CHINA'S economic cycle reached a trough in the second quarter, and an increasing array of data show that conditions are now gradually improving. Monetary and fiscal stimulus measures are evidently restarting the investment cycle, which will drive production in the near term. Although a soft landing is expected, risks are tilted to the downside.

To recap China's recent economic history: Policy was on a tightening cycle until mid-2011. The global environment deteriorated in the second half of 2011, undermined by the US debt ceiling fiasco and the worsening situation in Europe.

This depressed China's exports, increased manufacturer pessimism, and slowed hiring. Soon afterward, the government began shifting away from inflation concerns and back toward supporting growth.

Monetary easing began with reserve ratio cuts in November, followed by a 1.4 percent depreciation in the yuan against the dollar in May and interest rate cuts in June and July; this ensured an ample supply of credit. Meanwhile, the government accelerated approvals of various investment projects, restarted rail construction, and continued to build low-cost housing. All this boosted demand for credit, as seen in the monthly new yuan lending numbers.

An example of this can be seen in railway development. Construction was halted on around 6,000 kilometers of rail track after a collision in Wenzhou, Zhejiang Province, in July 2011, reducing rail investment 45 percent year on year in the first two months of this year. The construction ban was lifted this spring, allowing the Ministry of Railways to secure a 2 trillion yuan (US$316 billion) credit line with which to pay down debt and complete major projects, such as the Beijing-Guangzhou high-speed line. Rail investment in the year to June was 36 percent year-on-year lower, but on an improving trend.

The government has also focused on utilities, and is upgrading the nation's water infrastructure. Investment in water, gas and electricity production rose 20.5 percent year on year in the year to June, up from 3.8 percent at the end of 2011. These factors helped to drive the uptick in June fixed investment growth, the first increase in 13 months. The approval of two new steel mills in May also shows that a new investment cycle is at hand.

Because fixed investment tends to lead industrial production by around five months, a third-quarter bounce in production is plausible.

Sentiment indicators, such as the HSBC purchasing managers' index, have risen slightly over the past few months. A rebound in industrial production and hence GDP growth in the third quarter will ensure the economy expands at close to the key rate of 8 percent for the year.

Downside risks

There are, however, some near-term downside risks to our baseline forecast, principally Europe and the Chinese property market. If Greece leaves the euro zone in a disorderly fashion, the financial contagion effects could lower China's GDP growth to 5 percent year on year before it slowly recovers.

Europe's problems have already caused China's exports to slow. The government has responded by restarting subsidies on energy-efficient appliances and on purchases by rural households.

Certain provinces have also begun subsidizing automobile upgrades. The yuan's depreciation against the US dollar in May was also likely a response to the sinking euro. On the whole, however, the government has kept its powder dry. This is probably the best course in light of Europe's prospects over the next few years: grindingly slow growth and high unemployment, punctuated by moments of financial terror.

Property market

Another major risk is China's own property market. If overleveraged property developers are forced to sell inventories, it could cause house prices to fall sharply, dousing sales and leaving the banking sector with a slew of bad loans. The government would be compelled to step in.

Fortunately, the chance of a hard landing soon has receded in the property market, to the point where the government is again concerned about a reflating price bubble. The number of Chinese cities experiencing price declines has steadily fallen since the beginning of the year, and prices nationwide rose 0.1 percent month on month in May, the first increase in 10 months, according to the property web site Soufun.

Assuming the Mayans were wrong about the world ending in 2012, we expect China's soft landing to continue in 2013. This will mean a steady deceleration as China's potential growth rate adjusts downward. The years of better than 8 percent annual expansion are over, in our view, and growth closer to 7.8 percent is likely in 2013. This is slightly more downbeat than the consensus view - the International Monetary Fund, for instance, expects a rebound to 8.5 percent in 2013.

There are a number of reasons to expect a steady downward drift in China's potential growth rate. One is demographic. The working-age population is increasing more slowly, and will plateau around 2018.

The effects of this are already being felt, in rising wages for young workers and a 6,000-person decline in the number of students who took the Gaokao college entrance exam in Shanghai recently. Also putting a brake on growth is the shift away from manufacturing and investment towards services; the rapid gains from selling cheap goods to the West will be difficult to replicate in services.

Policymakers appear to be banking on another wave of reform to lift growth in a few years, once the next generation of leaders finds its footing. A quickened pace of reform in the past few months suggests that the reformists are in charge. Even so, it is hard to see how the likely reforms would lift the growth rate.

Some of the policies being mooted include increased dividend payments to the government and higher welfare payments to households; these would help rebalance growth towards consumption and avoid a potential crisis, but would not raise GDP growth much.

The article is based on a note issued on July 25. The opinions are his own. Shanghai Daily condensed the article.