Debates about the slowdown in China’s economy, the subdued global outlook and how the Chinese government should respond are heating up again. As in late 2008, China’s economy is slowing at the same time as the global economy is suffering from troubles in the developed world. Then, the centre of the storm was the US sub-prime market and the collapse of Lehman Brothers. Now, it is the eurozone and its fiscal and banking sector problems.

Looking back at the deep recession and collapse of global trade that followed three-and-a-half years ago, some people are urging China’s government to take action, possibly along the lines of the bank credit-financed stimulus package that China implemented from 2008 to 2010. This move has rightly been credited with keeping China’s economy growing at a critical time, thus supporting the global economy.

However, the stimulus package also saddled China’s economy with problems that it is still processing. New bank lending in 2008-10, which was equivalent to 60 per cent of China’s 2010 GDP, has raised concerns about non-performing loans and unsustainable local government debt. It also raised inflationary expectations and, with a lot of liquidity flowing into the housing market, fuelled a housing price boom that the government is still trying to rein in.

Until a month or so ago, the government largely resisted calls for major policy easing or a new stimulus. It did so because the deceleration of growth in China’s economy was gradual, with no signs of a hard landing.

However, following the release of especially weak economic activity data for April, the government has started to shift course. On the monetary front, banks’ reserve requirement ratios have been cut and guidance on bank lending has become more accommodating. In early June benchmark interest rates were cut for the first time since 2008, combined with reform giving banks more leeway in setting lending and deposit rates. The National Development and Reform Commission has also started to speed up approval of investment projects, including infrastructure and large new steel plants. In the property market, access to financing for property developers has improved somewhat. On the fiscal front, the government has introduced subsidies to stimulate consumption of energy-saving household products.

As the government considers possible further measures, how much policy easing is needed and what would be the most obvious types of measures to adopt?

After the weak April data, economists have revised down their forecasts. Most now expect GDP growth of around 8 per cent in 2012. This is down from growth in recent years but a far cry from a hard landing. It is also higher than the government’s own target for 2012 of 7.5 per cent. Admittedly, these forecasts assume some policy easing, and growth may well come out somewhat lower still. Nonetheless, given the strength still visible in key parts of the economy, China is on course to avoid a hard landing even without a new stimulus plan—barring a worsening global crisis. Indeed, the May activity data released last week were somewhat better than expected, especially on exports, housing construction and car sales, while the labour market remains buoyant.

For long, 8 per cent GDP growth was considered necessary to create enough jobs. However, with China’s shifting demographics, that benchmark should shift as well. China’s working age population (people aged 15-64) is growing at 0.5 per cent a year nowadays, or one-third of what it was ten years ago.

The future is inherently uncertain, and the outcome may well turn out to be weaker than the forecasts. For instance, the eurozone crisis may intensify further. But such risks call for flexibility and readiness to act when needed rather than upfront expansionary policy.

Some sectors are harder hit than the overall GDP growth numbers suggest. Heavy industry has slowed down especially noticeably. However, this is part of normal economic dynamics: heavy industry tends to show more pronounced ups and downs than other parts of the economy. Given the government’s strategy of re-balancing the pattern of growth, upgrading the industrial structure and containing property market excesses, it would not seem right to prop up parts of the economy that are meant, anyway,  to take up a more modest role in the future.

If and when growth supporting measures are deemed necessary, pure fiscal measures financed by central government debt are preferable to another bank-lending-based stimulus. While banks are leveraged up and many local governments financially strained, the central government’s fiscal position remains sound. In addition, a credit- and project-based stimulus is likely to perpetuate growth along the old lines, with an emphasis on investment -- especially in property and infrastructure -- and industry.

Fiscal policy measures, on the other hand, can be part of the effort to transform China’s growth pattern towards more domestic consumption and services. Expansionary fiscal measures, such as lowering social security charges paid by employees and further raising government spending on health, education, and social security, could be combined with structural reforms, such as removing barriers to service and private-sector development; encouraging full urbanisation, with migrants able to take their families along; and financial sector reform towards more competition and more non-bank financing, a stronger role for the interest rate in the conduct of monetary policy and more exchange-rate flexibility.

With its domestic growth engine still functioning, albeit at lower speed, China can afford to focus on the structural reform agenda rather than resorting once more on short-term stimulus.