UNPACKING CHINA’S NEW ECONOMIC PACKAGE

A week before China’s Golden week holiday to celebrate the 75^th anniversary of the founding of the People’s Republic of China started, Chinese financial regulators launched a series of measures to tackle existing economic slowdown. Spearheaded by People’s Bank of China (PBoC), National Administration of Financial Regulation and China Securities Regulatory Commission, some of the crucial measures included reduction in benchmark interest rates and reserve requirement ratio, relaxation in down payment ratio for second homes and additional liquidity infusion in China’s capital markets. Touted as one of the largest stimulus packages in Chinese history, it aimed to revive China’s ailing property sector, weak consumption, and most importantly, declining confidence in the Chinese economy. However, as initial optimism about the package reflected in the Chinese stock market settles down, doubts remain over the effectiveness of these measures for long-term economic revival and stability  given numerous challenges in its implementation.  

Shift in Priorities - A Course Correction

Analysts around the world described these efforts as too little too late, rightly so as it will fall well short of achieving this year’s growth target. However, given China’s dwindling economic scenario, its obsession with short-term growth targets will have to take a backseat for long-term macroeconomic stability. Nonetheless, despite its limitations, these measures hint towards certain critical changes in China’s approach towards economy, particularly with regards to managing current economic slump. Firstly, these measures emphasize on demand-side reforms as the package aims to boost liquidity in the market instead of heavily investing in infrastructure. Although challenges will continue to exist with this approach as monetary support alone will not be able to boost consumption, it still indicates leadership’s willingness to address core issues.

Secondly, re-recognition of the private firms as a major economic contributor is much more visible this time as evident from the new draft law on private sector to end discriminatory policies against private companies. Thirdly, in order to revive investors’ confidence and generate additional liquidity in the market, Chinese authorities have adopted measures to boost capital market in China.

Through these measures, regulators hope to revive some amount of lost confidence of global investors at least in the short term. Besides, this also shows the recognition of the strength of market forces required for China’s economic revival and highlights limits of Xi Jinping’s state authoritarianism. 

Beyond these much-needed changes, several “new situations and challenges” will continue to drag China’s economic recovery as recognized during the September Politburo meeting. This shows the urgency on the part of leadership as economy-related discussions and decisions are usually taken up in April, July and December Politburo meetings. This urgency has emerged from the economy’s average performance in August and the need to provide strong political backing to these measures. The follow up press conferences by National Development and Reform Commission Chief and finance minister Lan Fo’an further tried to build on initial measures introduced by other three financial regulators, indicating more coordinated efforts, especially on the fiscal side. While short term implications of these measures may look optimistic, evident from a temporary recovery in Chinese stock indices, its medium to long term implications will likely be overshadowed by more deep rooted structural issues, more prominently on demand side.

Headwinds in the Property Sector

For the weary property sector, the package includes measures such as reduction in down payment for second homes from 25 percent to 15 percent, decrease in mortgage rates by 0.5 percent and additional support to nudge local governments to absorb excess housing inventory and convert it into affordable housing. However, the structural issue for the industry lies in the loss of people’s perception to view real estate as a safe asset and thus, there is growing hesitancy to invest in this sector. This is quite evident from constantly declining real estate prices with August registering the fastest decline in over nine years, highlighting widening demand-supply gap.

Despite a surge reported in client enquiries during the Golden Week holiday, its conversion rate into sales is still questionable. Further, putting additional burden on local governments to sell inventories can further deepen their debt concerns. Moreover, despite efforts by local governments to revive real estate sector, reports show that only a handful of cities have witnessed growth in housing prices in recent months. In addition, more such rate cuts might put burden on lending commercial banks which are already facing reduced profitability due to slow credit growth and recent cuts in interest rates will only add to their woes. Thus, current measures adopted by regulators will not suffice in the long run as solutions for one sector may create hindrances for the other sector. Amidst these challenges, recent cut in mortgage rate can barely be able to revive consumers’ confidence in property sector as they have lost faith in developers due to recent bankruptcy cases of real estate companies

Herculean Task to Regain Confidence

Besides the trust deficit in real estate sector, Chinese authorities are currently grappling with a lack of consumers’ and investors’ confidence in China’s overall macroeconomic stability. While support for more activity in capital markets is being encouraged, it would only play a limited role in reviving investors’ confidence in the long run. Further, despite China’s objective to shift to consumption-led growth, household consumption to GDP ratio remains well below the global average, further putting a drag on GDP growth. Again, optimistic data from the Golden Week may not represent the real picture of Chinese consumption as month-on-month growth rate of retail sales continue to remain sluggish.

Some measures have already been implemented at local level recently such as consumer goods trade-ins and equipment upgradation to spur demand. Although these are welcome steps by authorities to boost effective demand, its impact is currently limited in certain sectors and more importantly, it does not address core issue of confidence deficit. In this case, measures aiming at increasing market liquidity can barely motivate people to spend when the macroeconomic situation remains precarious. Hence, push for more incremental fiscal policies make more sense instead of sudden shocks as it may help regain consumers’ confidence in the long run.

On the other hand, private sector has been badly affected by Xi’s overemphasis on state enterprises in the past few years and resulted in a decline in share of private investment in national fixed asset investment. Frequent scrutiny by state authorities, unpredictable policy environment, lack of financial support and unequal treatment vis-à-vis state firms have all contributed to erosion of trust between private firms and authorities. While the stimulus measures announced until now lack any specific incentives for private sector, the new draft law on private sector aims to revive private firms by creating a stable and predictable business environment. As authorities offer to amend their approach towards the private sector, more proactive actions such as financial assistance in the ongoing series of measures can help significantly in reviving the lost confidence.

Besides these measures announced until now, China’s financial regulators have hinted at more countercyclical measures in the near future to revive economic activities. While existing measures tilt towards monetary side, strong fiscal support is also essential to address structural issues facing the economy. Given the multi-sectoral implications of these reforms caused by inter-connected nature of China’s economic challenges, more financial prudence will be needed to optimize their effectiveness. Moreover, while providing monetary and fiscal support to different sectors, restricting the rise in existing debt concerns for both financial institutions and governments will be a critical task for authorities. Nonetheless, many Chinese officials have called for proactive economic measures in the past few years, but now it is time for authorities to act on these words in a timely and coordinated manner without going behind short-term growth numbers.