Chinese leaders struggle to balance growth and reform plans as economy cools

Economic Indicators Associated Press

China's slump is shaking the world economy, turning a country long seen as a growth engine into a possible threat.

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The slowdown started as a side effect of the Communist Party's plan to steer the world's second-largest economy to a "new normal" of lower, steadier growth. It has turned into a nose dive the party is struggling to reverse.

The party's plans call for keeping economic growth close to 7 percent this year while China shifts from reliance on trade and investment to more self-sustaining growth based on domestic consumption.

Exports were supposed to grow by 6 percent this year, but instead they are shrinking. Factories are shedding millions of jobs, threatening to inflame political tensions. New industries including e-commerce are growing but still are too small to offset job losses in traditional businesses.

"There are pockets of extreme weakness in China's economy but also areas of strength," said Mark Williams, chief Asia economist for Capital Economics in London. "The services sector seems to be doing well, but industry is really struggling."

THE NEW NORMAL: The Communist Party succeeded at cooling a debt-fueled construction and real estate boom. But creating a consumer economy is taking longer as households facing an uncertain job market tighten their belts. Steel, coal mining and heavy industry are cutting workforces while retail spending and new industries are growing but still are small. The government reported economic growth held steady at 7 percent in the latest quarter, though private sector analysts say the real figure might be 5 percent or lower. Whatever it is, growth is due to fall further. Communist leaders say they can tolerate lower headline growth so long as the economy generates enough jobs.

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MANUFACTURING AND EXPORTS: Sales by China's powerhouse exporters, who employ tens of millions of people, shrank by an unexpectedly sharp 8.3 percent in July from a year earlier. It looks increasingly unlikely China can meet its 2015 growth target of 6 percent. The ruling party wants to avoid dumping laid-off factory workers into the job market. The number of factory jobs in the southern province of Guangdong, heartland of China's export industry, fell by nearly 5 million from a year earlier to 13.3 million in first quarter of 2015. The China Labor Bulletin, a research group in Hong Kong, says there have been 211 strikes this year in Guangdong, mostly over back wages owed to laid-off workers.

CHINESE STIMULUS: The threat of job losses has forced Beijing to inject money into the economy through railway construction and other measures, setting back efforts to reduce reliance on investment. Beijing has cut interest rates five times since November. That reduces financing costs for state companies but does little for entrepreneurs who generate wealth and jobs but have little access to the state-owned banking industry. Private sector analysts say the quickest way to revive the state-dominated economy is to move faster on promised reforms to give entrepreneurs a bigger role. Beijing's surprise Aug. 11 devaluation of its yuan was criticized by some as an attempt to help struggling Chinese exporters, but economists said the 3 percent change was too small to make a difference due to weak global demand. Still, it prompted fears of a "currency war" if other governments responded by devaluing their own currencies to keep export prices low.

BANKS: China's state-owned banking industry is a powerful tool that allows Beijing to channel money to politically favored projects or to force cash into the economy to boost growth. Lending rose in July, but analysts say much of the increase went to other financial institutions. That included loans to a state-owned company that was charged with propping up the sinking stock market by purchasing shares. At the same time, lending to businesses weakened. Communist leaders say they want to make state-owned banks more market-oriented and competitive. But entrepreneurs still get few loans and borrow instead from an unregulated underground credit market at high interest. Defaults spiked as the economy weakened, making loans harder to get and inflicting losses on small investors who entrusted money to underground lenders. At the same time, regulators are tightening control over "shadow banking," or lending and the sale of financial products by state banks outside their normal operations. The lack of details released by banks has prompted concern they might be failing to disclose risks, but industry analysts say such uncertainty is decreasing.

CONSUMERS: Retail sales are a bright spot in China's economy. Growth edged down in July but to a still-healthy 10.4 percent, while online commerce is growing at twice that rate. Still, the industry is growing from a very low base. In the southern province of Guangdong, retailing employs 1.3 million people, barely one-tenth the number in manufacturing. And some industry segments have suffered setbacks. Auto sales fell 3.4 percent in June and that decline accelerated to 6.6 percent in July, startling forecasters who expected 7 to 8 percent growth this year. Some have slashed their growth outlook for the year to as low as 1.7 percent, a troubling development for Western automakers such as General Motors Co. and Volkswagen AG that face little to no growth elsewhere and look to China, the biggest market by number of vehicles sold, to drive future revenue. Sales of home appliances and furniture also have weakened, possibly due to slower housing sales.

SWOONING STOCK MARKETS: The explosive rise and abrupt fall of Chinese stock prices has inflicted losses on small investors and threatens to set back economic reform plans. The rise started last year after state media said stocks were inexpensive and accelerated despite weakening manufacturing and trade. The collapse in prices from their June peak has wiped out this year's gains, souring small investors. The number of Chinese households that own shares stood at a relatively modest 8.8 percent in the second quarter of this year, according to a survey by Southwestern University of Finance, well below the one-third or more of households in the United States and other Western markets that invest in stocks. The market slump would set back the party's hopes of getting more ordinary Chinese to invest in the markets and of having state companies raise money through stock sales to reduce debt and modernize.