May 3, 2010 / 12:47 PM / 9 years ago

FACTBOX-Key political risks to watch in China

BEIJING, May 3 (Reuters) - China weathered the global economic downturn with robust growth, but this has generated new risks and concerns over trade imbalances, currency policy and the overheating of the domestic economy.

Following is a summary of the key risks for China:

* TRADE AND CURRENCY DISPUTES

Signs of a thaw in relations between Washington and Beijing have convinced foreign exchange markets China will soon unshackle the yuan from its dollar peg and allow it to appreciate against other global currencies, two years after it was fixed at a rate many economists regarded as undervalued, and which many Western policymakers said gave Chinese firms an unfair advantage which worsened global imbalances.

U.S. Treasury Secretary Timothy Geithner delayed a report due in April that could have branded China a “currency manipulator”, avoiding an embarrassing spat during President Hu Jintao’s visit to Washington for a nuclear security summit. The two global powers also narrowed their differences over how to contain Iran’s nuclear ambitions. But while the consensus opinion in financial markets and diplomatic circles overwhelmingly expects a change in Chinese currency policy this year, the key questions of when and by how much the yuan is allowed to rise remain unknown.

There is also a risk another diplomatic row could complicate currency policy — members of the U.S. Congress have demanded tougher steps to press Beijing, including the threat of extra tariffs on Chinese goods, and rising disquiet about Chinese trade policy in the United States could be exacerbated by broader tensions over Tibet and Taiwan and by U.S. Congressional elections in November. Meanwhile, the willingness of China’s government to consider any policy change tends to be inversely proportional to how strongly such change is demanded by the West.

What to watch:

— Hints of a change in China’s currency policy. Most analysts expect China to keep the currency on a tight rein until at least mid-2010 to cement economic recovery. Offshore one-year dollar/yuan NDFs CNY1YNDFOR= imply a growing belief the yuan will be allowed to rise this year.

— The rhetoric from Washington and Beijing. Both sides want to avoid any serious economic dispute but also protect domestic industry and maintain popular support at home. Signs Congress is gaining more influence over U.S. policy, or that retaliatory trade measures could expand, would unsettle markets.

— The debate in China. The country’s top-down political system constrains any outright clashes between officials, ministries and provinces with rival views on the currency. But tracking the comments of officials and well-connected scholars can be a useful guide to the direction of yuan policy.

* THE INTERNET AND FALLOUT FROM THE GOOGLE DISPUTE

Google Inc (GOOG.O) has pulled back from China, shutting its Chinese-language google.cn portal, over concerns about censorship and hacking. Its complaint exposed broader disquiet among firms and governments about Beijing’s business and investment policies.

China has said it does not want the dispute to hurt broader commercial ties, adding that companies remain welcome as long as they accept the country’s laws and policies.

But with Washington pressing Beijing on Internet censorship, and state-controlled Chinese media launching salvos of harsh criticism, Western firms, especially in sensitive sectors such as the Internet, media and telecommunications, face uncertainty and potential regulatory fallout.

What to watch:

— Beijing could strengthen enforcement of rules intended to ensure international Internet companies obey censorship controls and other restrictions. It could also block access to other Google services from China, including the main google.com site, or use unannounced steps to frustrate access to such services.

— Chinese media’s harsh criticism of U.S. Internet policy could embolden some officials to protect domestic companies or sectors against foreign competition. Watch out for reports of foreign business deals in China that are slowed or shelved.

* FALLOUT FROM A HOUSING BUBBLE

Chinese property prices are looking bubbly and the government is stepping up its efforts to take the market off the boil. The latest policy changes aimed at cooling market exuberance were a hike in mortgage rates and an increase in downpayment requirements announced last month. After a meeting chaired by Premier Wen Jiabao the cabinet said property and land prices were rising too fast in some cities, putting home ownership beyond the means of most Chinese and increasing systemic financial risk. “We must take restrictive and forceful measures,” it said.

Property inflation appears to be slowing but ticked upwards in the year to March. A vocal minority of analysts argues prices have been propelled so far above rational levels by a lending boom last year that a catastrophic bursting of the bubble is inevitable. On top of housing worries, consumer prices rose 2.4 percent in the year to March, not far below the government’s 2010 target of 3 percent, stoking public disquiet about the cost of living. Wen has said inflation, income inequality and corruption, are key threats to social stability.

Two broad political issues should be on investors’ radar screens. First, housing is increasingly unaffordable for most ordinary Chinese, a potential source of social discontent that could prompt stronger policy responses.

Second, sharp falls in housing prices would cause pain for banks and for the many Chinese who have bought homes with their savings. The stock markets’ 70 percent tumble in 2008 from its peak did not cause serious social ructions, but Chinese have much more to lose from a housing crash.

What to watch:

— Monthly housing price data from the government is flawed but offers the best indication of market trends. Annual urban property inflation rose to 11.7 percent in March from 10.7 percent in February, emboldening China bears.

— The government’s efforts to gradually take the fizz out of the market have focused on cracking down on speculators through loan controls, while expanding the supply of affordable housing to tackle popular discontent. There is ample scope for policy missteps, especially a repeat of over-tightening seen in 2007, a major factor in the economy’s subsequent slowdown.

* SOCIAL STABILITY

China’s Communist Party has so far maintained general authority and control despite fears in 2008 and 2009 the global economic crisis could spark unrest among laid-off workers. Outbreaks of discontent have remained brief and localised.

But with the Party and global markets treating social stability as a crucial issue, even limited challenges to the Party’s control can produce outsize policy reactions.

Ethnic tensions in Tibet and Xinjiang have distracted the central government and drawn international concern, but have not seriously threatened national stability.

What to watch:

— Emergence of any regional- or national-level protest movements. So far, protests in China tended to be directed at local officials. Strict controls make it difficult for any organised movements to form beyond the local level.

— Signs urban public concerns about inflation and housing costs are congealing into broader discontent. That is unlikely to turn into mass protest, but could spur faster moves to cool economic overheating. [ID:nSGE60O00K]

Reporting by Chris Buckley, Simon Rabinovitch, Ben Blanchard, Emma Graham-Harrison and Lucy Hornby; Editing by Andrew Marshall and Jerry Norton andrew.marshall@thomsonreuters.com; +65 6417 4684; Reuters Messaging: andrew.marshall.reuters.com@reuters.net

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