Is China's economy in bad shape? 5 things to consider from silver linings and slow growth to Lehman Moments and Japanification

Global investors are becoming increasingly worried after China's economic growth seemed to lose steam over the summer, while the risks faced by embattled property developers and local government financing vehicles (LGFVs) have further raised market concerns about a systemic outbreak.

But there are still some bright spots, including the rapid growth of the new energy and technology sectors, which may provide a much-needed boost to the economy.

Policymakers may still also have deep pockets to handle a variety of crises that may face the world's second-largest economy.

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There were high hopes that China would return to its previous track of fast growth after abandoning its zero-Covid policy in December.

But its rebound lasted only one quarter, with an uneven economic recovery characterised by a manufacturing sector that was hit hard, while travel, catering and entertainment businesses reported strong growth.

Second quarter sequential economic growth then slowed to 0.8 from 2.2 per cent in the first three months as manufacturing activities continued to weaken.

And while the official manufacturing purchasing managers' index rose to 49.7 in August from 49.3 in July, it remained in contraction territory with a reading below 50 for the fifth month in a row.

However, year-on-year economic growth was still 5.5 per cent in the first half of the year, higher than most developed countries.

China's economic slowdown has been accompanied by a variety of problems, some of which are structural and stubborn to eliminate.

The youth unemployment rate hit a record high of 21.3 per cent in July before Beijing halted releasing the data in August as the statistics needed to be "further improved and optimised".

Financial risks, including from debt-ridden property developers such as China Evergrande as well as local governments, have also risen with trillions of yuan in outstanding debt.

However, a so-called Lehman moment - where one company's problems become everyone's problems - is seen as unlikely as the debts are mainly owed to domestic creditors, including state-owned banks, giving Beijing leeway to reduce risk.

Chinese authorities have also started to ease mortgage rules and extend tax refunds for homebuyers in a bid to prop up the faltering property market.

An outright bailout of LGFVs - the hybrid entities that are both public and corporate and were created to skirt restrictions on local government borrowing - also seems unlikely and existing tools, including debt swaps and loan restructurings, are set to continue.

China's thriving new energy sector - lithium batteries, solar cells and electric passenger vehicles - have emerged as the bright hope for the economy and a potential new engine to drive export growth.

Six of the world's top 10 electric vehicle battery producers are from China, representing around 60 per cent of the global market this year.

China's surging investment in critical technologies, particularly artificial intelligence, has also emerged as another growth driver, with investment in the hi-tech industry rising by 12.5 per cent, year on year in the first half 2023.

With fears over deflation rising, the central bank's recent easing measures, including interest rate cuts, may appear less appealing, and any sweeping accommodative monetary policies may struggle amid pressure to stabilise the yuan.

Without improving market confidence, lenders will also be reluctant to pump money into the real economy as profitability declines.

It is a long-term challenge for Beijing to upgrade economic stability, with a shift from growth driven by property development and infrastructure to a new model featuring cutting-edge technologies, a pressing task.

The current economic malaise raises the question whether China can avoid repeating Japan's decade-long economic stagnation after its asset price bubble burst at the end of 1989.

It is undoubtedly a tough challenge given the additional geopolitical risks and the rising risk-averse sentiment from foreign investors.

However, Beijing still has a much bigger fiscal capability, meaning a deepening debt crisis may not necessarily be imminent.

And if Beijing can effectively boost private sector growth, a recovering confidence could halt a further economic slowdown.

In the long run, China's commitment to new innovation-driven growth may also offer an antidote.

This article originally appeared on the South China Morning Post (SCMP).

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