BEIJING (BLOOMBERG) - Activity in China's vast factory sector contracted in September for the first time since the pandemic began, the latest sign of deceleration in the world's second-largest economy.

The drop in the official manufacturing purchasing managers' index below the 50 mark, which signals a decline in output, shows the damage a widespread electricity crunch is having on growth.

Alongside tough measures to rein in the property market, the latest developments have led economists to pare back full-year growth predictions below 8 per cent and warn that Beijing could be willing to tolerate a sharper slowdown as it tries to reform its economic model.

The problem for the economy is that manufacturing and property investment have been the main drivers of growth since the pandemic hit, while consumption growth remains relatively weak with households still cautious about travel and eating out.

Electricity shortages, which have caused power cuts across China this week, combined with property curbs are "a double whammy on the key drivers of growth this year", said Mr Bo Zhuang, China economist at Loomis Sayles Investments Asia. "A further growth slowdown is inevitable."

Beijing is focused on preventing instability: the central bank told financial institutions to prevent fallout from the property slowdown which has exacerbated a debt crisis at China Evergrande Group, and targeted financial easing aimed at the manufacturing sector may be likely.

But economists see little prospect of relaxation on tough policy, such as curbs on housing purchases and energy use limits, until December, when President Xi Jinping and top officials meet to set economic priorities.

When the government set its growth target at "above 6 per cent" in March, economists saw it as modest against their own predictions of 8 per cent plus. Many are now rethinking their views, with major banks from Goldman Sachs to Nomura Holdings downgrading their forecasts in recent weeks to as low as 7.7 per cent.

Here's a deeper look at the challenges facing China's economy:

Power crunch

Chinese factories in 21 provinces have been hit by power cuts in recent weeks, largely driven by a spike in coal prices that made it unprofitable for power plants to sell electricity at fixed-prices. The impact was in the official manufacturing purchasing managers' index, which declined to 49.6 from 50.1 in August, below the 50 median estimate in a Bloomberg survey of economists.

Beijing has scrambled to solve the problem by allowing power companies to raise prices and trying to funnel more coal to the sector. Those efforts could get production going again in many factories, but that relief might not come for weeks.

Beyond that, Beijing is signalling that it wants highly energy-intensive producers, like steel and chemical factories, to reduce output for the rest of the year, as it tries to meet environmental targets. China's aim to reduce energy intensity, or how much power is needed to drive output, by around 3 per cent in 2021 could drag down full-year growth by 0.3 to 0.6 percentage points, according to Citic Securities head of fixed income research Ming Ming.

A roll-back of energy intensity targets before the end of the year is unlikely, according to consulting firm Plenum partner Chen Long.

"This year's target is above 6 per cent, so growth is not really a concern," he said, adding that the economy could expand by less than 4 per cent in the fourth quarter.

Property slowdown

Evergrande is facing a debt crisis that's roiled financial markets and drawn global attention. The company accounts for only about 4 per cent of China's property sales, so economists are more worried about a broader slowdown in real-estate investment prompted by the government's efforts to slow the pace of mortgage lending and curb financing for property developers.

China's central bank told financial institutions this week to cooperate with governments to stabilize the property market, repeating a call for "healthy development" of the real-estate sector. That may signal a "marginal adjustment" of real-estate credit policy to ensure people who need housing can access loans, according to a report Thursday on a social media account of the official Securities Times.

Beijing wants to avoid a crash in the market, but has vowed not to use the property sector to stimulate growth and so is unlikely to shift to easing restrictions significantly.

Real estate investment could fall by 2 per cent to 3 per cent year-on-year in the second half of the year, according to a baseline estimate by UBS.

In the worst-case scenario, property investment could plunge by 10 per cent, dragging down China's economic growth by 1 to 2 percentage points in the next few months, according to UBS economists.

Weak consumption

China has been tested by Covid-19 clusters in south-eastern and northern regions in recent weeks. The nation's zero-tolerance approach to the virus means stringent curbs will impede an already-slow recovery in consumption. The slowdown is most visible in China's car sales, which fell nearly 15 per cent year-on-year in August.

The latest outbreaks led to lacklustre tourism revenue over a national holiday period last week. That's likely to be repeated over the seven-day National Day holiday at the beginning of October, with Chinese health authorities advising the public to avoid unnecessary travel.

Commodity prices

Surging prices of coal and other commodities have strangled profit growth for downstream manufacturers in sectors like electronics and automobiles, who were already dealing with challenges such as record shipping costs and a microchip shortage. Industrial profit growth already decelerated to its slowest level in almost a year in August.

Some factories are cutting back on production, meeting only the most profitable orders. Raising electricity prices might be the solution to power cuts, but will add to their cost burden.