China’s G.D.P. Growth Slows as Government Changes Gears

HONG KONG — China's new tough-love approach to overhauling its giant
economy showed through in lackluster economic data released on Monday,
underlining just how rapidly growth in the once-sizzling economy has
cooled.

China's economy grew 7.5 percent in the second quarter of this year,
compared with the same period a year earlier, the National Bureau of
Statistics reported. The figure was in line with economists'
expectations, but represented a progressive slowdown from 7.7 percent
gross domestic product growth in the first quarter and 7.9 percent in
the final three months of 2012.

Industrial output data for June, also released Monday, came in weaker
than forecast, with an increase of 8.9 percent from a year earlier —
down from 9.2 percent in May. The growth in fixed asset investment in
urban areas, another key measure of economic activity, also slowed
slightly during the first six months of the year.

On the upside, however, retail sales came in better than expected,
rising 13.3 percent in June from a year earlier. The May reading was
12.9 percent.

The slowdown in the world's second-largest economy after the United
States has left some analysts concerned that China could lose yet more
steam in the coming quarters, denting the ravenous demand for goods
that has been a key support to global growth at a time when Europe and
the United States are struggling to grow.

Xianfang Ren, an economist at IHS Global Insight in Beijing, wrote in
a research note on Monday that China's growth was "at risk of
stalling," and that "the downside risk for growth has become much more
elevated now than a few months ago."

Increasing signs that China is faltering have prompted a number of
economists to downgrade their forecasts for the country. Zhang Zhiwei,
China economist at Nomura, lowered his growth forecast for 2014 from
7.5 percent to 6.9 percent following Monday's data release (he
continues to project 7.5 percent growth for this year).

Officials in Beijing, however, continued to signal on Monday that they
were comfortable with the slowdown, which comes as the country is
preparing for a major structural overhaul designed to put future
expansion on a more sustainable and balanced footing albeit at the
price of more moderate growth.

Sheng Laiyun, the spokesman for the statistics bureau, said on Monday
that the latest data were within the bounds of official expectations,
though he acknowledged headwinds were buffeting the economy.

"Viewed over all, national economic performance in the first half of
the year was generally stable, and the main indicators remain within
the reasonable bounds for the annual forecast," Mr. Sheng said during
a news conference broadcast live on Chinese television. "But economic
conditions are still complex and changeable."

To a large degree, China's recent cooling has been engineered by the
authorities in Beijing, who are trying to steer the economy from an
increasingly outdated growth model toward expansion that is more
productive and sustainable.

While this slowdown has been happening for more than two years, a
flood of comments from policy makers in recent months has made it
increasingly clear that the new leadership that took the helm in March
is serious about tolerating significantly slower growth for the
foreseeable future in return for the longer-term gains of a more
balanced economy.

Evidence of China's cooling could prompt some limited policy shifts
aimed at supporting especially pressured parts of the economy,
analysts said. On Monday, for example, the governor of China's central
bank, Zhou Xiaochuan, and other officials said the government would
extend more support to small businesses as part of its efforts to
ignite new sources of growth.

Speaking at a conference about small business policy, Mr. Zhou
outlined the challenges confronting policy makers.

"Currently, domestic and external economic conditions are unusually
complicated, there are quite a number of destabilizing and uncertain
factors, and the downward pressures on the economy are quite
considerable," Mr. Zhou said, according to a transcript of his
comments on the Chinese government's main Web site.

Still, few analysts expect the government to revert to heavy-hitting
stimulus measures of the kind implemented after the financial crisis.

"The new leaders' tough-love stance will not be easily swayed, at
least not by this latest set of data," Yao Wei, China economist at
Société Générale in Hong Kong, said in a research note. "We continue
to see limited chance of any significant monetary easing or
infrastructure stimulus from Beijing in the near term."

For years, China has relied on cheap credit, heavy manufacturing,
infrastructure investment and exports as key economic drivers — a
combination that produced double-digit annual growth rates for much of
the past 30 years.

Increasingly, however, this growth model is running out of momentum.
China's population is aging and its labor force is shrinking, meaning
that labor productivity has to be raised to make up for the shortfall.
Rising wages and a stronger renminbi have eroded China's
competitiveness and are undermining its status as the blue-collar
factory floor of the world. At the same time, demand in the key export
markets of Europe and the United States remains slack.

Last week, China's customs department reported that exports in June
fell 3.1 percent from a year earlier, the first drop since early 2012.
Imports decreased 0.7 percent, falling for the second month in a row.
Both figures were far below the expectations of analysts, who had
projected a 4 percent rise in exports and an 8 percent climb in
imports.

Aware of these pressures, the new leadership has said it wants to
reduce the inefficiencies and environmental degradation that came with
headlong growth, permit more competition and market liberalization in
areas that have traditionally been dominated by state-controlled
enterprises, and shift the economy more toward domestic consumption.
It is placing a heavy emphasis on increased urbanization as a driver
of development and income growth.

Much uncertainty remains, however, as to the timing, pace and exact
nature of the changes that Beijing wants to achieve: The policy
pronouncements so far have been broad in nature, and little more
detail is likely to be forthcoming until a meeting of the Communist
Party Central Committee this autumn.

Shaking up the status quo, moreover, is likely to be tough, analysts
say, not least because any significant changes risk running into
resistance from vested interests in the political economy, and could
undermine the reach and authority of the Communist Party that has
ruled the country since 1949.

In addition to these structural challenges, Beijing also needs to
tackle a big increase in lending, much of it opaque and outside the
regulated banking system, that has fanned concerns of asset-price
bubbles and the risk of defaults in recent years.

Reining in this lending splurge, analysts say, is an undertaking that
will require a delicate balancing act. On the one hand, the
authorities want to clamp down on lending; on the other, they must
avoid snuffing out growth altogether.

A days-long cash crunch in the banking system last month – apparently
aimed at getting lenders to adopt more cautious lending practices –
has created an increasingly clear impression that Beijing is prepared
to tolerate a degree of pain while it pursues economic overhauls.

"The fact that we have not seen moves toward more stimulus seems to
show that they are comfortable with 7ish growth rather than 9 or 10,"
Paul Gruenwald, chief economist for Asia-Pacific at Standard & Poor's,
said at a media briefing in Hong Kong last week. "It suggests that the
authorities understand that there is a trade-off between growth and
financial stability. At the same time, if you let growth fall too low,
then you risk a deterioration of banks' loan books. They need to find
the sweet spot."

For the time being, most analysts believe that Beijing is likely to
hold off stepping on the economic accelerator again unless the overall
economy worsens sharply.

Highly sensitive to anything that could set off social discontent,
Chinese policy makers are likely to be especially responsive to any
signs that the job market is deteriorating.

"The labor market is a critical wild card for the policy outlook," Mr.
Zhang of Nomura said. Reliable data on the job market are hard to come
by, meaning that observers have to rely largely on anecdotes reported
in the news media to get a sense of how employment is holding up. But
so far, Mr. Zhang said, "we've seen nothing alarming" on that front.