastructure spending, coupled with the sheer size of China's economy, suggest that there might be less of an 'Olympic effect' than in the last Olympic games in Sydney, Australia.

But the recurring argument that China will not allow its economy to slow down before the showcase event is held is now being reconsidered, in light of the rapidly changing global economic scenario.

Soaring stock markets
Slowing growth may not be what investors had in mind for China in 2008, especially after the runaway climb its markets have been on this year. China's benchmark Shanghai Composite soared 130 per cent to a high of 6124.04 in mid-November 2007, though it has receded nearly 18 per cent since then.

Hong Kong's volatile Hang Seng index also shot up in the second half of 2007, after China announced new policies that enabled insurance companies and other financial institutions to invest abroad under what it called a 'qualified domestic institutional investor' (QDII) programme.

Coupled with it was a similar scheme to enable mainland individuals to invest directly in Hong Kong stocks. Hong Kong is considered a foreign market by Chinese regulators because of its separate legal system and governing apparatus.

Designed to give the excess liquidity in China's overheated stock and real-estate markets an attractive outlet, QDII's problem was that the amounts raised under the plan were much larger than expected.

It propelled the Hang Seng index almost 60 per cent higher in the four months till mid-November. The index has since fallen back, but is still up about 38 per cent for the year. The H-share index, which maps shares of mainland companies listed in Hong Kong, has risen 54 per cent during the year, till mid-December.

Problems of plenty
China's trade surplus also shows little sign of reducing. November's surplus was up 14.7 on the previous year at $26.3 billion, just short of China's record October surplus. The year's total is likely to reach $280 billion. Large trade surpluses usually contribute to a growth in money supply, which fuels inflation.

But analysts are unsure about next year's surplus. Any fall in exports owing to weaker global demand might be offset by reductions in imports. But it is clear now that given the rising renminbi yuan, Chinese exporters are having a harder time.

It's not just the stronger currency that they are up against, but reduced tax rebates, higher environmental standards and rising input prices. Yes, inflation is a major worry now for Chinese economists.

Year of the pig and prices
Among the biggest internal issues of 2007 were rising pork prices. China's favourite meat became more than 50 per cent costlier, as disease devastated livestock. The rise in the price of pork coincided, unfortunately, with the Year of the Pig under the Chinese zodiac calendar.

What is worse, it sparked increases in overall food prices. Food accounts for one-third of the Chinese consumer price index (CPI). Higher prices for grains, oil and vegetables pushed food prices 18.2 per cent in a single month - November - alone, causing a 6.9 per cent rise in consumer prices for the month. Many analysts think food prices are likely to move down next year, but other inflation indicators continue to look upwards.

China's CPI hit an 11-year high in November, while producer prices reached the highest rate of increase in nearly three years. This is a major cause of concern for the authorities, who are keen to keep a tight leash on both inflation and conspicuous consumption, at a time of growing social inequality.

Funny money
Also, there's no shortage of currency in circulation. Money supply grew by 18.5 per cent in November from a year earlier. Even for the three months preceding November, increase in money supply was well above the central bank's target rate of 16 per cent annual growth for the year. 

Beijing's planners now say their monetary policy is ''tight'', while they formerly described it as ''prudent''. Earlier this month, the Chinese central bank boosted the cash reserve ratio (CRR) of banks - money they must set aside as liquid deposits - by one percentage point, in a sharp increase from its normal half-point increments.

It was the tenth increase this year, and the cumulative effect of those hikes, in combination with higher lending rates, is being felt through the economy. In effect, China is imposing a credit squeeze to stabilise the rate of growth and curb the runaway property market.

Analysts now expect declines in real estate markets and shares of Chinese property stocks next year. Most of them also expect additional hikes in the base lending rate, which is currently at 7.29 per cent, as the People's Bank of China combats negative interest rates in an inflationary economy.

Currency conundrum
The yuan's slow appreciation against the US dollar may speed up a little in 2008. Analysts say this has less to do with the pressure the US government is putting on China, and more to do with Beijing's compulsion to combat inflation. Lehman Brothers has forecast the yuan to appreciate against the dollar by 7 per cent next year, as compared to 5 per cent this year.

Interestingly, as mainland China's economy cools, Hong Kong may see a mini-boom. Faster currency appreciation for the yuan will probably boost the shares of mainland companies listed in Hong Kong, which are priced in the city's US dollar-linked currency. Analysts also expect strong inflationary pressures in the island city-state. Merrill Lynch forecasts Hong Kong real estate prices to jump 50 per cent by 2009.