China stocks hit 7-year high, but where's the growth?

Chinese stocks rallied for their fifth successive day Monday to breach seven-year highs but growth prospects for the world's largest economy this year are yet to pick up according to economists.

China's key Shanghai Composite finished at its highest level since January 2008 for the second consecutive day, led by infrastructure and transport groups after the country's state planning agency announced a list of more than 1,000 proposed projects that it is inviting private investors to help fund and build on Monday.

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Investors watch computer screens at a stock exchange hall on May 8, 2015, in Fuyang, China.
ChinaFotoPress | Getty Images
Investors watch computer screens at a stock exchange hall on May 8, 2015, in Fuyang, China.

The country's Ministry of Finance also said it would slash import tariffs on consumer goods including skincare product, clothes, shoes and nappies from next month which also helped stocks rise 3.4 percent to 4,813.798. According to the International Monetary Fund, last October China overtook the U.S. as the world's largest economy with a $17.6 trillion gross domestic product.

Exchange Traded Funds (ETFs), securities that track an index or asset, have helped drive the recent rally in Chinese equities, with emerging market fund flows seeing close to $1 billion over the week to 20 May.

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"This was entirely due to flows to China ETFs, which turned positive after several weeks of outflows," said Daniel Salter, head of equity strategy at Renaissance Capital.

But the multi-year highs in the Chinese stock market follow an unexpectedly rapid slowdown in Chinese demand, where imports of goods declined by around 7 percent on the year in volume terms in the first quarter of the year – the fastest pace of decline since mid-2009.

As investors capitalize on the surge in equities, economists are bearish on the future of world's largest economy, as growth has proved elusive so far in 2015.

Some sparks

Recently, China introduced a series of measures including rate cuts and reductions in reserve requirement ratios, or the amount of reserves commercial banks are required to hold, in an attempt to ease monetary conditions.

"We are seeing some sparks, we saw a slight improvement in the April manufacturing PMI and we do think that a lot of the recent stimulus, including the benchmark interest rate cuts, are starting to feed through into an improvement in activity – we are also seeing a looser fiscal stance now," China economist at Capital Economics, Julian Evans-Pritchard told CNBC.

"We are optimistic that growth should at least stabilise, or downwards pressure on growth should at least should ease somewhat – but the long-run picture is on-going structural slowdown in investment and that is not going to reverse any time soon," he said, adding that in the next few years growth is set to slow further.

Senior economist at Oxford Economics, Adam Slater said while there had been a loosening of fiscal policy, the moves have "done little more than ameliorate what has been a rather significant overall tightening of monetary conditions over the last year or so," and current evidence pointed to decelerating growth.

"There are constraints on Chinese policymakers too. First, with significant deflation at the producer level, real interest rates have risen sharply and are now relatively high. Even if interest rates are slashed to the bone, China may still face a serious 'zero lower bound' problem," Slater said.

Over-investment?

China has pumped billions into state investments in the last 10 years or so, with estimates of the country's investment rate ranging from 40 to 50 percent of GDP, making it great than any other major economy in history.

While "credit splurge" was effective in boosting growth, China is now facing significant clean-up costs from this previous splurge (in the form of bad loans), Slater added.

"I think the bigger picture is and one that remains where China was investing, depending on what the numbers you look at, 40 percent of GDP investment in capital projects. Looking at history that is about as much as or more than anyone has done before. If you look at Korea in the 1950s and Japan in the 1980s - each and every time those episodes have never ended well, so you need to make a special case for China I guess, if you are optimistic on growth," founder of Carn Macro Advisors, Nick Carn told CNBC.