• China’s financial stability objective acted as a constraint on the willingness to deliver sizable policy stimulus, resulting in persistent uncertainty over the country’s growth path.
• The recent announcement of a coordinated, broad package covering monetary, fiscal, and property measures marks a significant pivot towards a progrowth strategy.
• The success of the stimulus package will largely depend on the take-up by households and businesses, along with timely execution of the announced measures.
Over the last few years, investors faced multiple walls of worry surrounding the People’s Republic of China (“China”). Economic growth was accorded low policy priority compared to other imperatives of maintaining social stability and geopolitical security. Policy became less predictable as decisions came from top leadership, instead of economic technocrats whose autonomy had been reduced over time. As growth numbers continued to slide, markets had little confidence of a decisive tilt towards pro-growth policies. The resultant loss of economic dynamism, low consumer and business confidence, and lack of animal spirits led to an austerity trap where consumers were unwilling to spend amid fiscal conservatism, as local governments continued to write down legacy debt.
Starting in September, these concerns were partially allayed by a broad, coordinated set of stimulus measures that encompassed monetary, fiscal, and property initiatives. Importantly, these counter-cyclical measures were endorsed by the Politburo, with explicit guidance to “stop the decline in housing”. To summarize the recent stimulus announcements: The People’s Bank of China (“PBOC”) unveiled a set of coordinated measures that covered monetary easing, property stimulus, and equity market support. These include interest rate and reserve requirement cuts, a lowering of minimum downpayment ratios for second-home purchases, a swap facility for financial institutions to tap on PBOC liquidity to buy stocks, and a relending facility for banks to finance listed companies’ share buybacks.
The Ministry of Finance of China (“MOF”) announced a fiscal stimulus program that aims to:
• Increase central government borrowing to aid local governments’ debt resolution, by reducing interest costs through a debt swap program.
• Expand special local government bond issuance to buy idle land and unsold homes to convert them into subsidized housing.
• Issue special sovereign bonds to replenish core Tier-1 capital of top state-owned banks.
• Increase spending on vulnerable groups to support household consumption.
• Provide strong forward guidance of “much scope to increase borrowing and raise the fiscal deficit” in coming years. Caixin, a local media group, subsequently reported plans to raise an additional RMB6 trillion from government bonds over the next three years to finance the fiscal stimulus package.
China’s Ministry of Housing and Urban-Rural Development (“MOHURD”) outlined the following policies to stabilize the housing market:
• Ramp up bank loans from RMB2.2tn to RMB4tn by year-end to a “whitelist” of property developers to complete unfinished property.
• Redevelop some 1mn homes in larger cities as part of its shantytown renovation program.
The shift to a growth pivot was a meaningful change from the drip feed of piecemeal, incremental measures that investors were accustomed to and were ineffective in the past. The positive aspects of the overall package were:
• Coordinated across multiple fronts – monetary, property, fiscal, and housing – and supported at the top leadership level by the Politburo.
• Targeted at what are believed to be the right areas.
o Local government debt resolution should reduce the overall public sector debt burden as part of China’s ongoing deleveraging policy.
o Measures to correct the supply-demand imbalance in land and housing, if carried out on a large scale, together with nation-wide easing of property restrictions, raise the odds of a stabilization in property sales in 2025.
o Measures to replenish bank capital to revive lending represent a key monetary transmission channel as China’s economy is far more sensitive to the volume of credit disbursed, instead of interest rates. Measures to support local consumption and housing sales are appropriate as household balance sheets have plenty of dry powder (see Figure 1).
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In the above areas, the need for debt resolution and deleveraging acts as a binding constraint to the size of fiscal stimulus, while the targeted areas of housing and consumption allow some room for policy maneuver.
Binding constraints: The financial stability imperative
Financial stability has become China’s paramount objective and policy choices have narrowed as a result. If China cannot ease up on its deleveraging objective, then the size of future fiscal and credit stimulus will be smaller compared to the past, which will limit the overall impact on growth.
The centrality of the financial stability imperative can be observed in many areas. The policy of deleveraging that began in 2016 has reduced debt held by the worst borrowers (local government financing vehicles and similar entities with no revenue streams) and sharply curtailed lending by the weakest institutions (non-bank financial institutions or shadow banks). The PBOC has provided the financial system with ample liquidity, with little volatility observed in domestic interest rates since 2016. The MOF’s latest plan for local governments to reduce their debt burden by swapping out their bank debt for lower-interest government bonds represents another step towards the stability objective, from which there will be no turning back.
Areas with policy room
But binding constraints do not mean that policy makers need to accept a lost decade in the property market as fait accompli. As a comparison, in the intervening years before Japan’s property bubble burst in 1990, land and property prices doubled relative to income and then crashed thereafter. China’s home and land prices show no such movement, as authorities have proactively tightened over previous housing upcycles and prevented a home price bubble from taking shape.
Bubbles typically burst when the price of a highly leveraged asset experiences exuberant growth that encourages ever greater debt to be taken on, then collapses when the source of funding ultimately dries up. This unleashes a rapid feedback loop that flows from levered balance sheets into the real economy, typically leading to disorderly unwinds, painful financial restructuring, and deep recessions. One is hard-pressed to find such a levered asset in China’s household balance sheets.
Instead, China’s potential homebuyers are held back from poor income prospects as well as concerns over credit risk of weaker developers. Many property developers remain distressed as their cash flows have been hit by falling home sales that are now more than 50% off their peak. The government can jumpstart housing sales by mobilizing state resources to backstop the market and act as a buyer of last resort. An earlier plan announced in May for local governments to buy housing and land from developers was too small to make a material difference. There is now scope for local governments to expand the buyback program by tapping on new bond issuance recently announced by the MOF.
Moreover, there is available space on household balance sheets to accommodate housing stimulus. Reflecting weak housing purchases, household net savings have increased since the pandemic. Household deposits have risen from RMB100tn to RMB150tn over the last two years as consumers ramp up precautionary savings amid a weak economic environment.
This framework of binding constraints versus areas with policy room is important to keep in mind. China’s policy choices are a lot more nuanced and cannot be addressed by simply overlaying the Japan 1990 template of fiscal spending to substitute for private sector demand.
What’s next
Thus far, markets have given the benefit of the doubt that China’s fiscal support for consumption and housing, and stress relief for local governments and banks, are sufficient to establish a near-term growth floor. Equity markets have rallied from a starting point of light positioning and cheap valuations, supported by fairly high expectations of policy rollout in coming weeks (see Figure 2). It is imperative that China builds on this positive policy momentum, or the rally could prove to be fleeting if upcoming measures underwhelm.
Given that the success of the stimulus program will largely depend on the take-up by households and businesses, timely execution remains key. Greater visibility of policy rollout needs to be seen shortly after the National People’s Congress (“NPC”) meeting at end-October, when formal approval of the new budget deficit and debt quota is expected to take place.
In addition, markets need to be convinced that a pro-growth pivot is accompanied by pro-business measures and legislation to protect domestic firms from arbitrary regulatory changes. These are badly needed to quell troubling perceptions of Beijing’s lack of commitment to improving the business environment. Such signals would at least raise the odds that the macroeconomic impact of fiscal and monetary measures will revive animal spirits and trigger a chain of multiplier effects greater than the sum of the individual parts. The downside risk is that the hurdle to a pro-business pivot is higher, and the path of future policy disappoints.
Vincent Low
vincent.low@rohatyngroup.com
Vincent has over 30 years of experience in covering global macroeconomics and markets. He is responsible for formulating investment ideas with PMs, strategists, and equity analysts and developing macro investment themes and processes for TRG’s public markets business. Prior to rejoining TRG, where he was previously CEO of its Singapore office and an Executive Committee member, Vincent held the role of Advisor to the Economics Policy Group at the Monetary Authority of Singapore. He also held roles as the Head of Currency and Fixed Income Strategy at Merrill Lynch, and Senior Economist for Southeast Asia at J.P. Morgan and Standard Chartered Bank. Vincent started his career at the Monetary Authority of Singapore in 1987 and received a Bachelor of Social Sciences in Economics from the National University of Singapore.
Luis Arcentales
luis.arcentales@rohatyngroup.com
Luis has over 20 years of experience in covering global macroeconomics and markets. He is responsible for formulating market strategy at TRG. Prior to joining TRG, he had a short stint as an independent macro researcher following a nearly two-decade career at Morgan Stanley in New York. In his role as Senior Economist, his primary focus was developing the macroeconomic and political outlooks for countries in Latin America, in addition to publishing on topics ranging from the business cycle to trade dynamics for the region. Luis started his career as an equity strategist at McGlinn Capital, a value-oriented asset manager in Pennsylvania. He holds an MS in Economics and a BA in Industrial Engineering from Lehigh University; he sits on the board of Lehigh’s Martindale Center for the Study of Private Enterprise and is a CFA charter holder.
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