SUMMARY
- The Central Financial Work Conference was incrementally supportive of growth and negative for longer-term market oriented reforms in the financial sector.
- A mild tone on local government debt risks was among the signals that China’s leadership is keen to maintain infrastructure spending amid a weak economy recovery; the conference pledged incremental support for the property sector but no bailouts for private developers, whose woes will continue to weigh on sentiment and activity.
- While these signals and China’s recent infrastructure stimulus lower the near-term risks of a double dip in growth in coming quarters, they do not assure a strong and balanced recovery; the upcoming Central Economic Work Conference will be important for gauging if policy will step up further and break China out of an equilibrium of weak private sector demand, subdued confidence, and risks of entrenched deflation.
- The work conference emphasized a broad theme of tightened Party control over the financial sector; these changes improve Xi Jinping’s ability to force compliance with his key directives, but also threaten to undermine professional/technocratic expertise in the sector and to add political distortions to the allocation of credit and capital.
On Tuesday, China’s government concluded the Central Financial Work Conference, a two-day meeting held roughly every five years to lay out key financial regulatory priorities. As expected in our preview note (link HERE), the meeting lacked bombshell announcements but sent important signals regarding China’s policy outlook. Our key takeaway from the conference is that it is incrementally supportive of growth, particularly infrastructure investment, while being negative for China’s longer-term market-oriented reforms.
Growth takes priority over deleveraging:
General Secretary Xi Jinping chaired the conference and thus its readout sets the overall political direction for financial policy over the next five years. While Xi remains intent to avoid systemic financial risks that could disrupt his long-term agenda, the conference readout was consistent with other recent statements that acknowledge the need to support growth amid a struggling post-Covid recovery, weak confidence, and the headwinds from debt and demographics. Beijing will use regulatory and political pressure to contain the growth of new debt, particularly by local government financing vehicles, but efforts to actively deleverage are on the backburner.
Macro policy will stay accommodative. The readout pledged to “pay more attention to cross-cyclical and counter-cyclical adjustments and enrich the monetary policy toolbox.” These and other statements suggest that monetary and credit policy will remain accommodative, including a likely rate cut this year and use of the PBOC’s balance sheet to support local governments’ refinancing needs and extend credit to targeted sectors such as clean tech (EVs, solar, batteries) and SMEs. Implications: supportive monetary and credit policy are incrementally positive for commodity demand and slightly negative for China’s currency, at least in the short term.
Beijing will avoid the risks of an aggressive crackdown on local government debt. Beijing’s recent announcement of additional infrastructure stimulus for disaster reconstruction reflects a clear desire by the leadership to avoid a sharp slowdown in local government spending in coming quarters given the weak recovery (see our writeup on the stimulus announcement HERE). The conference reaffirmed that message by signaling a patient approach to addressing local government debt. It did not repeat familiar commands such as “strictly controlling” local debt, pledging instead to “establish a long-term mechanism to prevent and resolve local debt risks, establish a government debt management mechanism that is compatible with high-quality development, and optimize the debt structure of central and local governments.” The latter reference to optimizing the debt structure is particularly interesting, as it implies a willingness by the central government to leverage its own relatively healthy balance sheet for spending and take some of the pressure off highly indebted local governments; this is also consistent with the recent stimulus announcement, in which the central government is issuing debt and transferring the funds to local governments to spend on infrastructure. Implications: Beijing will use regulatory and political pressure to limit growth in new hidden debt at the local level but is no rush to shrink the stock and risk tanking growth. This lack of urgency, along with suggestions that the central government will take on more responsibilities for financing spending, are positive for infrastructure spending through H1 2024. However, local government debt is China’s most serious financial stability issue and a major headwind to the medium-term growth outlook; more aggressive efforts to bring down debt, including allowing bond defaults by local government financing vehicles, could return in H2 2024 once China’s recovery is on more solid ground.
Beijing will encourage financial support to the property sector but not bail out private developers. As we expected, the readout did not imply significant bailouts for private property developers, an important watchpoint given that the financial struggles of developers continue to undermine household faith in the sector. Instead, the readout implied that Beijing will take a more incremental approach of easing regulation for developers, such as leverage limits and their use of reserves from pre-sales, and perhaps bolstering some of the existing mechanisms to improve developers’ access to finance. The readout signaled that Beijing will continue to ease city-level housing policies. It also pledged to “speed up” construction of the “three major projects,” which refers to urban village revitalization, affordable housing and certain municipal infrastructure; monitoring financial support for these initiatives will be an important watchpoint for construction activity over the medium term. Implications: This is not a game-changer for the property sector, which will continue to drag on growth through 2024.
Tightened party control aids compliance but is negative for market reforms:
The overarching theme of the conference was tightening Party control over the financial sector – notably telegraphed by changing the name of the meeting from the National Financial Work Conference (held since 1997) to the Central Financial Work Conference. “Central” here refers to the central committee of the Party.
You may be wondering: didn’t Xi already call the shots in the financial sector? Yes, but his direct command has increased further since March with an overhaul of the regulatory structure. These changes move the locus of financial policymaking from the State Council (cabinet), a more technocratic setting, directly to a new Party body called the Central Financial Commission (see our earlier report on “Party finance” HERE). In practice, this means that Xi’s directives for the financial sector carry a heavy political weight, increasing pressure for compliance by regulators and financial firms (banks, insurers, asset managers, etc.). Those directives include adhering to regulatory requirements (no favors for connected borrowers) and supporting Xi initiatives such as providing financing for high-tech sectors.
The conference provided relatively few new details on how Party control will work in practice, other than confirming that vice premier He Lifeng, a longtime Xi protégé, has the lead in overseeing the financial sector. Our concern is that in the long run, politicizing finance degrades professional/technocratic competence in the financial sector and risks increasing distortions in how credit and capital are allocated.
Another key theme at the meeting was Xi’s familiar emphasis on finance “supporting the real economy.” For Xi, this means that capital exists to serve national priorities and not for its own profit-seeking sake. Xi’s focus on innovation and promoting advanced manufacturing translates to continued support for the fund-raising role of China’s equity markets, particularly high-tech boards such as the STAR market, but still with significant formal and informal state direction to steer capital to desired areas. Investors should expect the financial reform agenda to remain cautious and state-led; indeed, there were no references in the statement to increasing private ownership within the financial sector, an explicit departure from a previous (if lukewarm) goal of expanding the role of privately owned institutions in a state-dominated system.
As an aside: It was interesting to note that the meeting prominently featured calls to make China a “financial power.” In our view this is more rhetorical than a practical political goal: Xi is focused on cementing China’s role as a manufacturing power, with finance playing a supporting role by funding innovation efforts. He is far too distrustful of finance and too risk-averse to give full play to the reforms necessary to put China anywhere close to matching the US, for example, in its role in global capital markets. Likewise, an insistence on maintaining capital controls will continue to constrain the RMB’s emergence as a major reserve currency even if Beijing has geopolitical motivations for accelerating this process.
What recent signals mean for the 2024 outlook:
China’s disappointing PMI readings for October underscore that the recovery is still struggling to gain momentum. We have stressed that while China’s economy has stabilized, we are not yet convinced that the recovery is on a strong footing. The latest PMI readings highlight such concerns. The official manufacturing PMI slipped from 50.2 in September to 49.5 in October, while non-manufacturing (services and construction) fell from 51.7 to 50.6. The composite PMI came in at 50.7, down from 52 in September and the lowest reading this year.
These are not disastrous readings, but they add to some of the points of caution in China’s forecast-beating Q3 GDP report (see our writeup HERE):
- Nominal growth was weak, with the GDP deflator negative for two consecutive quarters – a sign of continued deflationary risks.
- Growth remained highly dependent on stimulus. End-demand remained subdued, with household consumption showing some improvement, fueled by a drop in the saving rate, but still weak compared to pre-pandemic trends.
- Momentum was not robust. Monthly activity in September slowed relative to August for three key data series: industrial production, retail sales, and fixed asset investment. The latest PMI readings suggest momentum did not accelerate notably in October.
The latest signs of support from Beijing suggest that the leadership is aware of these vulnerabilities and keen to avoid repeating the double-dip in growth that took place this summer. China’s recent infrastructure stimulus, plus the signals above from the financial conference, show a recognition that the recovery needs continued support, particularly from infrastructure investment. While this reduces downside growth risks for the next few quarters, it does not necessarily mean that support will be of the right type or the right scale to promote a strong recovery in 2024. Growth remains overly dependent on stimulus, with private sector demand and employment still well below the pre-pandemic trends. Direct fiscal stimulus for households remains off the table for Beijing; infrastructure stimulus will support manufacturing activity but has only a modest impact on boosting employment, which remains a weak point in the recovery.
The upcoming Central Economic Work Conference – the annual December meeting in which Beijing lays out its policies for the next year – will be key to gauging policy support in 2024. Among the watchpoints will be CEWC’s hints at the GDP target for next year, which won’t be formally announced until next March. The most likely scenario is that Beijing will set a growth target of 4.5%, but there is an upside risk that Beijing will set a formal target of 5% or at least informally declare the intent to get there. What is the difference between 4.5% and 5%, other than 0.5 ppts of growth? This year has clearly seen an economy running too cool, with two quarters of deflation and signs of slack in the labor market. A growth target of 5%, backed by credible stimulus policies, could reduce slack and increase the chances that China can break out of a sub-optimal equilibrium of weak demand, restrained confidence, and risks of persistent deflation.
Another near-term watchpoint for the outlook is whether China holds a Third Plenum meeting to outline economic reforms. China’s typical political calendar would call for a plenum meeting this fall to lay out economic policies for the next five years. But as in many other areas Xi has not always held to this custom. A plenum would be the occasion to follow up on Beijing’s recent pledges to improve the climate for private business, so a decision not to hold it, or to focus on issues other than the economic agenda, would mark a disappointment in efforts to boost private sector confidence.
