Page 1 of 3

In the midst of the global financial crisis that followed the collapse of Lehman Brothers Holdings in 2008, China embarked on one of the world’s largest stimulus packages, injecting 4 trillion yuan ($630 billion) into its economy through a massive bank lending program. The policy succeeded brilliantly, boosting growth to a rate of more than 9 percent in 2009 and more than 10 percent in 2010.

The stimulus spending also reignited China’s red-hot property market, leading real estate prices in some major cities to triple over the past three years and driving consumer price inflation up to a three-year high of 6.5 percent in July. To prevent a destabilizing inflationary outburst, the People’s Bank of China tightened policy aggressively in the past year, raising interest rates three times in 2011 and lifting bank reserve requirements six times. The reverberations have been felt throughout China as banks have pulled in credit lines, forcing some companies into bankruptcy.

Now the authorities stand at a critical juncture. Their tightening efforts have combined with weakness in China’s main export markets, Europe and the U.S., to raise the threat of an economic hard landing, with sharply slower growth and rising unemployment. That’s a chilling prospect for the global economy at a time when Western countries are struggling under a mountain of debt. Can Chinese policymakers fine-tune their economy to avoid a downturn and maintain growth at a strong and sustainable rate?

Most analysts are confident that Beijing can avoid a crash. They point to the unexpected easing by the central bank, which cut reserve requirements at the start of December in the first such move since 2008, as evidence that the authorities are aware of the risks to growth and have sufficient means to respond.

“The Chinese government still has multiple tools to deal with any liquidity or illiquidity issue,” says Victor Shih, an associate professor of political science at Northwestern University, in Evanston, Illinois, who warned about the borrowing binge unleashed by the stimulus program. “Up until now they have reacted in a timely manner.”

Paul Schulte, Hong Kong–based global head of financial strategy and Asia banks research at CCB International Securities, a subsidiary of China Construction Bank Corp., estimates that in the past 12 months Chinese regulators have removed 4.4 trillion yuan in liquidity from the financial system—well in excess of the original stimulus spending—through tightening; he predicts that they are about ready to reverse course and ease. “Credit growth is running at about 6 percent, while nominal growth is running at about 18 percent,” he says. “This is clearly unsustainable.”