Govt caught between reform and growth

China will abolish all home purchase restrictions in the next 12 months and cut at least one policy rate in the first half of 2015 or before, said Shen Minggao, head of China research with Citigroup Inc.

"Look around the world. No country keeps monetary policy unchanged when a correction starts in the property sector," Shen said in an interview.

Experts believe the first half of next year will be even more difficult economically as the lagging impact of the property downturn hits demand for steel, furniture and other related items.

Most people agree that China's property market is cooling, but they are divided about how the government should react. Some said more easing would further inflate the property bubble and lead to a systemic financial crisis.

"Sure, there is a bubble, but the bubble does not have to burst now," Shen said.

It is not that the authorities should support property prices at current levels; rather, they should try to avoid more downturns. "That means you should be ready to cut policy rates," Shen said.

A 20 percent correction in property prices would have a limited impact on GDP. The problem is, potential buyers might then hold off as they await further declines.

"You have to act before it drops too much. A policy rate cut is always read as a signal that the monetary environment is easing and the government wants no more corrections," Shen said.

But the bad news is, even if the government cuts the policy rate, that may be not enough. The oversupply will remain, and reducing it demands hukou (urban residence) reform and faster urbanization.

China has about 174 million workers living in cities where they do not have legal residency rights. Hukou reform is a pressing issue, and the authorities should start as early as this year, he said.

China has two key tasks: One is reform, and the other is growth. And it is caught between them.

For reform's sake, the government should not pursue stimulus and should even avoid policy easing. But then the economy will not achieve 7.5 percent growth.

Some people are very bearish about the economic outlook because they do not believe China can reform. Shen said the next three to five years are critical. If China "takes its medicine", it can at least achieve a gradual cure over that period.

Then it can make a soft landing and transition to a "new normal" with annual GDP growth of 5 to 6 percent.

Without significant reforms, a hard landing is inevitable within three to five years.

With the property sector undergoing a correction, the government should tolerate slower growth, or it will have to stimulate the economy every year and there will be no room for reform, Shen said.