Can China Turn 'Economy on Steroids' to Real Growth?

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China is due to release its first quarter growth figures Monday and expectations are high that they will confirm economic recovery in the world's most populous nation is on track. But how sustainable is this stimulus-backed rebound clouded by elevated debt levels and a bubbly property market?

"The recovery has been largely government-driven, and has been underpinned by property froth and rampant shadow finance. The challenge still centers around stressed corporate balance sheets and a pervasive local government bailout culture. This is not a healthy recovery," said Alistair Thornton, senior China economist at financial analysis firm IHS.

Data out Monday are expected to show gross domestic product (GDP) growth picking up to 8 percent in the first three months of the year from 7.9 percent in the previous quarter.

(Read More: China's Growth Speeds Up, but for How Long?)

While such growth levels are the envy of major economies around the world, the continuation of the recovery - which has been largely fueled by a $157 billion infrastructure stimulus package unleashed in the second half of 2012 - remains in doubt.

"Fixed asset investment is dominated by the increase in infrastructure investment driven by local governments, while private industrial investment remains muted. This is a muted growth rebound and, to some extent, unsustainable," said Dong Tao economist at Credit Suisse.

One of the factors that could impede growth going ahead is the property sector which has attracted a lot of government curbs. Analysts say there is a risk that property construction could slow in the coming months as the latest anti-speculation measures announced in March begin to bite. Real estate construction accounts for 10-12 percent of GDP, according to IHS and a slowdown in this sector could really hurt.

(Read More: China Housing Curbs Kick In, So Why Are Stocks Up?)

While debt-fueled investment projects in the mainland have supported the economy's growth, Patrick Chovanec, chief strategist at Silvercrest Asset Management, warns that a "substantial amount of these debts are misdirected investments that are not generating returns," as they have created overcapacity, which is evident from the country's "ghost cities" and "roads to nowhere."

Growing Debt Worries

Another threat is the presence of a shadow banking system, which accounts for much of the debt used to fund building projects in the absence of bank credit, said economists.

The shadow banking system is estimated at 22.8 trillion yuan ($3.7 trillion), equivalent to 44 percent of GDP and 25 percent of the total outstanding credit, according to Credit Suisse. It estimates that around half of the new credit issued last year was by shadow banks.

(Read More: China's Brokerages Behind Growth in Shadow Banking)

Earlier this week, rising concerns over elevated debt levels in the world's second largest economy - brought on by the rise of shadow banking and rapid credit growth - prompted ratings agency Fitch to downgrade China's long-term local currency credit rating to A-plus from AA-minus.

Beyond Building

Outside of the infrastructure sector, economic activity remains "unremarkable," said Tao of Credit Suisse.

"Infrastructure investment seems to have failed to jump-start other economic activities," he said pointing to a softer consumer market - which has been dampened by the government's crackdown on conspicuous consumption - as well as subdued industrial production.

The latest purchasing managers' index (PMI), for example, showed a muted recovery in the country's key manufacturing sector. The official PMI came in at 50.9 in March - underperforming expectations for a rise to 52. Adding to this, producer prices continued to decline last month, falling by a more-than-expected 1.9 percent, from February's drop of 1.6 percent.

While deflation in producer prices is partly tied to weaker commodity prices, it is also a reflection of weak demand in the economy, say economists.

(Read More: China Services PMI: Not as Good as It Looks?)

Gordon Chang, author of "The Coming Collapse of China," said with deflation in the manufacturing sector, it is difficult to imagine how the economy is growing at all.

"China is going to come out with a big number for GDP growth - but how do you reconcile deflation and growth at the same time. Those things don't exist in our galaxy," Chang said.

According to Chang, "in reality" the mainland economy will grow just 4-5 percent this year, but added that the government will likely report a figure above 7 percent for the full year.

"If you strip out economically useless production - like the unsold apartments - then you would be at zero," he said.