BEIJING (Reuters) - China's government is engaged in the economic equivalent of holding its nose and swallowing nasty medicine, dosing up on investment spending, local government debt and real estate sales to push up growth.
Eight months of policy fine-tuning have yet to arrest an economic chill lasting six successive quarters and at risk of infecting a seventh, forcing Beijing to opt for near term expedients to boost growth ahead of a once-a-decade leadership transition later this year.
It's not easy for a government sensitive to the social impact of inflation and speculation set off by its last investment binge in 2009-10, which priced millions of middle class Chinese out of city centre property markets.
But the apparent recoil by Beijing from the pursuit of economic rebalancing that eschews short-term spending on more infrastructure capacity in favour of policies promoting services and consumer-driven growth simply highlights the urgency for more reform.
"Because consumption is still only 35 percent of GDP, the reality of that being able to drive the economy when fixed asset investment is falling and industrial production is slowing is unlikely," Jeremy Stevens, Beijing-based China economist at Standard Bank, told Reuters.
"In fact the ability of the government to massage and orchestrate economic momentum is less than it was two years ago because it is now more reliant on the corporate sector and that is struggling," Stevens said. "It does mean that they are having to look at things they didn't want to do six months ago."
China said on Friday that year-on-year growth in the second quarter slowed to 7.6 percent, just above the government's 7.5 percent full year target and the weakest quarter since Q1 2009 when the global financial crisis choked world trade flows and saw 20 million Chinese jobs axed in a matter of months.
With the world's second biggest economy set for its slackest year of growth since 1999's 7.6 percent and investors fretting about the risk of a lurch lower, there is evidence Beijing is relying on trusted methods to stimulate activity.
Investors have latched onto Premier Wen Jiabao's comments earlier this month on the importance of investment spending to sustain growth as a signal the government is going back to what it knows best.
A record price fetched at a Beijing real estate auction last week after June land sales snapped an eight-month decline and signs of acceptance of limited local loosening of tight property controls has only added to that perception.
"Exports are weak and it takes time to spur consumption, so boosting investment is the easiest way," said Liang Youcai, senior economist at top government think tank, the State Information Centre.
Commerce Minister Chen Deming said last month the country would hit its 10 percent trade growth target only "if lucky".
Capital spending meanwhile was fully 50 percent of China's growth in the first half of 2012, statistics bureau data shows, a run rate even faster than the 45 percent or so recently that has started to worry the International Monetary Fund, given the risks of massive over-capacity and bad bank debt.
Banks are already believed to be nursing massive undeclared losses on government-directed investment projects mandated as part of the 4 trillion yuan economic stimulus plan conceived in 2008 and rolled out in 2009-10.
That programme saw local governments rack up debts of 10.7 trillion yuan by the end of 2010, with analysts estimating that 2-3 trillion yuan's worth are now sour and cannot be repaid.
But Beijing, looking once more at local authorities to start ramping up construction, is relaxing controls on special financing vehicles set up for the purpose, according to one local official who declined to be identified.
Zhang Hanya, head of the China Investment Association -- a think-tank affiliated to the National Development and Reform Commission, the most pro-growth arm of government -- says local governments are so starved of cash after two years of a credit clampdown that they don't have the funds to start work on projects getting fast-track approval.
Some say easing credit controls is not only possible for local governments with sound fiscal positions, but vital.
"I think such relaxation is needed because it will be riskier if you cut the financing channels for all local governments," Liang, at the State Information Centre, said.
For those focused on the reforms needed to make China's financial markets deeper and more liquid, the way in which policy loosening is delivered is the crucial point.
So while China may have allowed banks to roll over loans from local government financing vehicles (LGFVs) to stop them defaulting, the more significant development is the speeding of approvals to bond issues made by firms run by local authorities.
Bonds issued by urban construction and investment companies, typically the bigger and healthier LGFVs, totalled 169 billion yuan as of July 5, almost matching the 174 billion yuan they issued in all of 2011, according to data compiled by Shenzhen-based Pengyuan Credit Rating Co Ltd.
Analysts say a vibrant corporate bond market is one of the surest ways to help China build a dynamic private sector with access to abundant, cost-effective capital.
And completing part-finished reform is the only way to replace the credit-constrained, semi-shackled and state-dominated corporate environment that persists.
Sources close to the central bank and financial regulators told Reuters earlier this year that authorities had readied a list of small, but significant reforms ready to be rolled out to help improve corporate sector access to capital.
And there are clear signs of a commitment to deliver on reform, even while at a headline level the government may be reaching for the familiar props of state-directed lending and spending, according to Ronald Gould, managing director in the Hong Kong office of Promontory Financial Group, a consultancy advising on financial regulation run mainly by former watchdogs.
"I think policymakers are taking advantage of the short term circumstances in exactly the right way to address some of the longer term structural issues they have to address too. Rate cuts and liberalisation are exactly the right moves at exactly the right time," he said during a recent trip to Beijing.
China has cut interest rates twice in the space of a month while also allowing banks more freedom to set differential rates for borrowers and depositors in clear steps towards letting the market set the price of capital.
"I'd be worried if we were seeing nothing other than an adjustment of bank lending terms. Then I would say that is not enough of a change. But they are doing many other things. It's just not all going to happen by tomorrow morning," Gould said.
A slew of reforms in the first half of this year, including widening the trading band for the yuan currency, the launch of a high yield bond market and an easing of rules for foreign investment into China's capital markets all signal change.
David Loevinger, managing director for emerging markets at Los Angeles-based fund manager TCW, says that has coincided with China's current account coming roughly into balance over the last six months which gave the government a need to adjust.
The durability of reform will be seen only as trade flows accelerate when the global economy recovers, rekindling speculative hot money trades that drive up the value of the yuan and inflation risks which China sets policy to actively manage.
"Has China really put something different in place? Have they essentially stopped intervening so much in the economy? That's the test," said Loevinger, formerly the U.S. Treasury's senior coordinator for China affairs.
Reporting by Nick Edwards and Kevin Yao; Editing by Dean Yates