22V Research led a delegation of investors to China last week (9/22-27), which turned out to be one of the most significant periods for China policy in recent years. In this note we review key takeaways from the trip and the insights they provide into China’s latest policy pivot. (You can also find a Webinar replay of Michael Hirson discussing the trip with Dennis DeBusschere HERE).
SUMMARY
- China’s leadership is finally acknowledging that the economic situation is urgent, an important turning point that lowers tail risks for growth in coming quarters; however, more aggressive and creative policy will be necessary to promote a strong recovery and escape deflation
- The pivot thus far is more beneficial for Chinese domestic equities than it is for real growth and commodity demand; officials have signaled new determination to boost equities, but not yet the follow-through on fiscal stimulus and property support necessary to rejuvenate activity
- We expect near-term fiscal stimulus of CNY 1 trillion, which is lower than many expect but would be followed by additional stimulus to cushion growth in 2025; this could be announced as part of larger issuance package that includes funds for recapitalizing banks and refinancing local government debt
- The desire to boost confidence ahead of the US election was likely one motivation for the policy pivot; while Beijing would need to increase stimulus to offset higher tariffs if Trump is elected, trade tensions would also give China’s leadership a political scapegoat for the weak state of the economy
WHAT A WEEK…
Over four days of meetings in Beijing and Shanghai, we spoke with officials at key economic and financial agencies, policy advisors in academia and think tanks, and private sector economists and financial journalists – all as Chinese authorities rolled out two rounds of stimulus announcements: a press conference by the central bank and financial regulators on Tuesday (9/24), followed by a surprise Politburo statement on the economy on Thursday (9/26). By Friday, China’s equities markets had experienced their best week since 2008. We also traveled to Changzhou, a clean energy hub in Jiangsu Province, to meet with a lithium battery maker and a solar PV maker and discuss the outlook for excess capacity and related issues in these sectors.
Our conversations indicate that China’s leadership has recognized a new urgency to support the economy and confidence, an important turning point after a period of complacency. Policymakers are also newly focused on stabilizing equity and property values to help improve expectations, a significant shift in emphasis. The overall policy approach is still incremental and may not be aggressive or creative enough to drive a strong economic rebound in the face of weak demand and structural constraints. However, the more proactive stance at least lowers downside risks to the economy in coming quarters. The near-term fiscal policy package is likely to underwhelm against very high expectations but in our assessment will likely be followed by announcements that cushion growth in 2025. In sum, the pivot thus far appears more favorable for boosting domestic equities than for real activity and associated commodity demand – at least until there is more visibility into Beijing’s follow through on fiscal and property policies.
BEIJING’S INCREASED URGENCY LOWERS DOWNSIDE RISKS TO GROWTH
Even before Xi chaired a surprise Politburo meeting on the economy on 9/26, our conversations in Beijing suggested that China’s leadership had very recently started to accept the depth of economic problems and that a policy pivot was underway. We assess that several key factors prompted the pivot:
- Worsening economic data that called into question the ability to meet China’s official growth target of “around 5%”, and that showed recent property support measures were failing to arrest the decline in housing prices.
- Growing awareness of the risks of a deflationary spiral. Recent months provide signs that deflation is not only symptomatic of weak demand but starting to contribute to it, which is playing through channels such as cuts to salaries. The urgency is highest at PBOC but is also starting to penetrate within Xi’s economic team – at least enough to approve the PBOC moving into a more proactive easing stance last week.
- Growing – but not yet acute – social pressures. Conversations suggest that the weak economy and labor market, and strains on local government finances, are creating social pressures palpable to Beijing. Still, these have not reached the level of acute concern over social stability such as during the zero-Covid protests – which is likely the threshold necessary for Beijing to abandon restraint and launch the “bazooka” such as a major fiscal stimulus package.
- The approach of the US election. Rather than waiting for the election results, Beijing likely calculated that it would be prudent to reinforce domestic sentiment ahead of time and protect against a hit to confidence should Trump win the election and signal major tariffs.
Policy has shifted into a more proactive stance even if most measures have been incremental. The economic and social concerns noted above have moved the policy dial in Beijing from its “restraint” setting (many would call it “complacency”) to “active support” mode – but (yet) not all the way to “emergency measures” and the proverbial bazooka:
- The surprise timing of the 9/26 Politburo meeting on the economy (usually held end-October) and the content are signals from the leadership to the markets and China’s system that it is no longer business as usual. The measures outlined have thus far been largely incremental, but send the message that supporting growth, asset markets and confidence have risen higher on the priority list relative to controlling financial risks.
- Likewise, the PBOC’s specific easing measures were modest in scale (a 50 bps cut to reserve requirements, 20 bps cut to the policy rate, and 50 bps cut to the rate on existing mortgages). More notable was that the moves were taken in tandem – taking advantage of recent Fed easing – and that PBOC Governor Pan Gongsheng emphasized the readiness to do more (including telegraphing another RRR cut by the end of the year) as necessary.
- The skeptical take on announcements to date – as we heard from several interlocutors – is that policymakers are dressing up familiar moves and still not moving aggressively or creatively enough to address current challenges. But our contacts tended to lean more constructive, at least for the near term, assessing that the change in the tone from the leadership as well as the technocrats reduces the likelihood that policy implementation will underwhelm as it has since the start of the post-Covid recovery. Most contacts believe that Beijing has sufficient tools to support growth, so long as the will is there.
Outlook: Beijing is not yet demonstrating that it will do whatever it takes, at least in so far as necessary to promote a strong recovery and decisively break out of deflation. But the more proactive stance and acknowledgement of urgency implies a significant reduction in downside tail risks to growth over coming quarters.
A NEW EMPHASIS ON STABILIZING PROPERTY AND EQUITY VALUES
China’s leadership is newly targeting a stabilization of asset prices – property as well as equities – to support growth and confidence. Beijing recognizes that reviving domestic demand is an urgent priority. At the same time, officials remain wary of major fiscal stimulus and question the effectiveness of directly supporting household income. The solution? While not explicitly stated as such, we view Beijing as attempting a strategy of generating positive wealth effects in equities and housing as a less fiscally costly way to boost private investment and household consumption.
Equities:
The most novel measure announced last week was two new facilities by the PBOC to encourage purchases of equities – the first time that the PBOC has used its balance sheet for this purpose. One facility (CNY 500bn) allows asset managers to swap holdings of stocks and bonds for highly liquid assets such as government bonds, providing liquidity to increase equity holdings. The second facility (CNY 300bn) encourages commercial banks to lend to listed companies and their major shareholders to fund share purchases and buybacks. PBOC Governor Pan pledged to increase the size of both programs if there is demand.
These new measures come on the back of earlier initiatives to boost the attractiveness and valuations of the domestic A-share market through higher dividend payouts, more stock buybacks, and tougher requirements around IPOs and de-listings. While Beijing has many reasons for promoting equities – including funding innovative companies – conversations with economic officials suggests they view it as an important aspect of the current stabilization effort. The direct wealth effects from equity markets for the household sector are small, but officials perceive equities as a visible barometer of the state of the economy and thus a way to reset the narrative among firms and consumers. These dynamics imply continued policy support for the equity market over coming months – though ultimately the macro backdrop will need to strengthen for the recent rally in A-shares to be sustained and extend further.
Housing:
The stakes for Beijing to stabilize sentiment in housing are even higher than for equities given that housing represents two-third of household assets and backs up local government finances as well as many private sector loans. It is also a much tougher task.
The 9/26 Politburo statement struck a significantly more supportive tone on housing. The statement introduced a new phrase – “end the decline and return to stability” – that likely refers to both housing prices and sales. It also moved the discussion on housing from the section on risk management (which had implied a desire to control the downside but not to promote the sector) to the section on macro stimulus. Several contacts in the property sector expressed cautious optimism about the shift in tone, while noting that the specific measures discussed by the statement are incremental and likely to have a modest effect. These include pledges to: further reduce property purchase restrictions in the largest cities (which Shanghai, Shenzhen and Guangzhou acted on over the weekend); increase lending to “white list” property projects; and control the stock of new housing.
The looming question for property is whether the central government will use more of its own fiscal resources to help restructure indebted developers and return them to financial viability. There are no indications yet that Beijing is prepared to do this, as it smacks of a bailout of developers and implies reversing Xi’s tough approach to the sector. However, the new resolve signaled from the Politburo increases the possibility that if recent measures fail to stabilize the sector in coming months – as seems likely – Beijing may finally be ready to put fiscal resources to work.
MONETARY POLICY HAS STEPPED UP BUT FISCAL STIMULUS IS KEY
Fiscal Policy:
The single biggest question for the economic outlook in coming quarters is what happens with fiscal policy, which has been a drag on growth this year. With local governments still deprived of revenue from land sales to property developers, government spending has underperformed the budget target this year. There is a broad consensus within policy circles that significant fiscal stimulus is necessary, and that the composition of spending should shift from investment (infrastructure and industry) to consumption (such as consumer subsidies and even direct income support). At the far end of the spectrum, an influential policy advisor, Liu Shijin, has made a high profile proposal for a CNY 10 trillion package over two years to fund social services and urbanization.
The Politburo statement pledged counter-cyclical fiscal measures, but with few details other than a pledge to make good use of so-called “special bonds” issued by the central government and local governments. There are also vague hints of openness to additional consumption-focused stimulus, following the introduction this year of a program subsidizing trade-ins of cars and appliances. The central government will very likely announce a new round of special bond issue by end-October to support spending over coming quarters. But expectations are wide-ranging in terms of the potential scale and composition, both in the media and among our interlocutors in China.
Our expectation is that Beijing will announce CNY 1 trillion in near-term stimulus funded by special bond issuance. To put this amount in context:
- The CNY 1 trillion amount is conservative relative to some expectations, which have been inflated by the overall excitement of the policy pivot and the large numbers being called for by advisors such as Liu. As our conversations in Beijing reminded us, officials are still dealing with the local government debt burdens created by China’s massive infrastructure spending package in 2008-9. But many of the headline numbers being floated in the media also include potential bond issuance for other uses, such as bank recapitalization and refinancing of local government debt (see further below). Like-for-like, our expectation of CNY 1 trillion for the stimulus portion is in line with reports by Bloomberg and Reuters.
- Stimulus in the CNY 1 trillion range would shift the fiscal stance from a drag to neutral in coming quarters and would likely be enough to put 2024 real GDP growth in the government’s range of “around 5%” (perhaps 4.7-4.8%). Most of the spending would take place in Q1 and Q2 2025. It provides a much-needed lift to growth but not a powerful counter-cyclical punch.
- Given Beijing’s focus on reducing downside risks, it is likely that this initial package would be followed by additional fiscal stimulus announcements. In other words, we expect continued policy support through at least the first half of 2025.
In terms of composition, we expect the majority would be spent on infrastructure, especially strategic priorities for the central government (e.g., data and clean energy networks). While a portion is likely to go towards consumption (such as consumer vouchers), we are skeptical of reports that Beijing is preparing major direct income support such as the introduction of annual income subsidies to households with more than one child. While China’s leadership is gradually becoming more open to the notion of income support – and will eventually embrace it out of necessity – there are still political and practical objections to doing it at scale. One official we spoke with echoed a common refrain that income support would provide only a short-term lift to growth. The political objections include Xi’s warning that China risks becoming lazy if it follows Western-style welfarism, as well as the Party’s preference for stimulus to produce tangible results such as infrastructure, a legacy of China’s socialist tradition. The ship is turning slowly.
Importantly, the Ministry of Finance could take a page from PBOC’s playbook and aim to maximize the confidence boost by announcing this stimulus plan as part of a larger debt issuance package that could easily total more than CNY 3 trillion. Bloomberg reported last week that the authorities are considering using public funds of CNY 1 trillion to recapitalize the largest state banks. We also find it very likely that Beijing will announce as much as CNY 1.5 trillion in funding to help local governments refinance maturing debt after a similar move last year. Our conversations with officials in Beijing pointed to growing concern over the financial strains on local governments, which are leading to a rise in arbitrary fees and fines and in unpaid receivables to private firms – a political as well as economic problem. We note that the Politburo statement dropped a reference to controlling local government debt risks for the first time since 2022. Relaxation of local government debt restrictions kicks the problem further down the road but is a practical necessity and (in our view) the right approach: in an environment of weak domestic demand, continued local government deleveraging is worsening deflation and debt burdens rather than improving them.
Monetary Policy:
PBOC is not out of bullets, if officials choose to fire. Economic officials believe that in the current environment of weak confidence and demand for credit, monetary policy is largely “pushing on a string” in terms of its ability to boost growth. But with real rates high (~4%) and mounting concern over deflation, an important question is how much scope there is for PBOC to ease further. With the Fed now in easing mode, the main constraint on monetary policy has moved from pressures on the exchange rate to domestic financial stability concerns – in particular, record low net interest margins (NIMs) for banks. On the whole, banking sector experts we spoke with conclude that the PBOC does have scope to ease further, such as by reducing deposit interest rates to manage bank funding costs.
An additional buffer for banks would come if the authorities move ahead with recapitalizing banks. Contacts regard such a plan as partly motivated by a desire to address the ongoing impact of the property downturn on bank asset quality. While banks’ reported asset quality and capital looks healthy, this is in part because of continued regulatory forbearance on loans to the real estate sector. At the same time, recapitalization would provide further room for banks to lend in coming quarters, even if mostly to SOEs and local government financing vehicles to support stimulus.
Contacts do not perceive major near-term risks to financial stability. Many of China’s smaller regional banks are encumbered by bad debts to developers and zombie loans to local government financing vehicles. Regulators are promoting mergers between small banks, which tends to paper over rather than address the underlying situation. Nonetheless, interlocutors assess that China’s financial agencies have both the will and the tools to prevent liquidity problems at these banks from becoming a potential “Lehman moment” anytime soon.
WATCHPOINTS
The two announcements last week represent an initial salvo designed in part to boost confidence ahead of China’s annual Golden Week holiday (Oct. 1-7). Further policy actions will follow in coming weeks, potentially even during this holiday week. These follow-on measures will provide a much clearer sense of the nature of the pivot and the extent of change in China’s policy framework.
Key watchpoints include:
- Fiscal stimulus announcement. The likely increase in the deficit for 2024 will be approved in late October, when the standing committee of the National People’s Congress meets. Further details could come out in advance.
- November Politburo meeting/Central Economic Work Conference (CEWC). The CEWC lays out policies for the follow year, preceded by a meeting of the Politburo. Key signals to watch include how aggressively Beijing intends to set the growth target next year, the fiscal deficit target, and whether PBOC changes its description of its monetary policy stance to signal further determination to fight deflation.
- More steps to bolster equity market confidence and property sentiment. Property measures will continue to roll out in coming weeks, particularly at the local level. Among potential equity watchpoints is the potential revival of the cancelled IPOs of Ant Financial and Didi, which had signaled the intensifying campaign against platform companies in 2020-2021. Their formal rehabilitation would a signal to foreign investors, especially, that Beijing is prioritizing confidence and growth over other goals.
