Wall Street Thinks China May Have To Do The Unthinkable

It appears China's leaders are now willing to do what was once unthinkable and allow the country's growth to fall below its stated 7.5% target for 2014.

This represents a major policy shift for a country that one famous investor once joked "is the only major industrialized country that knows its annual GDP on January 1 of that year."

The government would be letting growth slow in order reform the economy, moving it from one based on property development and foreign investment, to one based on consumption.

But there will be pain until that reform is completed, and indicators are already signaling that the economy is going south.

Since July all signs point to a major slow down in China. Last month's industrial production was especially horrid, showing that activity has lowered to levels unseen since 2008. Growth in everything from fixed-asset investment to gambling revenue to Scotch Whisky sales, and of course China's infamous property development sector, have fallen dramatically.

China's corporates are in pretty bad shape too, according to Morgan Stanley analysts.

But that isn't going to spur China's government into action. For the first time in recent memory, President Xi Jinping has signaled that it may be okay if the country misses its target.

It has been a quick change. In May and June Xi was demanding that officials "lower the cost of financing" and reiterated that local governments have "inescapable responsibilities to achieve the economic growth target (of c7.5%) set at the NPC meeting," Barclays pointed out in a recent note.

Basically he was saying 'reform be damned', we need to keep this economy moving.

In September, however, Xi and the media that his government controls changed their tune. Earlier this month, the government's publication, Xinhua News Agency, accused those calling for fresh stimulus after September's bad data dump of "failing to clearly see the Chinese economy's new normal."

Around the same time, Xi himself tried to sound calm saying "economic indicators still within a reasonable range", and China will maintain "prudent monetary policy" and "targeted easing," Barclays notes.

"Targeted easing" measures in the event of nasty data surprises like the one the world had this month are not enough to lift China from the doldrums, and they're not meant to be. For now, China's citizens will just have to tough it out as the economy rebalances.

"We believe the government will support the property market with measures such as mortgage rate cuts or lower down payments, but don't think these can change the picture," Barclays said. "We do expect more investment spending in place, eg on railways, public housing and environmental or clean energy projects, to cushion the slowdown... We see an increasing probability that the government may set a lower GDP growth
target of 7% for 2015."

But we'll see how long that lasts. The latest data out of China showed that while factory activity picked up from dismal August to less dismal September, factory employment slumped to a five and a half year low.

And that could be something the government - and the people have China - can't tolerate.