Is China drying up?

The Chinese economy may look like it can grow at 9% a year for ever, says Simon Wilson, but a shortage of water could soon call a halt to the country's industrial revolution.

Is China short of water?

Yes. The lack of water is acute. China is home to 22% of the world's population, but contains only 7% of its fresh water. Put another way, it has about as much water as Canada, but 100 times more people. China's population growth, its vast rural-to-urban migration and rapid industrial expansion mean that 30 cubic kilometres more water is being pumped out each year than is replaced by rain, according to New Scientist magazine. Of China's 669 cities, 440 regularly suffer moderate to critical water shortages. Meanwhile, according to research cited in a recent American documentary, Running Dry, half of the Chinese population drinks contaminated water laden with human sewage and toxic agriculture run-off.

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Why is China so vulnerable?

In part, because its rapid industrialisation has led to large-scale soil erosion and desertification, accompanied by a drop in rainfall. According to official estimates, China's deserts are growing by 1,350 square miles a year. They already cover 18% of the country, and threaten another third of the country and 400 million people. The north is worst affected by desertification and drought; for example, the Huai River, one of the country's seven great water systems, has water levels 70% lower than a year ago. Elsewhere, Hainan province is in the grip of a severe drought, and Guangdong province is facing a water shortage of seven billion cubic metres. The Gobi is growing southwards by 2km a year - and is only 130km from Beijing, which is now beset by sandstorms every spring.

Isn't China used to droughts?

Up to a point. Droughts are a regular feature of the parched northern regions, but the last six months have seen the worst dry spell in southern China for 50 years. The extensively polluted waterways add to the problems. According to Wang Shucheng, China's minister for water resources, 70% of the country's lakes and rivers are polluted to varying degrees. He says 300 million people are drinking unsafe water.

Will global warming make it worse?

Assuming the scientists are right about global warming, it could be devastating in the long term. According to a WWF report presented to last week's G8 London meeting on climate change, the retreat of the Himalayan glaciers is among the most rapid in the world, and has already resulted in water shortages. In the shorter term, rapidly melting glaciers will increase the volume of water in rivers, causing widespread flooding. But within decades, retreating glaciers mean river levels will fall, causing water shortages for the hundreds of millions of Chinese who rely on glacier-dependent rivers.

What is the economic impact of all this?

The Asian Development Bank says that drought and accelerating desertification in China "increasingly threatens the economic welfare of the nation". In the longer term, China's water problem threatens the country's ability to feed itself. Already, the production of each of the three grains that dominate China's agriculture - wheat, rice and corn - is falling. After a remarkable long-run expansion from 90 million tons in 1950 to 392 million in 1998, China's grain harvest fell in four of the last five years for which figures have been published - dropping to just 322 million tons in 2003. As the country continues to eat more than it grows, China will be obliged to cover the shortfall through imports of tens of millions of tons a year - pushing up world food prices.

What does it mean for China's future growth?

Foreign & Colonial's head of Pacific equities, Mike Hanbury-Williams, fears that scarcity of water supplies is the biggest threat to industrial growth in China. According to Chinese government estimates, around US$8bn was lost in industrial output during 2003 because of water scarcity, another $13bn lost from acid rain and $6bn from desertification. "This doesn't even take into account the significant healthcare costs. China simply does not have enough water to meet its current needs - let alone that of a rapidly expanding economy."

What firms will make money from thisChina will need to take measures to ensure it has enough food and water and there are some international firms in a position to benefit from China's drought. One of these is Consolidated Water (CWCO, listed on Nasdaq), which specialises in developing and operating ocean-water desalinisation plants and water-distribution systems in areas where natural supplies of drinking water are scarce - it isn't cheap, but expanding from the Caribbean and South American markets into China could give big growth potential. To cope with falling harvests, China will have to import food - good for Bunge (BG, NYSE), which, according to Dan Denning in Strategic Investment, "helps feed the world and makes a profit doing it". It "cannot fail to benefit from rising demand for food" from China.