China’s economy is at risk of  slowing further in the absence of more forceful government action as confidence among businesses and households continues to erode. 

For the leadership, delivering such action would mean retreating further from its commitments to keep debt levels in check and clean up the financial system. However, the costs of trying to hold the line are only set to increase. 

A slowing pace of growth was inevitable as China’s economy matured — the double-digit growth rates of previous decades were never sustainable. However, Monday’s report from the National Bureau of Statistics showed how much a crackdown on shadow finance and, to a lesser extent, the US-China trade war have hurt Chinese business and household confidence. 

It also confirms the failure of the government’s efforts so far to support growth. 

This was reflected in a slowdown in the growth of private investment, which fell to 5.7 per cent in the first half of the year from 6.4 per cent in the first quarter. Although growth of total social financing showed signs of recovery in June, this was because of increased issuance of special local government bonds, used to fund infrastructure. 

At the same time, the share of medium to long-term loans to companies, the kind of credit that tends to go towards productive, job-creating investments, has fallen as growing economic uncertainty  weighs on borrowing appetites

The loss of confidence among private companies is feeding through to households. Although headline June retail sales growth was helped by a short-term boost to car sales,  consumers are nervous. Sentiment is still relatively buoyant but much-vaunted income tax cuts have not supported household spending. Our monthly survey of urban consumers shows a greater propensity to save over investing or consuming as uncertainty grows.

Disposable incomes did rise 6.5 per cent in real terms in the first half, 0.2 percentage points faster than economic growth, but this is not enough to drive a solid rebound in consumption in the short term. 

As the shadow grows over the external sector from a slowing global economy and the US-China trade war, the authorities may become more reliant on infrastructure investment and property to deliver growth. Together, these accounted for 38 per cent of investment activity in the second quarter, down only slightly from the first quarter’s 44 per cent. 

But both face increased constraints. Although the year is only half over, Rmb1.37tn ($200bn) in special local government bonds have been issued, meaning that two-thirds of the annual quota has been used up, representing a significant drawdown of fiscal firepower

Such bonds are an important source of infrastructure financing, and projects face growing funding difficulties. The government has  relaxed rules on project financing but the impact will be limited. Either the government relaxes its crackdown on shadow finance and the ability of local governments to borrow, or it will need to push through an outright increase in the annual quota of local government bond issuance. 

Real estate construction growth may also slow further in the back half of the year after the drop in growth of new housing starts in the first half. This fall follows the collapse in land sales that began at the end of last year. 

The authorities have recently cracked down on the flow of trust loans to property developers but such a policy approach is unsustainable. Cumulative year-to-date real estate investment growth in June was the slowest so far this year and the sector is too important as a driver of economic growth — as are rising house prices as a  support of consumer sentiment

Within hours of the second quarter data release, US president Donald Trump was on Twitter crowing about how China’s economic problems were the result of the tariffs imposed by his administration. 

But he misreads the causes of the slowdown in Chinese growth. 

The US-China trade war has taken its toll on business and consumer confidence in China but efforts to rein in debt, including the crackdown on shadow finance, has had a far more direct and more painful impact.  

Although it still remains dangerously wedded to meeting pre-determined growth targets, China’s leadership has showed more willingness to allow the economy to slow. 

This is why officials have done a fair job so far in avoiding a resort to blanket stimulus policies, preferring to target relief at those parts of the economy they feel are underserved and could play an important role in driving sustainable growth.

But risks to economic growth may require, and result in, a more forceful response from a government under pressure.  

— He Wei, Finance Researcher, FT Confidential Research

FT Confidential Research is an independent research service from the Financial Times, providing in-depth analysis of and statistical insight into China and south-east Asia. Our team of researchers in these key markets combine findings from our proprietary surveys with on-the-ground research to provide predictive analysis for investors.