SUMMARY:
- PBOC’s flurry of support measures today represent growing urgency on the part of Xi’s economic team to confront slowing growth and deflation, but the impact will be relatively modest in isolation
- A major increase in fiscal and property support will be critical to breaking out of deflation; such moves require a political decision by Xi Jinping, which may not be forthcoming until economic and related social and political pressures get worse
- Our basecase is that China’s bazooka will not fire soon, though our conversations in China this week for 22V’s investor trip underscore that policy is in a highly fluid period
On Tuesday morning Beijing time, the heads of PBOC and the two other financial regulators announced a package of easing measures, including:
- A 50 bps cut to the RRR (reserve requirement ratio), with plans to cut an additional 25-50 bps if necessary. The RRR cut is best understood as a means to finance the mortgage refinancing cut and other easing measures by reducing costs for banks.
- A 20 bps cut to the 7-day repo rate (PBOC Governor Pan Gongsheng suggested similar magnitude cuts are forthcoming for the lending and deposit rates).
- A 50 bps cut to the interest rate on existing mortgages
- A cut to the down payment requirement for a second home mortgage from 25% to 15%.
- Slightly more generous terms for the PBOC policy lending facility that finances government property purchases.
- A new lending program that allows listed firms to borrow at a subsidized rate (2.25% effective borrowing cost) from banks to finance share repurchases.
- The PBOC will encourage banks to finance land purchases from distressed developers.
The critical question is whether PBOC’s moves represent the opening salvo in a broader campaign to boost demand and counter deflation. This would require a political decision at Xi Jinping’s level, allowing even more crucial steps to boost fiscal and property policy support. If, on the other hand, policy support is confined mainly to monetary policy, the impact will be modest. Our conversations in Beijing this week for 22V’s investor trip suggest a highly fluid policy dynamic, but not yet clear signs (to us) that the broad macro strategy has shifted from emphasizing restraint to attempting reflation.
PBOC’s show of force will have a modest impact on its own
Today’s moves – especially the 20 bps cut and the mortgage refinancing plan – will provide only a modest boost to growth:
- Even with the latest round of rate cuts, Chinese firms and households continue to face a real borrowing cost of ~4%.
- As a tool, reducing the interest rate on existing mortgages is a potentially boon for consumption. However, today’s cut is too small to significantly boost household income or reduce early mortgage repayments. We estimate today’s move will save households 150 billion yuan per year, compared to 170 billion yuan in annual interest rate savings from the 2023 round of refinancing.
- There are already loopholes allowing people to qualify for lower down payments when purchasing a second home, which somewhat blunts the impact of the cut to the minimum downpayment.
- The slightly more generous terms for PBOC relending to local governments is not enough to rapidly accelerate the inventory clearance scheme given the heavy fiscal problems of local governments due to lost land sales revenue.
While the Fed’s rate cut opened up somewhat more space for PBOC to move, there are limits to the effectiveness of monetary policy from here:
- In our meetings in Beijing, we found broad acknowledgment that monetary policy can only do so much in an environment of weak demand and confidence. Fiscal and property policy are ultimately more important.
- PBOC’s faces some constraints from the desire by the authorities to not see bank interest rate margins compress further. Governor Pan stated today that the latest round of easing will not come at the expense of bank profitability. Relatedly, the head of financial regulation mentioned that Beijing is considering recapitalizing the six largest banks. This would provide more headroom for lending, but there has been no suggestion of recapitalizing smaller banks, which are significantly weaker.
Going bold?
The backdrop behind today’s moves is not only a string of bad data but also growing alarm in China’s policy circles as to the seriousness of the economic situation and growing evidence that deflationary expectations are becoming more entrenched. Liu Shijin, an influential policy advisor, generated major attention with a call in recent days for a massive stimulus plan to counter deflation. Former PBOC governor Yi Gang also spoke publicly about deflation. The key question is whether this level is urgency is sinking in at top policy levels, sufficient to generate a broad-based response beyond PBOC’s moves today.
Some of our interlocutors contend that Beijing’s reaction function has shifted even in the last two weeks, and that senior leaders acknowledge – at least to a greater degree than before – the severity of the current situation. These same interlocutors believe that additional actions will come soon in other areas, such as additional financing for PBOC’s relending program to absorb excess housing.
However, other credible voices that we spoke with this week cited strong reasons to be skeptical of major near-term changes coming for fiscal and property support, including:
- Beijing’s reluctance to use fiscal resources to restructure property developers and provide them with a solid financial backstop.
- Beijing’s conservative approach to providing local governments with more fiscal resources or relaxing their debt constraints, given the leadership’s concern over the moral hazard problems.
- No signs that Beijing is contemplating direct income support for consumers, in part for ideological reasons. Indeed, today’s mortgage refinancing move may be a substitute for fiscal support for households rather than a prelude.
These more skeptical interlocutors believe that the most likely triggers for a bazooka would be political/social, such as significant protests. And China is not there yet.
The bottom line
For now, our basecase is that PBOC’s moves reflect increased urgency to boost growth and lift confidence, but not necessarily sign-off at the highest level to bring out the bazooka.
Our stimulus basecase has been that Beijing will announce an extra 1 trillion yuan central government special bond issuance to be announced in coming weeks. That support, on top of today’s moves, would probably allow China to achieve the bottom range of the growth target of “around 5” (i.e., 4.8%) or to come close. But it would not be the offensive against deflation that many policy advisors are calling for, especially given a lack of direct support to households. And it will only temporarily stabilize activity.
That said, it is clear that policy remains highly fluid. We will be watching closely for further signals in coming days and weeks, including at the end-October quarterly Politburo meeting on the economy. The clearest messages may not come until late November and early December, when Beijing prepares for the Central Economic Work Conference. The CEWC is the most logical venue for a major shift in policy – if it comes.
