A huge boost in bank lending has given China only slight support for economic growth, while short-term stimulus measures have added to mountains of debt, early readings suggest.
On Sunday, China's closely-watched purchasing managers’ index (PMI) for manufacturing in April dropped to 50.1 from 50.2 in March, showing weaker expansion.
The official PMI for non-manufacturing activity also dipped to 53.5 from 53.8, the National Bureau of Statistics (NBS) said. PMI marks below 50 indicate contraction in the economy.
Both results fell short of forecasts for PMI gains after a surge in first-quarter bank loans, which were expected to pump up growth.
Instead, the April readings suggest that lending lifelines have a diminishing effect in rescuing the economy, despite a return to stimulus policies that the government has resisted for the past three years.
Since taking office in 2013, President Xi Jinping and Premier Li Keqiang have made a point of rejecting a repeat of the 4-trillion-yuan (U.S. $617 billion) stimulus package that the previous government approved in 2008.
The giant loan and infrastructure program buoyed the economy through the worldwide recession, but it was also blamed for a spike of hasty construction, pollution and debt.
"The good news is that in the past couple of years we did not resort to massive stimulus measures for economic growth," Premier Li said in March 2015.
"That has made it possible for us to have fairly ample room to exercise macroeconomic regulation," he said in remarks quoted by the Financial Times last year.
Jump in bank lending
But stimulus concerns have been renewed by a 25-percent jump in this year's first-quarter yuan-denominated bank lending to 4.61 trillion yuan (U.S. $712 billion).
Total social financing, a measure that includes non-bank lending, hit 6.59 trillion yuan (U.S. $1 trillion) in the quarter, up 41 percent from a year before.
The volume of new loans has already surpassed the 2008 program, according to People's Bank of China (PBOC) figures.
March lending of 1.37 trillion yuan (U.S. $211 billion) soared 89 percent from February, the Financial Times said.
By the end of March, outstanding loans of 98.5 trillion yuan (U.S. $15.2 trillion) from China's financial institutions rose 14.7 percent from a year earlier, the PBOC reported.
First-quarter infrastructure investment of 1.54 trillion yuan (U.S. $237 billion) climbed 19.6 percent, the NBS said.
"Once again, China's return to growth has come through a revival in lending and construction — at the expense of progress on deleveraging and rebalancing," Bloomberg News analysts said in comments on the PMI results.
In a signed commentary on Monday, the official Xinhua news agency denied that the government had broken its no-big-stimulus pledge.
"This rapid increase in loans is temporary," it said. "China will not resort to large stimulus measures; policymakers are more than aware of the consequences of such a shortsighted program."
But the figures suggest that, if the pledge has not been broken, it has been seriously bent.
Old and new growth models
For much of last year, officials portrayed China's policy course as a choice between old and new growth models.
The country should rely on rising consumption, the service sector and innovation to propel the economy rather than the tired engine of industrial production, as in the past, leaders said.
With the first-quarter gross domestic product figures, the strategy seems to have shifted as the growth rate slipped to 6.7 percent from 6.8 percent in the previous period and an annual 6.9 percent in 2015, a 25-year low.
"The government should hope that business confidence — and consumer spending — grow in coming months, as government stimulus is the big reason the economy is so far meeting the government's growth range of 6.5 percent to 7 percent growth for 2016," said the website of Fortune magazine.
But in a commentary for the official English-language China Daily on April 14, a former PBOC policy official laid out the rationale for challenging the either-or approach to growth.
China needs to balance stimulus with "supply-side reform" to keep growth from falling further, wrote Li Feng, a former president of the China Society for World Economics.
Li argued that four years of deflationary pressure had trapped China in a "downward spiral," while real estate investment has been declining too fast for new demand from consumption to take up the slack.
Further producer price deflation will only worsen industrial overcapacity and cause debt levels to rise in real terms, he said.
"In this context, China is not facing a choice between Keynesian stimulus or supply-side reform, but rather a challenge in balancing the two," Li said.
Implicit in the argument is the message that the government will not simply shut down a slew of debt-laden state-owned enterprises (SOEs) and let growth rates continue to drop.
"In order to avoid a hard landing that would make structural adjustment extremely difficult ... another stimulus package that increases aggregate demand through infrastructure investment is needed," Li said.
Government officials seem to have adopted the approach, softening the rhetorical hard line against stimulus policy.
Buying time
In a Wall Street Journal interview during a Group of 20 (G20) meeting in Washington last month, Finance Minister Lou Jiwei spoke of "using monetary policy to buy time" as the focus for the group of major economies.
"It's buying time for reform to gain traction," he said. "We need to combine monetary and fiscal policies with structural reform policies."
Lou cited the need for "a stronger and more enhanced agenda," signaling that the government will try to fortify the economy with stimulus while developing reforms.
"That seems to be their strategy," said Harvard University economics professor Dale Jorgenson in an interview. "They've announced that and they seem to be following it."
"This is something where they need a careful balance," Jorgenson said.
In the recent update to its World Economic Outlook, the International Monetary Fund cited China's "announced policy stimulus" in deciding to raise the GDP growth forecast for this year from 6.3 percent to 6.5 percent.
But warnings against rising debt levels have caused the government and the PBOC to qualify their policies in delicately balanced terms.
Monetary policy "will maintain a certain degree of looseness in the coming months, but 'prudence' will feature more prominently than last year," Xinhua said.
"As the economy has yet to fully restore its strength, China will not shy away from using the ample tools at its disposal to bolster the economy," said the statement attributed to top officials.
"But it will be more careful to prevent the easing from going too far," it said.
In its separate Global Financial Stability Report, the IMF warned last month that China's banks could sustain major losses on U.S. $1.3 trillion (8.4 trillion yuan) of loans to "firms that do not earn enough to cover their interest payments," a fund official said.
Critical questions
Despite the government's stated opposition to "massive stimulus measures," China has been steadily pursuing policies with a series of interest rate cuts and lower reserve requirement ratios for banks over the past year.
The critical questions now are whether stimulus lending will support a 2008-style program of infrastructure projects, and whether loans will be used to "buy time" for restructuring or simply to forestall SOE reforms.
A high volume of transport projects and renewed real estate activity may be taken as signs that Li's stand against stimulus spending has been reversed.
Since last September, the National Development and Reform Commission (NDRC) planning agency has approved over 100 projects for rail, transportation and metro systems valued at more than 2 trillion yuan (U.S. $309 billion), Xinhua reported.
First-quarter reports from the NBS suggest that new credit is flowing into the housing sector, despite a backlog of unsold homes that could take years to digest.
New housing construction climbed 19.2 percent from the year-earlier period in terms of floor area after falling 14 percent in 2015, the NBS said.
Instead of waiting for the inventory to fall, property developers are pushing new projects, spurred by rising prices in first-tier cities like Shenzhen and the new stimulus signals from the government.
March prices of new homes were up 62.5 percent from a year earlier in Shenzhen, 30.5 percent in Shanghai and 17.6 percent in Beijing, the NBS said.
The boom mentality may be a sign that investors expect 2008-style stimulus policies to last as long as the government feels pressured by declining GDP growth rates.
Encouraging steelmakers
The stimulus may already be encouraging China's steelmakers to slow their planned cuts in production overcapacity, despite rising international pressure over low prices.
Thanks to the stimulus, daily crude steel production in March was close to a record high, said analyst Li Xinchuang at the China Metallurgical Research Institute, according to The Australian Financial Review.
But Jorgenson believes the new stimulus policy will not stop the government from putting reform and restructuring pressure on SOEs.
"They don't want to keep these people in business unless they have commercially viable products," he said. "I think they are moving in the right direction in terms of dealing with the SOEs."