In the short-term, the Chinese economy looks ready to run at a strong pace. Real GDP growth in 2005 was 9.9% and is expected only to moderate to 9%, hardly a slump in activity. Indeed, it is estimated that Beijing will see some $160 billion worth of construction in the lead-up to the 2008 Olympics. That money will go into luxury apartments, subway and rail lines, ring roads, sports arenas, and an upgrade of the international airport. Some 1 billion square feet of offices, shops and apartments will be added into making Beijing the shining beacon of the new China.

While the Olympic boom is providing a major face-lift for Beijing, it runs the risk of pushing up the country’s debt, increasing bad loans for the banks, and bumping the currently red-hot economy into a major slowdown.  This was the legacy of the 2004 Athens Olympics for Greece. Yet, for China’s leadership, the 2008 Olympic games are highly important as they represent a major coming to age of the world’s fourth largest economy.  In many regards this has echoes of Japan’s (1964) and South Korea’s (1988) earlier hosting of the games.  Indeed, the 1964 Tokyo Olympics were the first to be held in Asia.  For China, the 2008 Olympics are to showcase the advances made over the past several decades. 

One of the potential Achilles heels for China is its banking system. For much of the Communist period, the country’s banks were used to prop up a wide range of companies. Credit issues were trumped by political considerations and the banking system reflected this process. However, as China shifted gears to a more market-oriented economy, the authorities turned their attention to cleaning up the banking system. This issue became even more pressing as China moved along the path to joining the World Trade Organization in the 1990s. According to Moody’s, the government has spent $432 billion since 1998 to clean up the banking sector.

Although considerable progress has been made in strengthening China’s banking system, the banks are not yet out of trouble. In the first quarter of 2005, China’s four largest banks reported a rise in problem real-estate loans of $8.7 billion (10% of their property loans). We can expect that those numbers are only going to increase due to the ongoing construction boom. The most exposed banks to real estate development are the country’s four largest - Industrial & Commercial Bank of China, Bank of China, China Construction Bank, and Agricultural Bank of China. These account for 76% of all leading.

Any crisis in the Chinese banking system will have ripples far beyond Chinese shores. Beyond the general effects that will be seen in numerous sectors and markets that have been dependent on ever-increasing growth from a rapidly developing China, a number of Chinese banks have sold equity shares on foreign stock exchanges. In addition, a number of international banks have bought around $19 billion in strategic stakes in the Bank of China, China Construction Bank, Industrial & Commercial Bank, and the country’s fifth largest bank, the Bank of Communications. Among the foreign lenders most exposed are Allianz, American Express, Bank of America, Goldman Sachs, HSBC Holdings, Merrill Lynch and Royal Bank of Scotland. A possible bank meltdown in China would certainly catch foreign institutional players and small investors in the aftershocks.

China has faced tough economic challenges in the past. Indeed, the past 20 years have witnessed many proclamations of a coming demise of China’s economic miracle. Thus far, the policymakers have managed to steer China through several global shocks as well as the potential political disruption related to Tiananmen Square in 1989. For this, China’s policymakers deserve praise. However, times have changed. The economic policymaking environment is very different than it was in the last century. China is now the world’s fourth largest economy, it has a much more globalized economy than before, and its population is more likely to hold the government accountable. A major dip in the economy post-2008 could have rapid socio-political consequences. In all fairness, the government of President Hu Jintao is keenly aware of the stakes, but is caught between the desire to maintain strong economic growth and to keep the population happy, balanced with avoiding any shocks.

China since 1978 has been the scene of one of the world’s most amazing growth stories. Yet, with dynamic growth have come tough challenges – severe environmental pollution, rapid urbanization and transportation bottlenecks. Economic problems have challenged more than once, but the government has been able to manage the process and steer the country to calmer waters. The coming economic crisis – if it indeed happens - is likely to be the toughest test faced by the new China.