China's recovery is on shaky ground

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CHINA'S economic turnaround, on the back of its spectacular boom, is not looking so assured after all.

A glut of disappointing data emerged this week highlighting the narrow focus of the Government's 4 trillion-plus yuan ($770 billion) stimulus package, fuelling concerns it is not a sustainable base for the longer term.

The questions are not about whether gross domestic product growth will be 7 or 8 per cent this year, but about more fundamental and longer-term issues.

Perhaps the biggest near-term problem is that the country's once booming private sector is struggling.

The huge licks of cash coming from the Government are being mainly directed at the 170 state-owned enterprises controlled by the State Assets Supervision Commission and a raft of provincial-owned SOEs.

While the factory closures and pain in the export-orientated provinces in the south and coastal east of the country have been well documented, the problems are continuing to spread across the country.

Beijing Hitech Company, in the suburbs of the Chinese capital, which specialises in using high-end technologies to stick together different materials such as glass to steel and alumina to silicon, has been forced to cut half its 70 workers.

"Business is no good, and my neighbouring factories complain that there is no business too," the company's production manager Yu Yongmiao said.

"Our best time was in 2006 and 2007, the first half of 2008 was not so bad, but the Olympics was a turning point."

His company lost more than 2million yuan when all factories were forced to close during the Olympics. "Then the crisis came before our business could recover," Yu says.

"The central Government is investing, but mainly in infrastructure, not many buildings. Our products are used in building interiors and exterior decorations, not on roads and bridges.

"We cannot see the bottom."

Yet only one month ago, the country's cheerleaders, including many investment banks eager for deals, were convinced they were on the winning side on the back of first-quarter economic data.

While gross domestic product hit a 17-year low, the underlying trend indicated that the dramatic slump in growth down from 13.1 per cent in 2007 and 9 per cent last year had bottomed. The Chinese Government's 4 trillion yuan stimulus package -- the biggest single boost to any country in global financial history -- was hailed as a resounding success.

Australia and the free-spending Treasurer Wayne Swan have a lot -- possibly even their jobs -- riding on a sustained recovery by China, which has had, until recently, an insatiable appetite for Australia's resources. But after growing at an average of 9.8 per cent each year for the past 30 years, China's medium-term growth over the next few years will be more like 7 per cent than 10 per cent, Royal Bank of Scotland analyst Ben Stimpendorfer says.

Data for April saw exports continuing their slump, down 22.6 per cent from a year ago, industrial production growth weaker than expected and there was continued deflationary pressure.

The only bright spot, really, was surging government-backed fixed asset investment. While no one is suggesting China will stop growing soon, the recovery is patchy so far. Beyond the Chinese Government's impressive fiscal viagra, private investment is struggling, demand from the West will not return soon, reform has slowed and trade imbalances remain a problem.

There have been less than encouraging signs from China and other north Asian steelmakers, which are among the biggest consumers of Australian minerals.

China's biggest steelmaker, Baosteel, which is leading iron ore price negotiations with Australia's producers, has cut its prices twice in the past two months.

As well, China has stockpiled iron ore and other commodities and continues to demand a 40 per cent cut in iron ore prices -- none of which is good news for Australia's tax revenues and mining sector related employment.

Problematically too for the Rudd Government, it is now discovering, like its predecessors, just how hard it is to secure a free trade agreement with China.

After blazing into office spouting Mandarin and lecturing the country about human rights on its home soil, Kevin Rudd declared the talks unfrozen last year. Yet Trade Minister Simon Crean was forced to change strategy on his recent visit to China, instigating a two-track approach that brings in a bottom-up business-to-business strategy as well as continuing to pursue fading FTA hopes at government level.

There are real difficulties trying to get a good read on the Chinese economy, which is why most failed to predict its sudden downturn last year. It reflects the rest of the central command system: its operations are opaque and the powers that be only issue data that tells half the story.

The private sector, which makes up about 70 per cent of the Chinese economy, is in many ways near invisible. There are no unemployment figures, payroll figures, private consumption numbers or unemployment statistics beyond a single number.

China's share markets in Shanghai and Shenzen have risen faster than anywhere else, with a 57 per cent surge since November 20. But Jiang Xuewen, a Beijing-based private investor, is not sure the stimulus will have more effects than that in the market.

"Four trillion or 8 trillion yuan is like spraying sesame seeds into the ocean," he says. "Did you see that the hotels near the National Development and Reform Commission used to be full of officials from provinces and municipalities asking for investment? The government projects and state-owned enterprises got all the investment, but not private businessmen.

"The full effect (of the downturn) has not yet fully come to the surface. There is worse to come with millions of peasants losing their jobs."

Beyond the immediate effects, there is also growing concern that reforms are too slow and structural economic problems will take longer to repair.

"China is not likely to collapse economically, and we may see one or more rebounds over the next few years, but the glory days of growth are well and truly behind us until, I suspect, the financial system is sufficiently reformed that it leaves behind governance constraints that almost automatically assure systematic and massive capital misallocation," Beijing University economics Professor Michael Pettis writes in his China Financial Markets blog.

"That will take many years. Meanwhile the transition to a healthier and more balanced economy, which was slated to be long and difficult in the best of cases, is likely to be longer and more difficult as a consequence of the fiscal and banking response to the crisis."