David Rees, Senior Emerging Markets Economist at Schroders
Beijing’s pain threshold for the deflationary slump in China’s economy has finally been reached and onshore equities rallied following a raft of measures announced on 24 September. Looser financial conditions and housing regulations may eventually start to improve activity, but fiscal stimulus remains the key to driving a sustained turnaround in both the economy and markets.
As a result, markets – which were expecting further announcements on 8 October – fell back in disappointment when these didn’t materialise. On 12 October, the Ministry of Finance announced its plans to significantly increase debt to boost economic activity.
Background to Chinese policy measures
The last round of weak activity data for August and slump in September purchasing manager indices (PMIs) seemed to finally break the government’s patience. The disappointing data triggered a flurry of policy announcements that caused equity markets to soar. As we argued might be the case earlier this year, bad news on the economy has eventually proven to be good news for equities. But it has been a long time coming.
Part of the blistering performance of equities has been due to direct intervention in the market. CNY800 billion has been pledged to “maintain the stability of the country’s capital markets and boost investor confidence” through funding of stock buy backs while also giving brokerages and other market participants liquidity to buy equities. That, along with signals that more liquidity injections could follow, immediately caused equity prices to rise and stimulated huge interest from retail investors.
However, other China-sensitive markets have been slower to react as investors wait to see if what is good for China’s equities will ultimately be good for the economy. Indeed, while MSCI China is up by more than 30% in local currency terms (following the policy announcement, as of 8 October), other markets such as copper (+4%) and corporate bond index CEMBI China (+0.5%) have so far been less enthusiastic.
In a co-ordinated set of announcements, policymakers revealed several measures to loosen monetary policy with unusual forward guidance of most easing to come in the months ahead. The 7-day reverse repo interest rate was cut by 20bps to 1.50%, while the one-year medium-term lending facility rate (MLF) was lowered by 30bp to 2% and required reserve ratios for banks were reduced by 50bps.
At the same time, a further relaxation of housing policy was announced. Downpayment ratios for house purchases have been lowered, along with the removal of almost all restrictions on purchases of additional homes. Along with the cuts to interest rates on new mortgages, existing loans will also see interest rates cut by 50bps to reduce monthly payments.
Looser financial conditions brighten the outlook but will take time to work. One reason is that ongoing problems in real estate mean that the further marginal easing in house purchase restrictions are unlikely to have much immediate effect.
And while the steep declines in market interest rates mean that it may be long until we see leading indicators such as real M1 (a measure of money supply) start to turn upwards, the long lags mean that this is unlikely to stimulate economic activity until the second half of 2025.
Accordingly, fiscal stimulus is needed to give a more immediate shot in the arm for activity. Markets were disappointed by the lack of announcements at the National Development and Reform Commission’s press conference on Tuesday. But with policymakers quoted as saying “we should increase the intensity of fiscal and monetary policies” to boost growth, it may not be long before further public spending is announced.
As we previously argued, the ongoing drag on the credit impulse from weak private sector borrowing means that we think fiscal stimulus of at least 4-5% of GDP aimed at raising demand is needed to significantly improve the outlook.
ENDS
