Chinese dragon averts hard landing

Growth rebound in Beijing adds to investors’ relief

October 18, 2013

For the past two decades, China’s growth figures have been the envy of the developed world. Yet a deceleration in the first half of this year had made some wonder whether the Chinese flying dragon was losing altitude. Not any more. A smooth rebound in the third quarter shows that fears of an imminent “hard landing” were premature.

China’s acceleration from an annual growth rate of 7.5 per cent to one of 7.8 per cent added to the sense of relief that came to dominate the markets at the end of a tense week. After a fortnight of high drama in Washington, US politicians sealed a deal ending the partial government shutdown and lifting the debt ceiling until next February. This signalled an armistice rather than the end of the war between the Democrats and the Republicans. But it proved enough to send equities soaring, as investors resumed dancing to the tune of central bank largesse.

Markets are not alone in celebrating the good news out of Beijing. Exporters to China – including German manufacturers and commodity producers in emerging economies – are also bound to feel cheerful. So will the Communist party leadership, which is anxious that growth stays above 7.5 per cent to preserve social cohesion.

Last July the government in Beijing conjured a mini-stimulus, aimed at cutting taxes for entrepreneurs and stimulating rail and subway infrastructure. The People’s Bank of China let credit flow freely to lenders and enterprises, changing its earlier, more hawkish stance. Judging from the rebound, it seems the social planners have pulled most of the right levers.

A sprinkle of monetary and fiscal magic, however, will not solve China’s long-term economic problems, which are above all structural. The economy is over-reliant on state-driven investment, whose profitability has dried up. The government’s stimulus primarily benefited construction, with investment in fixed assets accounting for more than half of growth in the third quarter. But the effects of this boost are already fading. Industrial activity and retail sales both dropped back in September compared with the previous months.

The Chinese leadership is acutely aware of the need to rein in credit growth and promote domestic consumption. The recent crackdown on corruption in the dominant state-owned enterprises is probably a backhanded way of softening their influence. Phasing out a model that has proved widely successful without causing a slump is a hard balancing act, economically and politically.

China’s debt burden is manageable but there is no reason for more unproductive investment to add to the existing mountain. A Communist Party conclave, scheduled for late November, offers an opportunity for the leadership to spell out clearly the sequencing of its transition to a new economic model. The central bank should be given powers to curb the credit binge. China is an economic superpower in the making but the longer it waits to act, the bumpier the road ahead will be.