Activity in China’s vast factory sector contracted in September for the first time since the pandemic began, the latest sign of deceleration in the world’s second-largest economy.

The drop in the official manufacturing purchasing managers’ index below the 50-mark, which signals a decline in output, shows the damage a widespread electricity crunch is having on growth.

Alongside tough measures to rein in the property market, the latest developments have led economists to pare back full-year growth predictions below 8 percent and warn that Beijing could be willing to tolerate a sharper slowdown as it tries to reform its economic model.

The problem for the economy is that manufacturing and property investment have been the main drivers of growth since the pandemic hit, while consumption growth remains relatively weak with households still cautious about travel and eating out.

Electricity shortages, which have caused power cuts across China this week, combined with property curbs are “a double whammy on the key drivers of growth this year,” said Bo Zhuang, China economist at Loomis Sayles Investments Asia. “A further growth slowdown is inevitable.”

Beijing is focused on preventing instability: the central bank told financial institutions to prevent fallout from the property slowdown which has exacerbated a debt crisis at China Evergrande Group, and targeted financial easing aimed at the manufacturing sector may be likely.

But economists see little prospect of relaxation on tough policy, such as curbs on housing purchases and energy use limits, until December, when President Xi Jinping and top officials meet to set economic priorities.

What Bloomberg economics says…

Additional policy support will need to come soon to avert a sharp deceleration in growth. The economy’s near-term outlook is highly challenging and uncertain. Headwinds include softening external demand, continued virus risks and a lack of fast, ready solutions for the energy shortages. Regulatory tightening is also a significant drag—Chang Shu and David Qu.

When the government set its growth target at “above 6 percent” in March, economists saw it as modest against their own predictions of 8 percent-plus. Many are now rethinking their views, with major banks from Goldman Sachs Group Inc. to Nomura Holdings Ltd. downgrading their forecasts in recent weeks to as low as 7.7 percent.

Here’s a deeper look at the challenges facing China’s economy:

Power crunch

Chinese factories in 21 provinces have been hit by power cuts in recent weeks, largely driven by a spike in coal prices that made it unprofitable for power plants to sell electricity at fixed-prices. The impact was in the official manufacturing purchasing managers’ index, which declined to 49.6 from 50.1 in August, below the 50 median estimate in a Bloomberg survey of economists.

Beijing has scrambled to solve the problem by allowing power companies to raise prices and trying to funnel more coal to the sector. Those efforts could get production going again in many factories, but that relief might not come for weeks.

Beyond that, Beijing is signaling that it wants highly energy-intensive producers, like steel and chemical factories, to reduce output for the rest of the year, as it tries to meet environmental targets. China’s aim to reduce energy intensity, or how much power is needed to drive output, by around 3 percent in 2021 could drag down full-year growth by 0.3 to 0.6 percentage points, according to Ming Ming, head of fixed income research at Citic Securities Co. Bloomberg News

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