Explaining the recent China Stimulus

China’s economy is in a transition. For the past few years, the government has been intentionally deleveraging the property sector. To tackle the accumulation of debt, particularly amongst private property developers, it has been clamping down on the use of the aggressive debt-funded growth, which has led to the failure of business models such as Evergrande’s. The declining real estate market has been a drag on economic growth, but forms part of China’s long-term economic plan to divert capital towards the pillar industries of the future: the EV supply chain, industrial automation, semiconductor manufacturing, pharmaceutical development and healthcare equipment. Until these industries are strong enough to offset the shrinking real estate market, government stimulus is needed to help the economic navigate the transition. 

Change in tone from the Politburo 

China’s government recently intensified its efforts to support the economy, with the Politburo adopting a more decisive tone in its latest communiqué. Compared to the vague guidance in April, September's statement calls for stronger countercyclical policies, including interest rate cuts and fiscal measures. This signals a more assertive approach to stabilising the economy, which was accompanied by more aggressive easing by the People’s Bank of China (PBOC).  

In the table below, we compare wording from the April and September communiqués. For example, in April the Politburo called for prudent monetary policy, which we argue is an ambiguous aim. Additionally, they said they would flexibly use policy tools such as interest rates to boost the economy, but it is quite difficult to work out exactly what this means. In contrast, in September we saw more clarity in the Politburo’s wording. Now they are calling for an increase in the intensity of countercyclical monetary policy, accompanied by a reduction in the required reserve ratio and decisive cuts in interest rates. We also highlight greater clarity in terms of support for the property market and the consumer.   

Source: https://www.gov.cn/yaowen/liebiao/202404/content_6948449.htm and https://www.gov.cn/yaowen/liebiao/202409/content_6976686.htm, Oct 24 

How has the Politburo shown support to the Chinese economy?

The Politburo is now explicitly acknowledging people’s concerns about the economy. Their communiqué talks about benefiting people’s livelihoods, but is now specifically mentioning low and middle-income groups. China’s leadership highlights the need to develop the elderly care and childcare industries. They also call to safeguard the bottom line of people’s livelihoods, which we interpret as a stronger social safety net with graduates, migrant workers, unemployed, the elderly and disabled mentioned.  

We find it helpful to breakdown the support from policymakers into four pillars: monetary, property, equity and consumer support.  

Monetary Support

With the Federal Reserve in the US cutting interest rates, China now has room to cut rates without putting significant pressure on the Renminbi. One of the constraints facing policymakers for the past few years was that the Fed was hiking rates and if China cut rates, the interest rate differential would have increased. Hot money would have left China in chase of higher yields in the US, putting pressure on China’s capital account and the Renminbi. Now this is no longer true as the Fed has started to cut rates, giving the PBOC room to follow. The PBOC cut short-term rates by 0.2 percentage points (pp), larger than the usual 0.1 pp cut. To reduce the incentive for consumers to save the extra cash, deposit rates were also cut. The required reserve ratio was also cut by 0.5 pp, increasing liquidity by ~CNY 1 trillion (~$143bn). A possible further 0.25-0.50 pp cut is possible. While the cut in the RRR is helpful, the problem in China is not the supply of credit - rather it is the demand for credit, and so other measures are needed.  

Property Support

Existing mortgages have had their interest rates cut by 0.5pp which should reduce annual interest payments by CNY 150 bn ($21bn). But each household is only therefore going to save CNY 200-300 ($30-43) a month. So while the cut helps, it is ultimately going to have a small impact on boosting demand. The downpayment ratio for second homes was cut from 25% to 15%, putting it at the same level as first homes. Over the past few years, each time downpayment ratios have been cut, we have seen a short-term burst in activity but they have not lasted. In this case, we do not see why a further cut to downpayment ratios would have a notably different result. Home purchase restrictions were relaxed in tier one cities such as Shanghai and Guangzhou.

Equity Support

A total of CNY 800 bn was set up by the PBOC, of which CNY 500bn ($71bn) is allocated for a swap facility which brokers, funds and insurance companies can use to buy stocks. The remaining CNY 300bn ($43bn) is to fund a re-lending facility, which listed companies and major shareholders can use to fund buybacks and stock purchases.  

Consumer Support

In July, the government relocated CNY 150bn ($21bn) away from infrastructure spending and towards a consumer trade-in programme. The programme allows consumers to trade in older products and the government will subsidise some of the costs of purchasing a new replacement. The scheme covers home appliances, kitchen improvements and autos. To put the funding into context, in 2023 retail sales were worth CNY 47.1 trn ($6.7 trn), so the support is worth 0.3% of retail sales. Consumption vouchers have also started to be given out, which so far can be spent on restaurants, hotels and cinemas. Shanghai is to hand out CNY 500m ($71m) while Chengdu is to hand out CNY 400m ($57m). While these numbers sound impressive, they are worth 0.03-0.04% of retail sales in each city and so are going to have a far smaller impact than the trade-in programme. Overall, the policies the government has started using make sense, but the scale of support needs to be increased significantly. Reports indicate the government is to issue CNY 2 trn ($286bn) of sovereign bonds, which is on top of the CNY 1 trn ($143bn) of ultra long-term bonds already announced this year. We expect the proceeds to be spent on scaling up the funding behind the consumer trade in programme – some are calling funding to increase from CNY 150 bn ($21bn) to CNY 1 trn ($143bn), which move support from 0.3% of 2023’s retail sales to 2.1%.  

What’s next for China?

Overall, we have seen a clear change in wording from China’s political leadership. Monetary easing is necessary to increase demand but we believe the supply of credit is not the problem – it is demand. Fiscal policy is key and needs to be geared toward the consumer, not just business. The scale of support needs to be expanded significantly and we argue the government has substantial financial resources which are not close to fully deployed.  

What does the China Stimulus mean for investors?

Investors should look for progress on funding – to issue special bonds, China need approval from the National People’s Congress which meets later this month. Once approval is finalised, the funding behind the trade-in programmes and consumption vouchers can increase substantially. 

From an investment perspective, if the government does scale up its support, this could mark an end to the negative earnings and valuation de-rating cycle in China. Returns for equity investors can be broken down into having three sources: changes from valuation multiples, earnings growth and dividends. In valuation terms, China remains very cheap on a price-earnings basis, while the approach we take in managing the Guinness Greater China Fund and Guinness China A Share Fund is based on identifying those high-quality companies able to harness the secular growth themes in China to profitably grow their earnings. 

Watch our video with Portfolio Manager Sharukh Malik and Analyst Valerie Huang where they discuss this topic further

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