By Kevin Yao and Pete Sweeney
BEIJING (Reuters) - China's economy grew an annual 7 percent in the second quarter, beating analysts' forecasts, though its volatile stock markets took a sharp dive in a reminder of the threats to Beijing's efforts to direct the economy out of a slowdown.
Policymakers had already unleashed a series of measures to pull stocks out of a 30 percent nosedive and appeared to have succeeded last week, but Wednesday's tumble could reawaken concerns over the government's ability to manage the economy.
The day began on a positive note with the growth figures and monthly activity data that also beat expectations across the board, with factory output hitting a five-month high, following reports of increased bank lending on Tuesday.
As the National Bureau of Statistics released the upbeat figures, it described the stock markets as key to economic stability. As if on cue, the key indexes, already down in morning trade, fell more than 4 percent in the afternoon.
The CSI300 index (CSI300) eventually ended down 3.5 percent, while the Shanghai Composite Index (SSEC) lost 3 percent. [.SS]
"Investors liquidated their positions as the GDP data failed to impress," said Steven Leung, a director at UOB Kay Hian in Hong Kong.
It has been a difficult year for the world's second-largest economy, with slowing growth in trade, investment and domestic demand compounded by a cooling property sector, deflationary pressure, then the equity market panic from mid-June.
Beijing will need to keep providing liquidity to the stock exchanges and cut the cost of corporate financing, which remains far higher than returns on investment for many companies.
Economists have also called for more direct fiscal stimulus to help support heavily indebted local governments.
Wednesday's data showed fiscal expenditure rose 13.9 percent on an annual basis in June, a sharp rise from May's 2.6 percent but well below April's 33.2 percent spike.
FAITH IN THE FIGURES
Some analysts, who on average had tipped GDP to rise 6.9 percent, question the accuracy of official data, implying the numbers are more about reassuring investors than true reflections of performance.
For example, June power output only increased 0.5 percent year-on-year, though factory output climbed 6.8 percent.
The statistics bureau rejected suggestions that figures were being inflated.
It is not only the government reporting a warmer second quarter; the recent independent China Beige Book survey also reported signs of a broad-based recovery for the period, which it said was largely driven by growth in the interior provinces.
"While actual growth is almost certainly a percentage point or two slower than the official figures show, there are good reasons to think that the latest figures are mirroring a genuine stabilisation," wrote Julian Evans-Pritchard, economist at Capital Economics in Singapore.
"There is growing evidence of an improvement in the wider economy."
The statistics bureau described the nascent recovery as "hard won" and noted it was driven primarily by an increase in domestic consumption, which produced 60 percent of China's economic growth in the first half, compared with 35.7 percent for capital formation and 4.3 percent from net exports.
Consumption contributed 51.2 percent to GDP growth in 2014, so the rise will be welcomed by a government that is trying to reduce its dependence on exports in favour of domestic demand.
CREDIT QUESTIONS
The statistics bureau warned that recovery required more support to consolidate.
"We must also take note that domestic and the external economic environment remains complex, and the global economic recovery is tortuous and slow," it said.
Even so, bureau spokesman Sheng Laiyun predicted further improvements in the second half as previous policy measures, including several interest rate cuts, take effect.
Andrew Colquhoun of Fitch Ratings also expects an improvement in the rest of the year.
"The resilience of retail sales in June is a further encouraging sign that downside risk, while not negligible, is receding, despite recent equity-market volatility."
Data on Tuesday showed bank lending increased sharply in June, thanks to central bank support.
However, economists worry that many companies and individuals borrowed heavily to buy stocks in the first half, so the sharp stock market decline could inhibit banks' ability to lend.
Before the market plunged, key indexes had risen nearly 60 percent in the first half, which some economists estimate added more than a percentage point to total GDP growth in that period, mostly by boosting activity in the financial services sector.
If that boost peters out now the market appears to have run out of steam, it could drag on third-quarter figures.
The government has forecast economic growth of around 7 percent for 2015, which would be the weakest rate in 25 years.
