Stimulus ‘Short-Term Medicine’ for China’s Economy 

Stimulus measures by Beijing will provide just a temporary fix for China’s slowing economy and could derail the country’s long-term economic rebalancing plans, say experts.

Shanghai street scene
Joseph McNally | The Image Bank | Getty Images
Shanghai street scene

“Resorting to (infrastructure) investments and (lowering) interest rates is temporary short-term medicine for reducing (China’s) pain,” May Yan, Analyst at Barclays, said in a research note.

“(This is) contrary to what China needs in the long run, namely economic rebalancing, higher equilibrium interest rates and deleveraging of the economy,” she added.

Asian markets that had risen on expectations of aggressive stimulus measures from China, fell back into negative territory on Wednesday, after reports that Beijing was looking to dampen easing expectations.

The Chinese government, which launched a 4 trillion yuan ($630 billion) stimulus package - equivalent to about 13 percent of GDP – in 2008 to prop up the economy following a slump in global markets, is forecast to launch a new round of stimulus estimated at 1-2 trillion yuan.

Reuters reported Wednesday that the chorus against a huge 2008-style stimulus was growing in China with many academics warning that it could reduce the efficiency of economic growth and exacerbate over capacity in some industries.

Yan says that in addition to derailing the country’s economic rebalancing plans, excessive stimulus would add to concerns around non-performing loans (NPLs) down the road.

Non-performing loans have emerged as one of the largest risks for China’s financial sector after mainland banks, which were encouraged to go on a lending spree to spur growth in 2009, lent billions to local governments financing vehicles, many of which are now struggling to pay back their debt.

No Major Lift for China Stocks

Dariusz Kowalczyk, Senior Economist at Credit Agricole, expects the government to launch 1 trillion yuan in stimulus measures over the course of 2012-13, but is not expecting a big lift for mainland equities as a result of this increased spending.

“China isn’t going to announce one large package, instead the government is going to announce a series of smaller, targeted measures – this won’t have a big impact on the markets,” he said.

On Tuesday, for example, the Chinese state council said it would revive its cash-for-clunkers program for consumers whereby they can trade in their old cars for new energy-efficient ones at a discount, in a bid to support the country’s vehicle market.

Earlier this month, Beijing also announced a series of small measures to boost consumer spending, including a scheme of subsidies for energy efficient white goods.

“People expect more than China is prepared to do. China is concerned about falling into the trap of addiction to stimulus, like Europe and the U.S. They don’t want to continue to do this,” Kowalczyk said.

—By CNBC Asia’s Ansuya Harjani