FACTBOX-Key political risks to watch in China

By Emma Graham-Harrison

BEIJING, June 1 (BestGrowthStock) – 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

Relations between Washington and Beijing have thawed after
a tense start to the year, but with both countries still
worried about growth as the euro zone crisis threatens the
world economy, there is room for disputes over trade
protectionism or China’s currency controls to flare up again.

Financial markets and analysts forecast China will soon
free the yuan from an unofficial dollar peg, nearly two years
after it was fixed at a rate many economists regard as
undervalued, and which Western politicians says benefits
Chinese exporters.

The key questions of when and by how much the yuan is
allowed to rise remain unknown however, and if Beijing moves
too slowly for Western politicians the issue could become a
flashpoint.

Members of the U.S. Congress have demanded tougher steps to
press Beijing, including the threat of extra tariffs on Chinese
goods. 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.

But if the West pushes too hard, China’s leaders may decide
it is politically impossible to act — for risk of being seen
to set policy according to Washington’s agenda.

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 its economic recovery.

— 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. A top-down political system limits
outright clashes between officials and ministries with rival
views on the currency, but tracking public comments can provide
useful hints on the direction of yuan policy.

* HOUSING BUBBLE AND LOCAL GOVERNMENT DEBT WORRIES

Chinese property prices are looking bubbly and the
government is stepping up its efforts to take the market off
the boil.

A small number of investors, such as hedge fund manager Jim
Chanos, made waves in recent months with dire predictions of a
collapse of Chinese housing prices.

Most analysts, however, say that risks are largely confined
to high-end segments of the property market in some cities and
that the broader market will be on sound footing, so long as
the government is able to stabilise prices.

Intertwined with worries about a property bubble are
concerns about local government debt. With weak revenues
streams, provinces and cities borrowed heavily to fund a surge
in investment last year. To a large extent, they rely on cash
from land sales to pay back debts.

If property prices head south, falling land prices could
expose a mountain of bad debts on local governments’ books.
Some analysts reckon that they owe as much $10 trillion, a
growing risk to Chinese public finances.

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

Sharp falls in housing prices would cause pain for banks
and for the many Chinese who have bought homes with their
savings. Stock market tumbles have not cause serious social
ructions, but Chinese have much more to lose from a housing
crash.

If local governments cannot repay debts, this risks
squeezing cash flow for spending on areas like education and
healthcare, and leaving banks with portfolios of non-performing
loans.

What to watch:

— Monthly housing price data from the government is flawed
but offers the best indication of market trends.

— 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.

— Beijing has moved recently to rein in loans to local
governments. Look out for new assessments of debt, or
restrictions on land rights, often used as collateral.

* TENSIONS IN NORTHEAST ASIA

Northeast Asian ties have been put to the test by the
sinking in March of a South Korean warship, with the loss of 46
lives. Seoul, Tokyo and Washington blame Pyongyang.

China, secretive North Korea’s only major ally, has refused
to join the chorus of condemnation and says only that it is
still assessing Seoul’s investigation into the sinking.

Beijing is wary of abandoning its unstable neighbour,
fearing loss of influence. Ultimately it wants to avoid a
collapse of the government of Kim Jong-il, which could send
hundreds of thousands of refugees flooding across its border
and remove a buffer against the U.S. troops stationed in South
Korea.

China’s relations with its near neighbours are at risk, and
the U.S. has stressed the importance of a strong response to
the “act of aggression”. Meanwhile, China and the U.S. have
narrowed their differences over how to contain Iran’s nuclear
ambitions.

What to watch:

— China’s eventual response to South Korea’s report, and
its support for any measures to sanction Pyongyang through the
U.N. Security council. If China remains obdurate, trade ties
could suffer as well as progress on other East Asian issues
that require Seoul and Tokyo to work with Beijing.

* INTERNET CONTROLS, AFTER THE GOOGLE DISPUTE

Concerns about censorship and hacking were highlighted by
Google Inc (Read more about Google Stock Analysis)’s (GOOG.O: ) closure of its mainland Chinese-language
google.cn portal, after it said it was hit by a cyber-attack.

China says it condemns hacking and 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 controls,
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.

* SOCIAL STABILITY

China’s Communist Party has so far maintained general
authority and control despite fears in 2008 and 2009 that 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]

Investing Research

(Reporting by Emma Graham-Harrison, Lucy Hornby, Simon
Rabinovitch, and Chris Buckley; Editing by Andrew Marshall)

FACTBOX-Key political risks to watch in China