Growing fears of a hard landing for China's economy

China controls its economy like a heater — it turns it up and down. After two years of cooling, Chinese policymakers are turning up the heater again.

But before the stimulus measures actually kick in, China’s economic growth may dip below policymakers’ comfort zone. An investment-driven rebound is expected in the third and fourth quarters this year, when monetary easing gradually trickles through the economy, according to Morgan Stanley.

China recorded relatively low GDP growth of 8.1% during the first quarter, but it is expected to slow further. “Things have to get worse before getting better,” said Helen Qiao, a China economist at the bank. “And we are in the middle of getting worse.”

One strong indication of the slowdown, Qiao reckoned, is the growth of industrial production, which has dipped to 9.3% recently. “It was a scary number,” she said at a press briefing yesterday, “since industrial production has a very strong correlation with GDP. Industrial production growth of 9.3% implies roughly 6% GDP growth.”

Such low growth is well below consensus expectations for the full year, but is a frightening data point nevertheless. According to some economists, 6% is the threshold for a so-called hard landing.

However, Morgan Stanley remains bullish on China and has set its 2012 GDP forecast at 8.5%, down from a previous forecast of 9% due to the latest set of weak data and because policymakers’ responses have been less aggressive and slower than expected, Qiao explained.

HSBC estimates that China’s economy will grow 8.6% this year, providing the government eases monetary and fiscal policies.

Even so, the rapid turnaround has surprised many China watchers. “China’s trade surplus, the GDP and inflation all came down very quickly, within six months,” said James Rickards, a partner at JAC Capital Advisors. “I thought it would take 18 months.”

The dramatic economic slowdown is attributed to relentless monetary tightening, meaning in effect that the stimulus measures are China’s response to a problem of its own making.

“China manages its monetary policy like adjusting the thermometer for a nuclear reactor,” said Rickards. “If it does it right, it gets a good temperature, but if it does it wrong, it could lead to catastrophe.”

Sun Junwei, a China economist at HSBC, noted that the historical Rmb4 trillion stimulus package launched in late 2008 will not be repeated again.

Not surprisingly, Beijing is acting more cautiously in its response to slow growth. It has lowered reserve requirement ratios three times since November, but it hasn’t changed interest rates since an increase in July last year.

Qiao forecast that China will cut interest rates twice in the near future and halt renminbi appreciation until the end of this year.

Official data suggests more monetary easing is on the way. According to data from National Development and Reform Commission (NDRC), there has been an increase in the number of projects that have been approved. These projects are mostly focused on infrastructure and electricity, and mainly in western China.

Moreover, local governments in western China, which are usually short of funding, have seen a notable pick-up in the pace of highway construction recently — a sure sign that they are getting financial support from the central government and approval from the NDRC.

So the heater is clearly up again.