China's leaders face thicket of obstacles in turning cooling economy into consumer society

BEIJING – Business should be picking up for Zhao Guoping, a Beijing shopkeeper, as Chinese leaders try to build a consumer society to replace a worn-out economic model based on trade and investment. But his financial struggle highlights the hurdles that ambitious effort faces.

Squeezed by higher costs and weak sales to budget-minded shoppers, Zhao said the income from his neighborhood shop has fallen by half to 50,000 yuan ($6,000) a year.

"Prices are rocketing up. People's incomes can hardly catch up," said Zhao, 38. "Daily necessities, yes, I still have to buy them. But anything I don't necessarily need, then no."

The reluctance of Zhao and his customers to open their wallets wider is one of a thicket of obstacles facing communist leaders as they try to rebalance China's economy away from reliance on investment that is losing its ability to boost growth.

Combined with an export boom, a flood of spending on new factories, highways and other assets powered the past decade of explosive growth. That helped China rebound quickly from the 2008 global crisis. But it was paid for with a surge in borrowing that economists warn looks like debt booms in other developing countries that spiraled into financial crises.

As urgency for change mounts, so do potential hurdles. Consumer spending accounts for only about 35 percent of gross domestic product, well below neighboring India's 60 percent, and that percentage declined last year. Curbs on investment will mean less money flows to wages in construction and building materials industries such as steel and cement.

"It is a pretty narrow path that policymakers have to push the economy along," said Mark Williams, chief Asia economist for Capital Economics. "The risk is that if investment spending slows too much, then that starts to undermine consumer spending and you get a downward spiral."

Forecasts of this year's growth range from 7 to 8 percent, far ahead of the United States and Europe but down from China's double-digit rates of the past decade. Last year's 7.7 percent growth tied with 2012 for the weakest performance in two decades. And it hit that only after Beijing launched a mini-stimulus in mid-2013 with more spending on building new railways and other public works.

The impact of a government clampdown on lending and construction is showing in slower economic activity, raising the risk of politically difficult job losses.

A survey by HSBC Corp. found manufacturers cut jobs in January at their fastest rate in five years. Profits at China's biggest companies grew in December at their slowest rate in nine months. Growth in factory output and retail sales weakened, suggesting the quarter's headline growth of 7.7 percent might mask a deepening downturn.

Moves to encourage consumer spending are part of a marathon effort by the Communist Party to transform China from a low-wage factory into a high-income creator of technology with self-sustaining economic growth.

A broad-strokes plan issued by the party leadership in November promises to give entrepreneurs who generate most of China's new jobs and wealth more access to state-dominated industries.

Regulators announced this month they will allow the creation of five privately financed banks this year. Beijing has announced plans for a dozen new free-trade zones in Shanghai and other cities with promises of easier restrictions on business.

But such changes will take time to show results.

"Our expectation is that there isn't going to be any national-level substantive reform within 2014," said economist Brian Jackson of IHS Global Insight. "They're going to launch small experiments."

The biggest potential growth risk cited by many analysts: A rapid buildup of debt in China's government-owned banking system.

China's banks avoided mortgage-related turmoil that battered Western lenders but ramped up lending under orders from Beijing to help fend off the effects of the 2008 global slowdown.

The IMF and industry analysts warn they might be hit by a rise in defaults if toll roads and other projects approved in haste fail to earn enough.

The central bank says debt levels are manageable but economists say the speed of the increase is a warning sign. Outstanding bank loans have swelled by the equivalent of 70 percent of China's gross domestic product over the past five years. Analysts point to countries such as Thailand that have plunged into financial crises after seeing smaller debt increases of as little as 30 percent.

China "needs to contain the building of risks in the financial sector without excessively slowing growth," said the IMF chief economist, Olivier Blanchard, at a news conference this month. "This is always a very a delicate balancing act."

At the same time, Beijing's effort to clamp down on credit and tighten control over informal lending that support entrepreneurs has sent shock waves through financial markets. Markets in which banks lend to each other ran short of cash twice last year, causing interest rates to spike and fueling unease about the availability of credit.

"The uncertainty related to rate spikes and liquidity squeezes may affect business spending more broadly," said UBS economist Tao Wang in a report.

Wages in some areas such as the manufacturing-intensive southeast are forecast to rise this year by as much as 10 percent. But workers complain gains are eaten up by rising living costs — a bad sign for government hopes for higher consumer spending.

Lei Qiang, a logistics manager in Shanghai, said he and his wife have little left every month after paying for basics and save whatever they can. They plan to return to their hometown of Xi'an in western China with their 2-year-old daughter to escape Shanghai's high cost of living.

"Living in Shanghai for three years, my rent went up every year by 20 to 30 percent," said Lei, 38. "That was far more than my pay rose."

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AP researchers Zhao Liang in Beijing and Fu Ting in Shanghai contributed.