Is China Taking Its Eye Off the Ball on the Economy?

A growing stack of gloomy economic numbers from China has triggered a concern that China’s policymakers may be taking their eye off the ball when it comes to the economy, especially as officials prepare for a once-a-decade leadership transition.

A policeman patrols under a giant communist emblem on the Tiananmen Square on June 28, 2011 in Beijing, China.
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A policeman patrols under a giant communist emblem on the Tiananmen Square on June 28, 2011 in Beijing, China.

The change in China’s political leadership is expected to take place next month and comes as the economy, which has enjoyed double-digit growth rates in recent years, has slowed faster than expected this year.

The worry for financial markets, analysts say, is that rather than focusing on getting the economy back on track, officials have become sidetracked by political maneuvering ahead of the leadership change. And that’s not good news for China’s stock market,which has been languishing at 3-1/2 year lows.

“We are worried about the slowdown in China because there seems to be no policy response at the moment and it seems very unlikely that we will see anything until the whole leadership transition has taken place,” said Aadil Ebrahim, Managing Director at fund manager Bowen Asia.

“The leadership transition has caused a lot of uncertainty right now and caused some of them (Chinese policy makers) to take their eye off the ball,” he told CNBC Asia’s Squawk Box on Tuesday.

Indeed, it was a Chinese political scandal that was grabbing the headlines on Tuesday with news that a close ally of President Hu Jintao has been demoted amid reports that the ally’s son was involved in a deadly crash involving a luxury sports car earlier this year.

Still, it’s the economic news that has made particularly grim reading: China’s factory output in July was the weakest in just over three years, July exports rose just 1 percent from a year earlier, and China’s official Purchasing Managers’ Index (PMI) fell to 49.2 in August from 50.1 in July – dropping below the 50-mark that separates expansion from contraction.

“They need to do something just to get back to where market expectations have been, let alone get ahead of market expectations,” Richard Yetsenga, Head of Global Markets Research at ANZ, told CNBC on Monday after news that the HSBC China PMI fell in August to its lowest level since March 2009.

Analysts point out that China’s central bank, which has developed a reputation of acting quickly and decisively at signs of trouble in the economy, has been notably quiet in recent weeks as poor economic data mounted.

“With the change in leadership coming, there is a feeling that things are on hold in China,” said Justin Harper, Market Strategist at IG Markets in Singapore. “When we’ve had weak data in the past, we’ve had monetary easing but we haven’t had that recently. People are disappointed that more is not being done to boost the economy.”

Rob Subbaraman, Chief Asia Economist at Nomura in Hong Kong told CNBC Asia’s “The Call” on Tuesday that clients say investors seem more worried about China right now than Europe, which is grappling with a debt crisis and a recession in much of the region.

China’s central bank cut interest rates in June and July and has also eased monetary policy by lowering reserve ratio requirements for banks three times since November 2011.

Differing Perceptions

Even without the upcoming leadership transition, analysts agree that China is in a bit of a tricky situation with regards to economy policy.

For starters, policymakers are mindful of not repeating the mistakes of the past. Four years ago, the government announced spending worth $586 billion or 14 percent of its GDP, to protect the economy from the global financial crisis, but that spending has subsequently been blamed for problems such as inflation and over investment in housing.

Then there’s the issue of inflation. Although consumer inflation fell to its lowest in 30 months in July at 1.8 percent it is expected to creep higherin the months ahead, limiting the central bank’s room to maneuver on interest rates.

The issue, according to Dariusz Kowalczyk, Senior Economist and Strategist at Credit Agricole, is that the markets’ perceptions of what action China should take on the economy and policymakers’ perception of measures they should take are completely different.

“What is happening is that China has different growth objectives to the market,” he said. “China will miss exaggerated market perceptions of their growth targets, but what is important to China is that during the political transition it manages economic-related social issues, which is why they have wanted to keep a lid on house prices.”

Average home prices in China's 100 big cities crept up in August for a third straight month but the pace of the rise has slowed, a private survey on Monday showed, suggesting that the government’s desire to keep tight controls on the property market are working.

Others say the point is not whether or not China delivers large fiscal and monetary stimulus measures, but that even a delay in modest economic measures could hamper an economic recovery.

“The concern is that the delay until the new leadership takes over could stop economic progress,” said Harper at IG Markets. “The political aspect could damage the economic revival.”

- By CNBC's Dhara Ranasinghe