Why China's economy may be heading for a hard landing

An alarming batch of economic indicators from China in the past 10 days has cast a pall over the country’s economic growth prospects, rekindling debate about whether one of the few bright spots in the world economy may be heading for a hard landing.

And the government’s initial efforts to pull out of the dive suggest that it may be putting off – once again – long promised policies to rebalance the Chinese economy by relying more on consumption than on its traditional growth drivers, exports and investment. 

Industrial production grew by only 9.3 percent in April, year on year, its slowest rate since the financial crisis. “That is a real and serious problem,” says Xiang Songzuo, chief economist for the giant China Agricultural Bank.

Equally worrying, he says, is that bank lending is stagnant, and not just because of the government’s yearlong policy to dampen inflation by curbing loans. “The real demand for bank lending has been slowing down quite obviously,” Mr. Xiang says.

That nervousness was reflected in a survey published recently by the Central Bank showing business confidence in the economy sinking for the third quarter in a row to 39.2 percent, well below the 50 percent mark dividing optimism from pessimism.

That, warns Xiang, means that there will be “no very obvious or significant impact” from the government's move last week to cut banks’ reserve requirement ratio. That reduced the amount of money banks must hold in reserve against bad loans, thus freeing up more money for them to lend.

What happened?

For more than two decades China has been enjoying gross domestic product growth rates of more than 10 percent a year, driven mainly by exports and investment at home.

But Beijing’s massive trade surpluses angered its trading partners, and many state-funded investments, especially in infrastructure such as roads, airports, and industrial development zones, have not turned out to be very profitable.

That has especially been the case with projects launched helter-skelter in 2009 and 2010 as part of the $600 billion stimulus package that the government used to escape the worst of the 2008 financial crisis.

The authorities pumped so much money into the economy that it began to overheat, sparking inflation above 5 percent a year, so last year the government curbed lending sharply, forbidding local governments to take out more loans.

“The reason for this turn in the business cycle is the government’s determination to end the stimulus policy and bring down inflation,” says Andrew Batson, an analyst with the Beijing-based Dragonomics consultancy.

“Cycles in the Chinese economy over the past four or five years have been very much policy driven,” Mr. Batson adds. “I don’t think a month or two of bad economic data means the government has lost its ability to manage things.”

‘A tricky balancing act’

Officials here have been pledging for some time that they will seek to rebalance the Chinese economy, making it less reliant on exports and investment, and more dependent on domestic consumption. That would please US and European governments, anxious to export more of their own goods to Chinese consumers.

But making that transition is “a tricky balancing act,” says Batson. Domestic consumption is less easy to goose than investment spending, which can be ordered by government fiat.

If cuts in investment meant a serious economic slowdown before domestic consumption picked up significantly “there is a question whether they would be politically feasible,” says Victor Shih, who teaches Chinese politics at Northwestern University in Evanston, Il.

Echoes of eurozone crisis?

Now there are fears that the crisis in the eurozone, China’s biggest trade partner, will slow Chinese sales there. Exports to the European Union fell in April by 2.4 percent from the year before, dragging overall year on year export growth to only 4.9 percent.

If domestic Chinese consumption does not grow quickly enough to take up the slack – and there are no signs yet that it will do so – the government is likely to fall back on investment to boost economic growth, says Huang Weiping, an economics professor at Renmin University in Beijing.

“Premier Wen Jiabao has the bullets,” says Professor Huang. “He can use central government money to stimulate the growth rate. If we want a normal growth rate we have to depend on investment, and especially on government investment.”

Though that “would be the worst thing they could do, reinforcing the imbalance and their reliance on investment,” argues Patrick Chovanec, who teaches economics at Beijing’s Tsinghua University, “nobody wants to interfere with growth, even temporarily.”

The government has forecast 7.5 percent GDP growth this year, in a bid to lower public expectations after decades of double-digit growth. “People took that for granted, but it was actually extraordinary,” says Batson. “We should not be surprised to see it come down.”

“Chinese people must face reality; we cannot sustain such high growth rates,” agrees Xiang. “We must accept 8 percent a year, or even lower.”