China: Waiting for stimulus

Reducing our Chinese growth forecasts

The latest round of data from China largely disappointed expectations, with many areas of economic activity actually reversing in annual terms. Retail sales were flattered by strong base effects from last year’s lockdown period, but even consumption spending is disappointing relative to expectations.

While aggregate fixed asset investment levels declined only modestly, in line with industrial production, the downturn was especially intense in construction investment. Indeed, in level terms, the property sector has reversed all the gains it accumulated since the COVID re-opening.  

Infrastructure and manufacturing investment held up better than construction did, but still remain disappointing. In light of this broad-based economic weakness, we have reduced our forecast for Chinese growth in 2023 to 5.5%, from 5.8% previously.

Assessing the economic problem

Given the weakening economic data, some form of increased economic stimulus from Beijing seems likely to us. On the monetary side, we have heard increasingly dovish rhetoric from the People’s Bank of China’s Governor Yi Gang, followed up by benchmark interest rate cuts.

Before we consider what further tools Chinese policymakers have at their disposal, we need to take have a brief look at the problem and consider why attempts to stimulate the economy have failed thus far:

• The post-COVID rebound quickly fizzled out as Chinese consumers didn’t have hugely increased savings rates (unlike in developed markets), few people want to buy a house from weak developers, and the global goods sector recession has weighed on Chinese industry
• Within the property sector therefore, private sector developers continue to struggle despite debt maturity extensions and promises of funding to complete projects, while banks are wary of committing more capital
• Local governments have large funding holes given disappointing land purchases from property companies
• We are starting to see serious issues in local government financing vehicles (LGFVs) from poorer regions. This is making banks even more nervous about their loan books

Attempts by China to stimulate the economy have so far failed because all these factors neutralise the impact. For example, reducing mortgage costs doesn’t work because people aren’t buying from private developers. Asking banks to lend money to help complete developments doesn’t work, because they just want to lend to state-owned developers. And cutting interest rates by a few basis points doesn’t work because it’s a balance sheet problem.

What form of stimulus could work?

One potential option for effective stimulus would be an injection of unencumbered capital from the central government that could guarantee LGFVs, buy property developer debt at par and reignite an infrastructure spending spree.

We believe this can be done – central government debt is pretty small and authorities can direct financial institutions to support local government. However, the problem is that this would be a return to the old playbook of investment-led growth and property market speculation – something that President Xi has distanced himself from. It would also deepen the connection between central government and local government debt, which is politically contentious.

What might we get instead? Probably more of the same, which helps boost sentiment a bit, but ultimately disappoints. Perhaps a few hundred billion renminbi of new local government infrastructure spending, some consumption incentives/vouchers, funds for banks to lend to property developers etc.

However, it’ll be difficult to get genuinely excited about the potential for a real change in economic direction unless the stimulus moves risk and losses from banks/local governments onto the central government balance sheet. The only other event that would really help China right now, in our view, would be a global investment/goods boom. But we’re expecting the opposite.

Time to be contrarian?

The weak economic data and limited options for stimulus notwithstanding, it’s important to note that investor sentiment towards China is particularly bad right now. It seems like everyone is reducing exposure (active China allocations are at a 20-year low[1]) and has little confidence that the economy will turn around.

So, with everyone on the same side of the boat, we’re shuffling over to the other side and have very tactically increased Chinese equity exposure in some of our multi-asset portfolios. Maybe the bar to a positive surprise is low enough that even a modest stimulus package improves confidence, gets private sector spending going and triggers investment?

[1] Source: Bloomberg, as at 19 June 2023