Is This China’s “Do Whatever It Takes” Moment?

In a now-famous speech, former European Central Bank President Mario Draghi pledged to do “whatever it takes” to save the eurozone. Is China at a similar watershed moment? Facing a protracted property market downturn, weak economic activity data, a downward deflationary spiral, and increasing challenges in meeting its five percent growth target for 2024, China unveiled an unusually long list of stimulus measures at a press conference on September 24, including:

• Monetary policy easing via large, forceful cuts in the seven-day reverse repurchase rate (RRR), policy rates, and deposit rates.
• Property market easing through large cuts in mortgage rates and downpayment ratios and extensions on banks’ relending coverage on property destocking and lending to developers.   
• Stock market support in the form of a new swap facility with firms to support stock purchases and buybacks. Guidelines also were issued to promote M&A and restructuring.
• Bank support as six major commercial banks will gain support to increase tier-one capital.

Immediately following the announcement, an emergency Politburo meeting was called, which focused on urging further strengthening of countercyclical monetary and fiscal policy, arresting the decline in the real estate market, and boosting employment and consumption. Other highlights include:

• Strict controls on new property construction and further relaxation of housing purchase restriction.
• A potential law to promote private economic development to create a favorable environment for non-public economic sectors.
• A solid livelihood guarantee, focusing on employment for underrepresented or at-risk groups. Employment will become a more central focus of policies and government.
• Pledges to boost consumption, especially for low-income groups.

While full details are still lacking, some measures are already in motion. For example, there is news of cash handouts to households of extreme poverty and consumption voucher handouts in Shanghai. The Politburo meeting suggests a holistic economic support package is on its way. It is also significant that both monetary and fiscal policy are on the agenda, signalling more forceful supports to the economy.

What Is Special about This Round of Stimulus?

There are several stark contrasts to prior stimulus measures that suggest this round really is different. The urgency and forcefulness represent a material turn in policymaking for China.

• The style: In contrast to China’s piecemeal and ad hoc style of stimulus announcements, this one looks more coordinated and tackles all the key problems with a holistic approach. The live televised press conference followed by Q&A demonstrated uncharacteristic transparency.
• The magnitude: The magnitude of rate cuts is much larger compared to the incremental, tiny tweaks in the past. Furthermore, there is direct forward guidance of future stimulus if needed. The seismic shift from “bare minimum tweaking” to “do whatever it takes” conveys a sense of acute urgency.
• The focus: Prior stimulus focused on building infrastructure, manufacturing, and exporting excess capacity to global markets. So far, the new stimulus centers on stabilizing the property market, consumption, and employment—the crux of China’s economic malaise. A bigger focus on boosting domestic consumption and less on exporting excess capacity should boost imports, which also may help improve the trade relations between China and global markets.
• The shift: Post-Global Financial Crisis, China conducted stimulus via property market construction and infrastructure building. For the past two years, China’s focus has been largely on new productive forces, such as high-end manufacturing. This recent round of stimulus calls for stopping new property construction, and there is less of a focus on infrastructure building. This shift likely will impact commodity demand, although property developers might accelerate the completion of properties under construction, which could also boost commodities demand.

Ironically, after years of deleveraging campaigns, the stock market support measures directly encourage financial institutions to purchase stocks via increased leverage. In the same vein, the lowering of mortgage downpayment ratios also incentivizes households to lever up with home purchases. While these policy shifts may sow the seeds for too much leverage in the financial system in the future, they do underscore the serious “whatever it takes” nature of the stimulus.

Is It Significant and Sufficient?

The stimulus package is significant in that it indicates the policymakers acknowledge growth is weak and needs urgent and decisive policy support. We view the “shock and awe” approach as necessary to salvage China’s balance sheet recession. And markets appear to be welcoming the unusual urgency and forcefulness. The Chinese stock market rallied along with the renminbi (RMB), while the Chinese government bond market started to sell off (see Exhibit 1).

We think China’s focus up to now on monetary easing alone is insufficient. It must be combined with big and decisive fiscal easing and related structural reform, such as a fiscal transfer from central to local governments and wealth transfer from state-owned enterprises to households. More details on fiscal easing should come soon.

China’s declining growth rate has garnered much attention. However, the importance of restoring private sector confidence, which has broadly deteriorated, should not be discounted. Developing new productive sectors is good to have, but the property market needs to be stabilized first. The destruction of household wealth from both the property market downturn and income and job losses hurts confidence and restricts spending. Policymakers need to boost private sector confidence and credit demand by stabilizing the property market, ensuring policy stability, creating jobs, increasing household income, and enhancing social welfare. Implementing these policies also matters, however, they can get lost in translation amid local governments’ dire fiscal situation.

Investment Implications

The 50-basis point rate cut from the US Federal Reserve and the sweeping stimulus from China both signal determination from the two largest economies to remove the left-tail risks of recession or stagnation. The resolute attitude matters. We are hopeful for more comprehensive measures from China, even though most of its problems are more structural than cyclical. These measures can buy China some time to embark on structural solutions to the structural problems.

We believe the stimulus announcement is generally good for Chinese risk assets, emerging markets, and eurozone economies that are sensitive to Chinese growth. The stimulus may be especially beneficial for Asian currencies, commodities, and commodity related currencies. Furthermore, if these announcements are followed by big fiscal measures and implemented well, we would expect to see more sustainable repricing higher of Chinese assets. These reflation efforts, if they gain traction, will not bode well for developed market sovereign rates, which are sensitive to inflation.  

If policymakers fail to follow through, China may see yet another false dawn. The longer they wait, the larger the measures needed to fix the problem. The US election is another risk to watch out for.

The yuan (CNY) should benefit from the stimulus measures. However, the interest rate differential with the US is still substantial, signaling that CNY is rich and might have limited room to rally against the US dollar (USD) beyond 7.00 (see Exhibit 2). Policymakers prefer a stable currency with reasonable two-way movement; they do not want speculators betting on one direction of appreciation or depreciation or to see the currency appreciate too fast. In the short term, portfolio inflows will probably improve and support CNY. The US election outcome will be another determining factor for CNY.

CGB yields should sell off further with interest rate curve steepening if we see a deluge of long-term government bond issuance to fund the fiscal bazooka. Additionally, we would expect this trend to continue as these measures gain traction. In the longer term, we believe China’s demographic headwind will be a challenge to reflate away, portending a “lower for longer” trend for CGB yields.

Index Definitions

The Shanghai Shenzhen CSI 300 Index is a free-float weighted index that consists of 300 A-share stocks listed on the Shanghai or Shenzhen Stock Exchanges. The Index has a base level of 1000 set on December 31, 2004.