China’s Economy Faces Deepening Troubles in Years Ahead

HONG KONG—With the property market that long fueled China’s growth mired in a prolonged downturn, China’s economy is shifting into a lower gear.

The country’s struggling economy showed some signs of life on Wednesday, with strengthening retail sales helping to drive growth to a faster-than-expected 4.9% in the third quarter.

The data suggest that recent stimulus measures, including interest-rate cuts and steps to encourage home sales, have helped stabilize the economy, putting it on track to hit Beijing’s official growth target of around 5% this year. It allayed, at least temporarily, fears of a worsening economic crisis.

Still, economists warn China’s economy remains fragile and its long-term prospects are darkening. In recent weeks, a bevy of economists have lowered their forecasts for China’s longer-term growth trajectories, even as they raised their shorter-term predictions.

The International Monetary Fund this month lowered its forecast for China’s growth next year to 4.2%, down from 4.5%. The IMF projected Chinese growth would drop to 3.7% in 2027 in its latest economic outlook report, down from a forecast of 4.6% in its report last October.

Oxford Economics, a U.K.-based research firm, last week revised its expectations for growth over the next five years to around 4%, down from 4.5% previously. Even more pessimistic is Morgan Stanley, where economists said in a report last month that they expect China’s growth to slow in the coming years, dropping to 3% by 2030.

“If investors want to worry, worry about the long-term, not the short-term,” said Derek Scissors, a senior fellow at the American Enterprise Institute, a conservative think tank in Washington.

The rapidly deteriorating growth trajectory has implications for one of Xi’s long-cherished political goals—seeing the Chinese economy surpass the U.S.’s in overall size. For many economists, the question had long been a matter of when, not if, the Chinese economy would surpass that of the U.S. As recently as 2021, when China’s hard-line approach to containing the Covid-19 pandemic allowed it to enjoy a rebound, many economists were moving forward their timelines for when China might overtake the U.S.

Now, many economists have shifted their timelines back again—and many no longer think China will eclipse the U.S. at all.

Economists pointed to a range of factors, including an extended hangover from the effects of Chinese leader Xi Jinping’s zero-Covid policies, rising geopolitical tensions with the U.S. and delays by Chinese policy makers in addressing some of the country’s structural imbalances.

One of the biggest factors, though, is the unraveling of the property sector that has fueled its growth for decades. Economists have estimated the property sector accounted for about a quarter of the country’s gross domestic product at one point.

Home sales remain in the doldrums despite provincial and local governments loosening restrictions and implementing other favorable policies to entice buyers. In the long run, an aging population and already elevated homeownership could undercut demand.

The country’s massive developers, who were long at the center of that growth model, have shown fresh signs of distress. On Wednesday, Country Garden, once considered one of the country’s most stable developers, missed a final deadline to make an interest payment on a dollar bond.

As a share of GDP, Chinese local governments’ fiscal resources—which relies heavily on home sales—have deteriorated to their worst level in more than a decade, according to Adam Wolfe, emerging market economist at Absolute Strategy Research, who argues that local governments may be forced to slow their investments in infrastructure projects and cut back on industrial subsidies as a result.

“The overall drag on growth could be more severe next year,” said Wolfe, who predicts that growth may slump to 3% or less in the coming years as Beijing seeks to reduce real estate’s outsize role in driving growth.

There is an emerging consensus among economists that another significant factor in China’s darkening outlook is the residual impact from strict Covid lockdowns. Some are beginning to question whether China’s economy will ever return to the levels of activity that it saw before the pandemic.

Various indicators show that economic activities, including investments and industrial output in China have stabilized at around 5% below the prepandemic trend, according to Louise Loo, lead economist at Oxford Economics. “This all suggests a bigger-than-expected permanent output loss to the economy, likely due to a structural shift in spending and investment patterns,” she said in a report last week.

In the long term, China is also facing deep structural problems. Its productivity growth is stalled, its population is aging and its debt levels are rising.

U.S. restrictions on tech exports and curbs over investments to China, coupled with sluggish private investment, will constraint productivity gains, noted Shuang Ding, chief China economist at Standard Chartered.

“In the absence of major policy reforms, China’s potential growth rate will continue to trend down in the long run,” he said.

Another concern is the rising risk that China’s policy responses may fall behind the curve in responding to slowdowns and therefore yield limited impact. That is in part because top leadership is now pursuing multiple objectives other than economic growth alone, said Robin Xing, chief China economist at Morgan Stanley.

In contrast to his predecessors, Xi has hammered home the idea that protecting national security, including girding China for greater conflict with the U.S. and its allies, rather than seeking economic growth alone, is his focus.

Policy makers need to roll out more measures to reflate the economy or risk getting mired in a debt-deflation loop, where deflation and financial distress reinforce each other, said Xing. “The private sector is still suffering from a confidence deficit.”

Write to Stella Yifan Xie at stella.xie@wsj.com