Dark economic clouds on the horizon for China as economy overheats - by Heather Stewart

Barely a week goes by without yet another stunning fact from the Chinese economy. Last Friday brought news that despite spending billions on the world's largest fiscal stimulus package to help escape the global downturn, China's vast foreign exchange reserves shot up by another 23% in 2009, to a stunning $2.4tn (euro 0.24 trn) – almost twice the GDP of the UK. Official figures this week are expected to show that while the rest of the world was struggling to emerge from recession, Chinese growth was running at a rampant annual rate of more than 10% in the final three months of the year.

Capital controls protecting the currency from a financial exodus mean it's hard for domestic investors to send their surplus funds abroad – so with banks directed to pump up lending, cheap cash is pushing up asset prices at home. Bank lending in December was more than 95% higher than a year earlier, according to the People's Bank of China."Ample liquidity and capital controls, having protected China from the worst of the global financial crisis, now threaten economic and financial stability," said Ben Simpfendorfer of RBS in a note last week. "Investors are searching for yield, but are limited in their choices. Higher inflation and the state council's reluctance to raise interest rates may only accelerate the rush into equities, property, and, increasingly, into repackaged loans."

The Chinese authorities are well aware of the risk of a bubble, and have taken a series of steps in recent weeks, including increasing banks' reserve requirements, to try and cool things down. "They've got very scared that they can't control it," says Mark Williams, senior China economist at consultancy Capital Economics.

Stephen Roach, chairman of Morgan Stanley, Asia, says, "There is good reason to believe that China gets it – and is about to take dramatic steps in rebalancing its domestic economy in a fashion that would provide a sustained and meaningful reduction in its current account surplus,"

But not everyone agrees. There have already been a series of protectionist moves against China since the downturn began. The US has invoked World Trade Organisation rules to slap tariffs on Chinese tyres, paper and steel products; the EU has done the same to exports of aluminium wheels and steel products, as their producers struggle to compete with the Chinese juggernaut. The chorus grows ever louder from politicians around the world calling for Beijing to allow the yuan to appreciate. Japan and the eurozone in particular are likely to feel that China is growing at their expense.

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