Chinese stimulus for a happy anniversary

What’s in the stimulus?

The Chinese central bank cut policy rates by an unusual 20-30bps, the reserve requirement ratio by 50bps, rates on existing mortgages by 50bps (as foreshadowed in August) and down payment ratios on second homes by 10ppts. It also signalled further cuts are likely later this year.

Additionally, the central bank improved the terms of its relending facility for buying unfinished homes and promised to back the purchase of surplus land from developers without providing details. Finally, the central bank promised RMB800bn (0.6% of GDP) in liquidity to prop up the stock market.

Meanwhile, the banking regulator has pledged to recapitalise the six largest banks, reportedly to the tune of RMB1trn (0.8% of GDP), which is the first recapitalisation since 1998.

Later last week, Reuters reported that the government plans to issue RMB2trn in special treasury bonds (1.5% of GDP). Half of the proceeds would be used to stimulate consumption through trade-in schemes and child allowances. The other half would be used to ease local governments’ debt woes.

The government has certainly understood that words alone will not turn around the economy. The stimulus is also larger and more comprehensive than most observers had expected. However, we remain sceptical that the recent stimulus will lead to a durable recovery in the Chinese economy.

For starters, the monetary easing, while eye-popping by recent standards, is still impotent, in our view. People, worried about their jobs and owning houses that are worth less, are repaying debts, not spending. And, with the economy in deflation, the real policy rate is still close to all-time highs.

Fiscal spending required?

Fiscal spending is essential in such a liquidity trap, as the authorities have understood. However, the mooted RMB2trn fiscal stimulus needs to be gauged in the broader context. Fiscal spending is on course to fall RMB3.5trn short of the budget target, as revenues from land sales have collapsed and investment projects are hard to identify. Hence, the authorities are playing catch-up, rather than providing another boost to the economy.

The proposed bank recapitalisation is a welcome step to underpin people’s confidence in the financial system. Note that the authorities have allowed banks to rollover loans to developers and small enterprises without reclassification through 2027, from 2025 previously. 

At some point, these loans will need to be classified as non-performing loans and banks no longer have the net interest margins to deal with this on their own. However, since credit demand and not supply is the problem currently, bank recapitalisation will not boost growth in our view.

Turning to the property market, the ground zero of today’s ills, policy announcements have been lacking. The People’s Bank of China’s re-lending facility at RMB300bn remains insufficient to reduce the stock of unsold homes and no new ideas were tabled to accelerate the completion of unfinished housing projects.

Of course, the announcements of last week could be just the beginning of a long list of policy measures to be revealed over the coming months. Similarly, the child support announced might herald an about-face on consumption support which in the past has been labelled ‘welfarism’.

However, we remain cautious. Unless we see convincing measures to deal with the housing overhang and greater use of the sovereign’s balance sheet, we stick with our outlook of an L-shape recovery.

What are the implications for investors?

After a 25% rally since mid-September, Chinese equities are no longer cheap in our view. For example, the forward price-earnings ratio of the Hang Seng China Enterprises Index (HSCEI) is now above its long-term average, as shown in the chart below.

It is possible government efforts to boost asset prices are successful for a period as sentiment become less negative, but for the equity rally to last, we think earnings need to recover.