China is struggling to wean itself off a habit picked up from its more advanced neighbour: Relying for growth on exports and credit-fuelled investment. That has left its economy lopsided, economists say, with massive over investment in property and industries rapidly losing their cost advantage, from mining and electronics to cars and textiles. Wages are rising, the return on investments falling.
With growth slipping, Chinas President Xi Jinping and Premier Li Keqiang seem determined to avoid a US-style financial crisis, complete with widespread bankruptcies and job losses.
Preventing such a crisis though could embalm diseased sectors, stifling efforts to make growth more sustainable and instead create the kind of zombie banks and companies that sucked the life out of Japans economy, economists say.
Add a population greying faster than Japans did, and economists worry China may be attempting the impossible.
There is a huge amount of denial. People think that demographics dont matter," said Chetan Ahya, chief Asia economist at Morgan Stanley in Hong Kong. Im worried about the deflationary risk.
Deflation may seem unlikely in an economy still growing at a 7.5% clip and where consumer prices are rising 2.7% a year. But economists warn that China in many ways resembles Japan in 1989, two years before its crash.
Like Japan, China relied on banks to funnel investment into export industries to create jobs and finance development. In return, interest rates were regulated to ensure banks a healthy profit. Because the most profitable loans were those to the least-risky borrowers, banks concentrated their lending on big state-owned companies.
As Japan did in the 1980s, China tried to remedy this by partially liberalising the financial sector, creating new avenues of finance, a bond market and other non-bank lending. But as in Japan, this encouraged banks to lend more, not more wisely, helping fuel a property bubble. Things got worse in 2009, when China launched a 4-trillion-yuan, credit-powered stimulus to ward off the global crisis.
Chinas problem now is that each yuan of new investment is yielding a diminishing amount of new GDP. The slowdown is already creating signs of deflationary pressure: producer prices have been falling for 16 months and Morgan Stanley notes that real borrowing costs of 8.7% are outpacing the sectors growth.
One risk, therefore, is that Chinas reforms push growth low enough to trigger a wave of defaults that shakes the entire financial system.
Since profit margins will be cut, banks will try to increase lending volumes by reducing their credit standard, said Wataru Takahashi, a former Bank of Japan official who is now a professor at the Osaka University of Economics. This is the story of the Japanese banks in the late-1980s.
Ultimately, it may be demographics that put China most firmly on Japans deflationary trail. Thanks to its one-child policy, Chinas working age population is already shrinking. Thats what happened to Japan in the 1990s, resulting in lower consumption and sharply lower growth rates.
The solution may lie where else in Japan, where the government is fighting deflation with aggressive new policies to lower borrowing costs, by boosting government spending and, though it has implemented few of them yet, by removing bottlenecks to growth.
"Two things are needed to avoid deflation after a credit binge, said Ahya at Morgan Stanley. One is good fiscal and monetary response and the second is structural reforms.
Chinas politburo holds meeting on economic situation, says Xinhua
Beijing: Chinas top decision-making body, the politburo, held a meeting on the economic situation in the first half of the year and to discuss key tasks for the second half, the official Xinhua news agency said on Tuesday.
The meeting, presided over by President Xi Jinping, came after official data showed economic growth slowed to 7.5% in the second quarter from 7.7% in the previous quarter. The economy has slowed in nine of the past 10 quarters.