Investors are waiting for signs that Beijing, facing mounting downside pressures on growth, will adopt significantly more forceful and effective stimulus policies. The latest signals are not very encouraging, suggesting continuation of a conservative approach despite the risks that it is insufficient to address China’s current challenges.
On Monday, the PBOC guided banks’ one-year loan prime rate (LPR) lower by 10 bps, less than the 15 bps expected by the markets. The reduction was lower than the 15 bps cut on August 15 to PBOC’s benchmark medium-term lending facility (MLF), which serves as the primary reference rate for the LPR.
To be sure, there are some pragmatic reasons behind the smaller-than-expected move:
- It reflects caution on the part of regulators at further narrowing banks’ net interest rate margins. Interest margins have narrowed after a series of cuts to lending rates (not completely offset by cuts to deposit rates). At the same time, regulators are pressuring banks to maintain lending to support growth and, in coming months, to extend the maturities on loans and bonds of local government financing vehicles.
- Regulators want to preserve room for banks to lower rates on outstanding mortgages, not just new loans. Rates on outstanding mortgages taken out in recent years are relatively high, crowding out room in household budgets for consumption and for future property purchases. The PBOC has pledged to work with banks to guide rates on existing loans lower, but this requires ensuring that interest margins can bear it.
- Following the July 24 Politburo meeting, many local governments are in the process of reducing or cancelling the floor on mortgage rates and down payment ratios in their local markets, if slowly (see further below). That means there is scope to lower mortgage rates through these administrative channels without a cut to headline rates.
However, the fact that PBOC delivered a negative surprise to markets just one week after a surprise MLF cut reflects continued challenges in managing expectations during a fragile time. A key theme in our analysis, particularly over the last two months, has been that China’s economic apparatus is trying to straddle two goals: maintaining financial discipline while also boosting growth and confidence. Even as downside pressures mount, the balance remains tilted towards the former (please see: Can a thousand Band-Aids stop the bleeding, August 4, 2023). A growing chorus of domestic economists, including prominent policy advisors, argue that macro policy is too conservative and must become bolder and more expansionary.
One could argue that monetary policy faces important constraints and isn’t the place to look for bolder policy. Rate cuts add to short-term pressure on the currency. They may also not necessarily boost domestic demand in a climate where spending by firms and households appears to be held back by lack of confidence in the outlook, not by borrowing costs. There is thus a strong case that the most important levers right now are fiscal policy and property. However, in these areas as well the messages from the top leadership are not highly promising.
We noted earlier this month that among the key watchpoints would be what Xi Jinping signals as to his economic priorities following the conclusion of the annual leadership retreat to the beachside retreat to Beidaihe – in particular, would Xi suggest greater urgency to support growth? Leaders returned from the beach last week, with Xi chairing a meeting of the Politburo Standing Committee on the response to recent flooding in North China. Xi has not spoken publicly on the economic situation, but the Party’s main ideological journal, Qiushi (Seeking Truth), on Monday published a speech by Xi, originally delivered in February, on the theme of “Chinese-style modernization.” There was little new content in the speech, but its dissemination in the state media right now sends an overall message that the current economic approach is correct and that China must resist following the Western political-economic model. The speech doesn’t discuss stimulus policies directly but is surely an effort to push back on recent Western commentary on China’s economic situation and perhaps to quiet domestic voices pushing for Beijing to embrace a fiscal package focused on households rather than infrastructure investment and support to firms. Another CCP journal, Study Times, took this theme head-on with an article last week addressing the “misconceptions” behind views that Beijing should focus on boosting consumption rather than investment.
Simply put, there is little to suggest that Xi is abandoning his view that China must remain patient in the current recovery, avoid adopting measures that would worsen long-term debt risks, and focus on cultivating new growth drivers (such as clean tech) rather than propping up old growth drivers such as property.
I fully realize that all this political analysis might seem abstract in a period where investors are rightfully focused on tangible events such as the collapse of the largest property developer, but it is extremely important. In the top-down, highly politicized environment in China, the priorities coming the top leadership are echoed throughout the system. Until officials receive a stronger message that supporting growth is the key priority, the rollout of stimulus and other support measures is likely to continue to underwhelm.
Consider other recent signs of a lack of policy consistency and coordination:
- Disconnect within property policies: Despite the Politburo’s approval in late July for localities to ease property policies, progress to date has been slower-than-expected. This suggests that local officials remain cautious about the extent of easing given Xi’s long-held determination to move to a new model in the property sector. More broadly, efforts to stabilize property sales and sentiment are likely to be overshadowed by the collapse of Country Garden – and thus far there are no signs of a meaningful bailout in the works.
- Disconnect between property and fiscal policies: The central government is working on a plan to address financial pressures on local government financing vehicles, but the amount thus far appears to be very small (roughly RMB 1 trillion in bonds to refinance LGFV debt, out of a stock of perhaps RMB 50 trillion in LGFV debt outstanding). A worsening of property sector activity and sentiment post-Country Garden will only increase the pressures on local government finances, which rely on land sales to developers as a critical source of revenue and collateral values. It also means that fiscal policy will stay tight this year rather than loosening to support aggregate demand.
- Regulatory campaigns and private sector confidence: In recent months Beijing has pledged a series of measures to boost the environment for the private sector, including more regulatory certainty. But in late July, Beijing kicked off a new campaign to combat corruption in the healthcare sector that has cratered domestic healthcare stocks and is likely to put a long chill into activity in the sector (see HERE for an excellent explainer on the campaign and the risks from Yanzhong Huang at the Council on Foreign Relations). And Xi’s republished speech this week repeated refrains on the ‘common prosperity’ campaign, including warnings to not follow the West’s “maximization of the interests of capital,” that strike a discordant tone with appeals to embrace the entrepreneurial sector.
Implications:
- Beijing remains behind the curve in addressing pressures on growth and confidence. Inconsistent and underwhelming policies are likely to continue in the absence of a clearer emphasis from the top that supporting domestic demand is the highest priority.
- Clients continue to ask about Beijing’s tolerance level – what might prompt a more aggressive response? Could youth unemployment trigger protests that force the leadership to move off the dime? While youth unemployment is a serious social, economic, and political issue, I am skeptical it will trigger widespread protests. The more likely triggers for Beijing to step up its stimulus response would be: (1) signs that growth will badly miss the 5% GDP target for this year. That increasingly appears the case – most of the better sell-side economists have marked down growth below 5% — but the leadership may wait to see if August and even September data show any signs of stabilization; and (2) major cracks forming in the financial sector, such as widespread defaults in shadow banks, smaller regional banks, or the bond market. Keep in mind that there are some tangible stimulus measures in the pipeline, including a boost in infrastructure investment that will provide some support for construction and manufacturing activity in September-November.
- In the meantime, investors should put China’s growth pressures in the proper context. The main problem remains a lack of will – not capacity – by Beijing to adopt the strong counter-cyclical response necessary to stabilize the recovery. The risk that the leadership allows a hard landing or systemic crisis this year is very low. The real danger is that by muddling through with a very anemic recovery this year, Beijing ends up fostering a deeper malaise – potentially worsened by entrenched deflation – that becomes harder to shake in 2024. Those who read our trip report from July [link HERE] may recall that one interlocutor described China’s current economic response as “the US in the 1930s before Keynes,” when the Fed and the Hoover administration adopted conservative policies that ended up deepening the recession. China isn’t facing a depression, but the key point is that Xi’s focus on financial discipline now could well end up increasing the eventual cost of policies necessary to prevent an even sharper slowdown in growth in the not-distant future.
