China’s upbeat PMI manufacturing data for June, published this week, points to an expanding economy and improving economic conditions in Q2. But how should one read this data in light of growth prospects for China?

Short-term outlook improving

Concerns of a hard landing are abating as government’s interventionist policies have been supporting China’s stock markets and currency.Fears of a sharp devaluation of the currency have eased. The inclusion of China’s A-share market along with the government’s stock/bond connect programs and relaxation of restrictions on foreign capital have been buoying global confidence in Chinese markets.

Long-term growth prospects seem bleak in absence of structural reforms

While these government steps are expected to bring down currency/market volatility, they do not take away the real risks to the economy – rising debt levels and gross misallocation of resources. With a debt at ~280% of GDP, the country remains exposed to possibilities of a deep financial crisis. And with its credit growth expansion rate exceeding its GDP growth, the country remains vulnerable to resource misallocation. Useless credit expansion to feign growth will satisfy short-term growth targets but will lead to sharp decline in productivity and eventually growth in the long term. The country needs to introduce massive reforms and shift resources to productive areas to be able to sustain long-term growth – however, this would entail bankruptcies, job losses, bank failures, etc. which would not be politically popular.

Despite upbeat data, China’s long-term growth prospects look bleak sans structural reforms.

Read more about China’s currency and markets here