China heads for a hard landing

China’s economy is starting to sputter. Manufacturing is shrinking, growth in services has all but halted, and the property bubble is bursting. There will be no soft landing for China.

China's engine is starting to sputter, says Keith Bradsher in The New York Times. A survey of Chinese purchasing managers in the manufacturing sector, by HSBC and Markit Economics, has now been pointing to marginally shrinking activity for three successive months. Its service sector equivalent is barely expanding.

Air is also hissing out of the property bubble. Between July and August, prices in more than half the 70 biggest cities were flat, or fell. In some areas, price- to-income ratios had reached extreme highs of more than 20. Consumption is easing too. Family vehicle sales in August were still up by 6% year-on-year last month, but that follows years of double-digit growth.

Walking the tightrope

Inflation, however, remains high. Annual consumer price inflation was 6.2% in August, only slightly down from July's three-year high of 6.5% and well above the government's 4% target. That's despite five interest-rate hikes and nine increases in bank reserve requirements (the amount of money banks have to set aside rather than lend out).

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The government is well aware that high inflation can lead to social unrest: rising prices were a factor in the Tiananmen Square uprisings. At the same time, it is widely acknowledged that the economy needs to expand by 8% a year to ensure that there are enough jobs for the rapidly urbanising population. Walking this tightrope, as Lex points out in the FT, "has rarely seemed so complex".

On the inflation front, the problem stems partly from volatile food prices. But a key problem is that "too much money finds its way into the economy through non-bank lending", says Emily Kaiser on Following the state-mandated lending spree that kept China afloat through the global recession, the authorities are trying to cool the credit boom.

Money supply figures are down, but The Daily Telegraph's Ambrose Evans-Pritchard cites figures from credit-ratings agency Fitch saying that credit growth was still running at 38% for this year if off-book financing (such as letters of credit or loans from Hong Kong banks) is included. Moreover, many worry that "China's shadow banking system looks ominously similar to that of the US before the last crisis", says Kaiser: "enormous, murky and loosely regulated".

With a record $2.7trn worth of loans extended over two years, there is ample scope for a nasty slowdown due to vast overcapacity and a "massive non-performing loan problem" in the banking sector, says Nouriel Roubini of New York University.

So rather than engineer a gentle slowdown while taming inflation, as the world hopes, China could well end up suffering a hard landing. One area analysts have highlighted as especially vulnerable is local government debt. These loans are thought to be worth more than 25% of the economy's total output. Lending was driven by a "patronage spree", says Evans-Pritchard.

China faces an export shock

Given that exports remain a crucial driver of growth, the external environment could also trip China up. Just as the authorities "are managing to hammer down demand growth", says Diana Choyleva of Lombard Street Research, "the rest of the world is not looking healthy, so there's going to be an export shock". She sees growth sliding to an annualised 5% later this year. Many economists reckon that counts as a hard landing, given China's typical growth rates around double digits.

China depends on growth in the developed world and in any case remains too small an economy to compensate fully for a downturn beyond its borders. Deutsche Bank's Jun Ma says that, to offset a drop of 3% in American and European growth, China would have to increase its own growth by 18%: "China to the rescue? Mission impossible."