China’s policy measures: a pivotal week?

China’s policymakers have announced a significant package of easing measures designed to lift China from a state of entrenched economic weakness. Comprehensive monetary policy easing, targeted at supporting the beleaguered real estate market and boosting Chinese equities, has now been rounded out by an impactful pledge to support fiscal spending and stabilize the troubled property sector. The reception from global markets has been very positive so far, with the CSI 300 Index and the Shanghai Composite Index erasing all of their losses year-to-date. Yet, the sustainability of the positive market response will ultimately depend on the size and implementation of the various measures.

China’s fundamental economic problems

After an initial surge in activity and optimism after lifting China’s zero-COVID policy in 2022, China’s economy has descended into a serious downturn. Both consumer and investor confidence remain deeply depressed, scarred by the pandemic and further dragged down by weakening household incomes and persistent fears of a deflation trap stemming from the troubled real estate market. Multiple rounds of policy actions in recent years have missed the mark, failing to recognize that a lingering property rout and indebted local government require meaningful stimulus, effective implementation, and—most importantly—fiscal expansion.

With persistently disappointing economic data prompting concerns that China will miss its 5% GDP growth target this year, investors have been hoping that the deepening economic slump would force China’s Politburo to recognize the desperate need for significant policy action. This week, the Politburo appears to have delivered.

The initial policy announcement

On Tuesday, September 24, the People’s Bank of China (PBoC), together with two financial regulators, announced a series of easing measures aimed at supporting an improvement in real estate demand via cuts to mortgage rates, reduction in downpayment requirements, and a plan encouraging banks to finance purchases of housing inventory from distressed developers.

In addition, authorities have created a RMB 800bn lending pool to provide liquidity to support the equity market through various market participants, while the PBoC is also considering a National Stabilisation Fund, which would involve government sponsorship of the equity market.

While the initial market read of the measures was positive, question marks over the impact on the underlying economy remained. Indeed, these initial measures were best characterized as “market first, economy second.” Policymakers will be acutely aware that elevated debt levels and low confidence among China’s households and corporations have rendered them unwilling to borrow more. So, cutting the cost of credit can be somewhat ineffective.

By contrast, successfully engineering a bull market would restore some confidence and stop the deflationary trend in at least one economic segment. And since boosting the equity market has become cheaper to implement as China’s market cap has been declining and onshore market trading has become very thin, it is no wonder policymakers have focused on the equity market. However, the read-through to the broader economy is relatively limited, as equity exposure only represents a small share of Chinese household wealth.

Overall, the impact of the initial measures was expected to be fairly modest in isolation, requiring fiscal stimulus to sustain an equity market recovery beyond the initial positive moves.

The second announcement

On Thursday, September 26, two days after the PBoC’s stimulus announcement, China’s Politburo surprised markets by pledging a new round of fiscal easing and promising to stabilize the property market.

Although no details of the fiscal stimulus have been announced yet, Reuters has reported that the Ministry of Finance plans to issue 2 trillion yuan ($284 billion) of special sovereign bonds this year and that some of the funding will be used to stimulate consumption and recapitalize banks.

Markets are taking strong encouragement from the clear and direct tone of the Politburo’s announcement, as well as the earlier-than-scheduled timing of the Politburo meeting. Ultimately, however, it is the exact size and design of the fiscal package that will be of the most significance. For example, tax or consumption subsidies may have a meaningfully smaller impact than policies that provide a clear fiscal injection to consumption or that directly address the root problem of the property market.

The main takeaway

Investors have received this week’s news with cautious optimism. The fiscal pledge announcement suggests that policymakers have recognized that the lingering property rout and indebted local government require meaningful fiscal expansion—and that monetary stimulus should prove to be most effective if it is working in conjunction with fiscal stimulus.

Ultimately, provided the magnitude of the fiscal measures is sizeable, and policymakers proactively and sufficiently target rejuvenating the property sector, prospects for China’s economy are likely to improve. This week may mark a pivotal moment for China—but it all comes down to the details.

Principal Asset Management