China is still nursing a hangover from its 2008 stimulus spending spree and may be reluctant to kick off another big round, leaving less potent options on the table should the global economy tilt toward a cliff.
Just two weeks ago, economists were banking on at least one more interest rate rise from the People`s Bank of China this year because inflation remained hot. Indeed, Tuesday`s figures showed it hit a fresh three-year high at 6.5 percent.
But the worsening global economic outlook has many people predicting a policy about-face. Asia`s stock markets tumbled on Tuesday as investors fretted over the risk of another U.S. recession and deepening debt crisis in Europe.
"It`s time for Beijing to announce to the whole world that it will try to stimulate domestic demand again," said Tang Yunfei, an analyst with Founder Securities in Beijing.
China`s fiscal firepower is not in doubt. With $3.2 trillion in reserves and low public debt, China could afford to kick up spending, but the side effect would be worsening inflation when prices are already rising too fast for comfort.
Beijing is particularly sensitive to inflation because relentlessly rising prices can stoke social unrest, which could be dangerous for the Communist Party.
Besides, the last round of stimulus in 2008 caused more than a few headaches that linger today. Beijing encouraged banks to lend freely to government projects such as railways, airports and roads. Some of the loans have soured, and local government defaults now pose one of the biggest threats to China`s growth.
Local government liabilities amount to nearly 27 percent of China`s total annual output, so if the state is forced to mop up those bad loans its deep pockets would look a bit more shallow.
That means China would most likely rely on more modest measures if the economic outlook deteriorates. Possible steps include cutting taxes for small- and medium-sized businesses, ramping up investment in affordable housing, altering bank lending rules to get more money into the hands of smaller companies, and lowering interest rates.
"We are still digesting the mess of the 2008 stimulus package," said Yu Xuejun, local head of China`s banking regulator in Jiangsu province. "It`s unrealistic to hope that China will come to the rescue of the global economy this time."
In 2008, when the Lehman Brothers bankruptcy triggered a sharp global slide, China was among the first in the world to implement a large-scale stimulus package, pouring 4 trillion yuan into the economy.
Local governments borrowed heavily from banks to cover their share of the stimulus, leading to an explosion of debt estimated at 10.7 trillion yuan. Some economists think as much as a quarter of that total could end up in default.
The burst of spending helped China lead the economic recovery that began in 2009. But if it comes to reprising that role, banks may be leery of lending to government investment projects again given the well-publicized problem loans, said Vincent Chan, a research analyst at Credit Suisse in Hong Kong.
With property prices already high, the government will have to be careful not to overstimulate, he said.
"China may again be seen as a `safe haven` as in late 2008, but this time its ability to rely on the old credit-cum-investment model to get out of trouble will be hindered by many more constraints," Chan said. "Investors should not expect a repeat of the 2009 China market performance any time soon."
Investment now amounts to almost half China`s gross domestic product, up from 41 percent in 2008 when Beijing ramped up spending for the Olympics. In the decade before that, the ratio of investment to GDP averaged a relatively modest 36 percent.
Ting Lu, an economist with Bank of America-Merrill Lynch in Hong Kong, said if there is another recession in the United States, China could respond by allocating more money for social housing or infrastructure.
"I don`t think they would announce a big investment program as in 2008," Lu said.
That suggests it will be the central bank doing the heavy lifting if conditions do worsen.
Tang, the Founder Securities analyst, said it was "worrisome" that the PBOC still insisted that inflation, not growth, posed the biggest economic risk.
"If Beijing does not change the tone of its policy until the end of this year, it might be too late," he said.
But other economists argued that China`s economy is still growing at an annual rate well above 9 percent, and it is less reliant on U.S. and European exports for growth than it was just a few years ago.
"As the global market is in turmoil, the last thing we need is panic," said Zuo Chuanchang, a researcher with the Academy of Macroeconomic Research, a think-tank under China`s economic planning agency.
Zuo said Beijing would not be in a hurry to announce any policy relaxation.
Ben Simpfendorfer, an economist and managing director at Silk Road Associates in Beijing, said China`s economy looks quite different from in 2008.
Inflation expectations are higher, making it riskier for the PBOC to relent on rate hikes, the housing market is strong, and state firms are still investing heavily. Indeed, he said there were no obvious signs of a dramatic and worrisome slowdown that would warrant a strong response from Beijing.
"At this point, I think any sort of easing would be dangerous," Simpfendorfer said.