China's GDP growth slowed to 8.9% in the last quarter of 2011, compared with a year earlier, showing that the world's fastest engine of growth is downshifting.
While China's fourth-quarter performance would be the envy of most any other nation—and surprised analysts who had expected a sharper decline—it is still modest by the measure of the past 30 years. China's gross domestic product has soared by an average of 10% a year in that period.
When measured on a quarter-on-quarter basis, China's growth fell much more rapidly to 8.2%, reflecting slower growth in exports and weaknesses in the country's property market. Late last week, J.P. Morgan forecast that GDP growth will decline further in the current quarter, to 7.2% compared with the fourth quarter of 2011.
The global economy increasingly depends on China for growth. An expanding Chinese economy creates demand for commodities from many developing countries and for industrial products and services from wealthy ones. China, the world's second-largest economy, has also become one of the world's leading destinations for foreign investment.
Among the world's major economies, Europe is widely forecast to slump into recession this year, Japan to limp along at growth of roughly 1% and the U.S. to be lucky if it reaches 3% growth. The data eased fears among investors in Asia that China's growth would suffer a more precipitous decline, sending Shanghai's benchmark stock index up 4.2% in its biggest rise since October 2009, while Hong Kong rose 3.2% in Tuesday trading. Markets in Japan, Australia and India also rose.
The last time the Chinese economy slowed significantly was in the last quarter of 2008 when the world was tumbling into recession. Over the next two years, China responded with a four trillion yuan ($586 billion) stimulus plan that was financed by a surge in lending by state-owned banks. The response helped boost China's growth to 9.2% in 2009 despite the global downturn.
But the stimulus also produced a legacy of inflation, a real-estate bubble and a hard-to-quantify level of bad debts. Throughout 2011, Chinese policy makers struggled to contain price increases, and now they are unlikely to unleash a new round of lending that could undo their gains. "Overall, we need to plan for the worst external environment without relaxing efforts to keep prices from rising too quickly," China's central-bank governor, Zhou Xiaochuan, told prominent business-news magazine Caixin recently.
Even if Beijing wanted to step on the gas, the potential growth rate of the Chinese economy isn't what it was. A labor force that has already plateaued and will soon start to shrink in size, and diminishing returns to further investment mean the double-digit growth of the precrisis years are likely a relic of the past.
Forecasts by the Conference Board, the U.S. think tank, see growth in China at 8% year-to-year in 2012, and slowing to an average of 6.6% from 2013 to 2016. Economists Barry Eichengreen of the University of California at Berkeley, Donghyun Park of the Asian Development Bank and Kwanho Shin of Korea University, after studying the history of other onetime growth champs, argue that China's annual growth rate will begin to "downshift" by at least two percentage points starting around 2015.
For all of 2011, China grew 9.2%, compared with 10.4% in 2010. For the fourth quarter, the 8.9% GDP growth, compared with a year earlier, was the lowest reading since the second quarter of 2009 during the global recession.
China has begun to ease monetary policy to try to avoid a calamitous drop in growth. In November, the central bank moved earlier than expected to reduce the bank reserve requirements by 0.5 percentage point, paving the way for a bounce in new loans in the final months of the year. But the government's policy response is constrained by the consequences of the last surge of stimulus lending, which ended up heavily burdening local governments that borrowed for infrastructure projects. In 2011, a report by the government's own auditor acknowledged 10.7 trillion yuan ($1.7 trillion) in debts taken on by local governments.
Dong Wenbiao, the chairman of Minsheng Bank, China's ninth-largest bank by asset value, said that the risk of a local-government-debt bubble blowing up is grossly overstated. "Local governments borrowed a lot, but they used the money to build roads, railways, bridges," he said. "Those are assets they can sell to make good on their debts."
The Chinese economy is buffeted by two very different forces. Slow growth globally has hurt Chinese exports, including to the European Union, China's largest trading partner. Chinese exports there grew just 7% year-to-year in December, down from a midyear high of 22% in August.
Exporters foresee further trouble to come. Li Ji, a sales manager at Hangzhou Iron and Steel Group, says the firm's main concern is demand from Europe and the U.S. "The orders don't flow as freely as they once did," he said. Wages are rising, and the government hopes that will encourage domestic households to spend more, but perhaps not fast enough to make up for the shortfall in foreign orders in the year ahead.
Market analysts pointed to strong retail sales as cushioning the decline in GDP growth. In December, the value of retail rose 18.1% compared with the year earlier, somewhat faster than sales growth in November. J.P. Morgan attributed the gain to "some front-loading of consumer spending" ahead of the Chinese New Year holiday, which starts Jan. 23.
More fundamentally, domestic spending represented about 52% of GDP growth in the first quarter, according to Barclays Capital, a higher percentage than in the full-year GDP results for 2009 through 2011. China has long been criticized for relying too much on investment and exports for growth and not enough on domestic spending.
Chinese officials have said they are working on new incentives to spur domestic spending because ones subsidizing purchases of cars and appliances have expired. During U.S. Treasury Secretary Timothy Geithner's recent visit to Beijing, China's vice president, Xi Jinping, who is expected to become China's president and Communist Party chief by 2013, privately reiterated China's desire to shift its economy to rely more on domestic consumption and less on exports and foreign trade. The U.S. believes that the weak global economy has made China more aware of the need to change.
China's other major weakness is its property market, but there Chinese government policy plays a major role. Beijing has been trying to rein in prices by making it more difficult for developers to finance luxury apartments and making it harder for investors to buy them by requiring down payments of as much as 60%, among other measures. Almost two years of such controls on the property sector has put a serious dent in sales, and developers are starting to go slow on new projects. New floor area under construction contracted in December compared with a year earlier, a stark contrast with growth of 32% in August.
In a company newsletter, Song Weiping, chairman of Hangzhou-based luxury developer Greentown China, said in December that the firm's 2012 priority would be to "make every effort to survive."
China is counting on its massive effort to build low-income housing, called "social housing," to provide enough demand to keep the real-estate market from collapsing. China's real-estate sector could account for roughly 25% of its GDP, when counting raw materials, construction and the furniture, appliances and other goods used to outfit apartments.
But it is unclear whether China could accelerate the program, whose goal is to build 36 million subsidized apartments by the end of 2015—enough units to house the entire population of Germany. The Ministry of Housing has reduced the 2012 target for social-housing starts to roughly seven million in 2012 from a goal of 10 million in 2011. Some reduction was expected, but the large decline reflects concern that local governments couldn't meet the construction targets and were inflating their claims of progress.
Financial markets anticipated worse news ahead. The Shanghai Composite Index fell 21% over the course of 2011. "China's equity markets haven't always got it right, but if they are in any sense a discounting mechanism they suggest much worse economic data to come," said Paul Cavey, China economist for Macquarie.
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