CHINA has endured an inexorable slide in real growth in 2012, particularly in manufacturing. Things are now showing signs of picking up, but actual GDP growth is probably still running below the official numbers, and sentiment has been fragile both offshore and on.

This is not a country for old ideas - China's new leadership will need to think anew about how to run this economy.

Below-8 percent GDP growth

We expect official GDP growth for 2012 to come in at 7.7 percent. The monetary stimulus delivered in the second quarter of 2012 was measured, and the infrastructure and housing sectors have shown signs of slightly higher levels of activity. We look for a slow recovery in the first half of 2013. We estimate official GDP growth in 2013 at 7.8 percent. Growth in the 7-8 percent range should be achievable over 2013-18, but will depend on the implementation of a program of structural reforms.

Keeping leverage flat

While the US and Europe are in the midst of a painful multi-year deleveraging process, China is undergoing something slightly different. It increased overall leverage in 2012 by 15 percentage points to 205 percent of GDP - and the leadership will look to keep leverage flat in 2013. While this is a different experience from the debt-fuelled growth of 2009-10, it is nowhere near as painful as the deleveraging going on in the developed world. The corporate sector is still suffering, though.

Bosses who grew companies by boosting assets, relying on cheap cash and achieving endless top-line-sales growth now have to worry about margins, cash-flow management and overall efficiency. We foresee a recovery in profit growth in early 2013. As the destocking process continues, enterprises will likely restart production and resume investment projects.

Tax cuts, spending cuts and a slightly bigger budget deficit

China has been able to run small budget deficits as massive infrastructure spending was pushed off to banks' balance sheets. Such loans to local government investment vehicles (LGIVs) have been reclassified, but they remain a key quasi-fiscal risk. All of this debt needs to be brought onto the public balance sheets. Tax revenues are down, and the slow land market has further tightened local fiscal revenues. In order to stimulate growth, the government could consider cutting budgets for official banquets, cars and holidays and study trips, as well as spending on domestic security and industrial subsidies, and use the savings to finance a cut in value-added tax.

Housing

The first half of 2013 will be dominated by the absorption of residential housing inventory and a recovery in housing construction. We expect home purchase restrictions to be tweaked but not eliminated, and do not expect the rollout of a significant property tax. Such a tax would be progressive, but the politics of introducing another tax are extremely difficult. House prices in Tier-1 cities are likely to rise; as inventories fall in the rest of the country, prices could also rise there in the second half of 2013.

Opening up the services sector

Services are growing on the back of the expanding urban middle class, but the government urgently needs to nurture the services boom by getting out of the way and selling down its interests in businesses such as hotels, telecommunications, financial services, and entertainment. The sector could also do with a big regulatory clean-up and a reduction in the number of rules and regulatory agencies.

Selling state assets

Premier Zhu Rongji oversaw a big sale of small state enterprises in the mid-1990s, driven by debt and inefficiency; this boosted productivity growth and catalyzed the emergence of the private sector. Given rising local government debt, a second wave of state-owned-enterprise (SOE) sales would be welcome. SOEs at the central government level need to donate 30 percent or so of their profits to the budget; until now, their dividends have been channelled back into industrial subsidies.

Resolving non-performing loans

Banks' non-performing loans (NPLs) and corporate receivables started to rise in 2012, and these are likely to become bigger problems in 2013. The State Council will need to consider a new NPL resolution regime. This may involve setting up a dedicated loan-resolution mechanism for LGIV loans. A working corporate bankruptcy regime would help. Many banks will need to recapitalize.

A debate about inflation

In 2013, CPI inflation will be driven by the pig cycle, easy money in the US and Europe, and more utility price reform. Metro, water, gas and electricity prices for households need to rise to make these sectors sustainable - water by 50 percent, for instance.

Wage pressures will be contained, though. We expect CPI inflation to average 4 percent in 2013, up from 2.6 percent in 2012. We expect it to breach 5 percent year on year in the second half of 2013, triggering a new round of rate hikes from the People's Bank of China - one in the fourth quarter of 2013 and four more in 2014. If the central bank again lifts the cap on the deposit rate (currently set at 10 percent above the benchmark), this will necessitate fewer hikes in the benchmark rate in the next cycle.

The end of active monetary policy

With the loss of large foreign-exchange inflows, there is now no natural river of China's base money growth (although we expect a rising trade surplus in 2013 to result in net foreign-exchange inflows). M2 growth will be around 14 percent again in 2013, we expect. The central bank seems to believe that rates are already at an appropriate level. In terms of rate reform, the next move will be to use an interbank rate (the repo or reverse repo) as a new benchmark. Repo volatility needs to be reduced before this is feasible.

Market outlook

The case for substantial Chinese yuan appreciation is very weak, in our view. The expected current account surplus at 2 percent of GDP in 2012 is a long way below the 9.7 percent level in 2007. While we predict little change in the yuan's trade-weighted value through to end-2013, there is still room for modest yuan gains against the US dollar. We project dollar-yuan at 6.28 at end-2012 and 6.16 at end-2013 (a 1.9 percent yuan gain over the year). Of the three major foreign-exchange forward curves, the dollar-offshore yuan deliverable forward curve is the most steeply upward-sloping, discounting the most forward foreign-exchange depreciation. Firms with onshore yuan payables and US dollar receivables in 2013 should hedge these flows in the offshore deliverable market.

Chinese credits have outperformed the JACI (the Asian credit index) on a total return basis in 2012, thanks to the rally in Chinese high-yield (HY) credits throughout the year. Quasi-sovereign credits in the high-grade (HG) space have performed reasonably well, but have underperformed their Korean peers due to a combination of higher-than-expected supply and concerns about slowing growth. We are currently "Underweight" Chinese HY corporates and prefer stronger BB names over single-B names given slowing growth; we broadly prefer property names to industrials. We see value in selected HG quasi-sovereigns.

In rates, onshore/offshore convergence will remain the key force driving offshore China Government Bonds (CGBs). Overall liquidity conditions will remain tight in the medium term on widened remittance channels. We believe offshore CGBs offer limited value given high offshore yuan funding costs and lower yields than onshore counterparts. We expect 25 billion yuan (US$4 billion) of gross issuance of offshore CGBs in 2013 (versus 20-23 billion yuan in 2011-12). Onshore, accessibility by foreign investors, including to the interbank market, will improve. The QFII quota granted in 2012 has increased to four times the previous annual average, and the R-QFII quota will be expanded by 200 billion yuan in 2013. Moderate liquidity conditions will likely be maintained in 2013. Although government bond yields could retreat from their recent highs in the near term, they are likely to rise in the second half of 2013 as inflation pressure re-emerges.

Stephen Green, Robert Minikin, Becky Liu and Sandeep Tarian are economists with Standard Chartered Bank. The opinions expressed are their own.