Should investors be worried about China?

By Tim Gray

(Fortune) -- For China, the superlatives keep coming: strongest exporter, biggest consumer of cars and cellphones, largest producer of coal and solar panels. Some, though, worry that the China engine is overheating. A few, such as noted short-seller Jim Chanos, even argue that the country's economy is a full-blown bubble.

The Chinese government recently reported two worrisome statistics: GDP is growing at 12% a year -- serious inflationary territory -- and urban property prices are rising just as fast (despite efforts to cool the housing market). Investors have been selling, sending the MSCI Broad China stock index down 7% in the first third of the year.

The culprit is the stimulus undertaken to stave off the West's recession, says Arjun Divecha, who oversees emerging-markets investing for GMO. Given China's dependence on exports, leaders feared a serious slowdown. But, as Divecha points out, "they massively overstimulated." China's largely state-controlled banks, he says, lent $1.4 trillion in the first half of 2009. Much of it went into real estate, pushing up prices and raising questions about loan quality. If home prices falter, Chinese banks could find themselves larded with bad loans.

Longer term, Divecha argues, China will thrive. It has a huge population hungry to modernize and has invested heavily in industrial infrastructure. In short, China resembles the Internet a decade ago: The changes are undoubtedly revolutionary, but that didn't mean that Webvan, the now defunct online grocer, was worth $10 billion. Nor does it mean that the Chinese economy can grow at 10% a year indefinitely. To top of page