Economists weigh a Chinese hard landing

(Financial Times) — When Wen Jiabao, the Chinese premier, announced this year’s annual growth target of 7.5 per cent in March, most analysts assumed he was being unduly modest and that the world’s second-largest economy would actually expand much faster.

The Chinese economy has consistently outperformed annual targets over the past decade, averaging close to 11 per cent growth over that time, despite the 2008-09 global financial crisis.

But with activity cooling much more than expected in recent months the 7.5 per cent target is starting to look ambitious.

Most economists still believe China is in the midst of a gradual and manageable “soft landing” slowdown but some are beginning to wonder whether the economy may be in for a much rougher time.

Economic expansion in the second quarter slowed to 7.6 per cent from the first quarter’s 8.1 per cent and at this pace the country appears set to post its lowest annual growth rate since 1999.

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Even after Beijing cut interest rates for the first time in almost four years in early June and then cut them again less than a month later, virtually all economic indicators showed the slowdown continuing into July.

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Industrial production, a key measure of manufacturing activity, grew 9.2 per cent in July from a year earlier, down from 9.5 per cent in June, while Chinese exports grew just 1 per cent from a year earlier after growing 11.3 per cent in June. New bank lending in July was also disappointing.

Some analysts are starting to contemplate what a Chinese “hard landing” would mean for the country and the rest of the world at a time when Europe is mired in crisis and the US economic engine is stuttering.

“A hard landing in China would look like the fourth quarter of 2008 and the first quarter of 2009 when exports collapsed, factories had no orders and migrant workers were laid off by the tens of millions,” says Wang Tao, an economist at UBS. “That hasn’t happened yet and probably won’t unless Europe falls apart or there’s a serious problem in the real estate market.”

Investment in real estate accounted for more than 13 per cent of China’s gross domestic product in the first half of the year and the sector has been a key growth driver for most of the past decade.

But forests of empty apartment blocks cover much of the country and land purchases for new residential housing were down 24.3 per cent in the first seven months from the same period a year earlier, suggesting future investment will not hold up.

Housing prices in many large cities rose for the first time in almost a year in June and were up again marginally in July.

But that is not necessarily good news since the government has spent the past two years trying to suppress surging prices that have put home ownership out of reach for most of the population and a strong rebound could provoke even tighter restrictions on real estate.

The impact of a Chinese hard landing would be devastating for commodity-exporting countries such as Australia, Brazil and Indonesia, which rely heavily on Chinese demand but it would also have less direct consequences.

“If China does have a hard landing it would have huge ramifications for global investor confidence and would create turmoil throughout global financial markets,” said Alistair Thornton, an economist at IHS Global Insight.

While China’s slowdown has so far been relatively mild, it has had a disproportionately large impact on corporate profits, especially for property developers and companies in real estate-related industries.

Sales of construction machinery have plummeted, dozens of small steel mills are cutting production and large state-owned mining and transport companies have reported losses for the first half of the year.

The deteriorating situation has already affected global investor sentiment.

Foreign direct investment into China fell 8.7 per cent in July from the same month a year earlier and was down 3.6 per cent in the first seven months.

Some analysts believe the current slowdown is more structural than cyclical and even if the government wanted to it might not be able to do very much to spark a big rebound in growth.

“There is persuasive evidence to conclude that the Chinese economy is actually growing at just 4 or 5 per cent right now based on a composite of other indicators,” says Patrick Chovanec, a business professor at Tsinghua University in Beijing.

“Of China’s 9.2 per cent GDP growth in 2011, 5 percentage points came from investment which means that if China builds just as many roads, bridges, condos and villas as it built last year and no more it will knock five points of this year’s GDP growth. Growth is dependent on ever-rising levels of investment in an environment where that investment is not creating adequate returns.”

Officials and state media reports have suggested local governments will be able to compensate for slumping exports and real estate construction by embarking on a new infrastructure building binge.

But analysts point out that local government revenues rely heavily on corporate profit taxes and land sales to property developers, both of which are falling, leaving them in a weaker position to launch a new round of construction.
On Wednesday, Mr Wen wrapped up a tour of the heavily industrialised Yangtze River delta region with a pronouncement that was intended to boost faith in the flagging economy.

“The more difficult the situation, the greater confidence we must have,” he said in comments published prominently in Chinese state media. “We have the conditions and the ability to definitely achieve this year’s economic and social development targets.”

Chinese investors are not the only ones hoping he is right. –Jamil Anderlini, FT.com