China faces tug-of-war over growth strategy; “We can’t rule out the possibility that the situation will be different from what leaders expect and that the economy will suffer a hard landing”

July 10, 2013 12:37 pm

China faces tug-of-war over growth strategy

By Simon Rabinovitch in Shanghai

Is this the end of the ‘Beijing put’? Over the past five years whenever China’s growth slipped below 8 per cent, global investors could count on the government to unleash stimulus and re-energise the world’s second-largest economy, boosting demand for everything from Audis to iron ore.

China is now sliding toward 7.5 per cent growth and likely lower. But the country’s new leaders are refusing to ride to the economy’s rescue, as they did most spectacularly in late 2008 when the global financial crisis struck. There is virtual unanimity among analysts that China has entered an era of slower growth, and that the government, far from panicking, welcomes this change, believing it will give rise to a more sustainable economic model.The latest evidence of China’s slowdown came in wobbly trade data on Wednesday. Exports fell 3.1 per cent in June from a year earlier, the first decline in 17 months. Imports slipped 0.7 per cent from a year earlier and fell nearly 10 per cent from a month ago, well below expectations.

Zheng Yuesheng, spokesman for the customs administration, which compiles the figures, was blunt in his assessment. “Our country is facing serious challenges,” he said.

With analysts and indeed government officials agreed that China will not – and should not – return to its double-digit growth of the past decade, the debate instead centres on whether it is slowing too abruptly.

In one corner are those who believe the government will stand firm in the face of the deepening slowdown, potentially leading to much more pain for the world’s second-largest economy as a cash-tight environmentforces companies to cut spending and eats into fiscal revenues.

“So far, it [the government] has sent consistent signals that the policy stance will remain tight to contain financial risks,” said Zhang Zhiwei, an economist with Nomura who sees a 30 per cent chance that growth could fall below 7 per cent in the second half of the year.

But in the other corner are those betting that the government will lose its nerve, and potentially quite soon.

“The slowdown is already very fast. If the current policies remain, I think the situation will keep sliding down the hill until China enters an era of deflation, which will lead to massive unemployment, and that’s a situation the leadership cannot accept,” said Xu Gao, chief economist of Everbright Securities.

The government’s tough policy stance was one of the main causes of the poor export figures. By sticking to a path of moderate appreciation for the renminbi against a resurgent dollar, the Chinese currency now stands as one of the world’s best performers, despite the economy’s woes.

“External demand for Chinese goods is really suffering and that leads to the point that Beijing needs to rethink its currency policy. There is no doubt that the renminbi is too strong,” said Yao Wei, an economist with Société Générale.

The trade disappointment came on the heels of inflation numbers that also highlighted the weakness of Chinese domestic demand.

Although consumer price inflation rose in June, it averaged just 2.4 per cent in the first half, missing the government’s 3.5 per cent target by a large margin. Even more worrying was the 16th straight month of deflation in the producer price index. Weighed down in part by excess capacity, companies have cut their selling prices, chipping away at their profits.

The picture of a slowing Chinese economy is expected to be reinforced next week when the second-quarter gross domestic product is announced. Most analysts believe growth edged down to about 7.5 per cent year on year, a second straight quarterly slowdown.

Li Keqiang, who was appointed premier in March, has been sanguine in his public statements to date. “China’s economy is generally stable so far this year, with the main economic indicators within a reasonable range and in line with our expectations,” he said at a meeting this week.

In honour of the premier’s apparent tolerance for slower growth and his desire to move the economy away from investment and towards more consumption, analysts at Barclays have dubbed China’s new policy mix ‘Likonomics’.

A restructuring of the Chinese economy may be desirable, but it certainly will not be easy. In June when the central bank tried to rein in lending by banks, relatively minor actions it took to reduce liquidity in the economy were quickly magnified by market forces into a cash crunch that placed intense pressure on overextended companies.

“The lesson from June is that we can’t rule out the possibility of mistakes by policy makers,” Mr Xu said. “We can’t rule out the possibility that the situation will be different from what leaders expect and that the economy will suffer a hard landing.”