Does China’s financial bazooka have any bullets?

Equity markets the world over got a boost this week as Chinese monetary authorities announced multiple measures to ease monetary policy in the hopes that it stimulates growth—nowhere more than China, where the Shanghai Composite Index and the Hang Seng Index both rose by more than 10% in the days following the announcement. Although the measures are notable because of their scope and the signal that this sends about the government's acknowledgment of the problem, we fear that it will not meaningfully alter the trajectory of consumption and GDP in the near term.

The measures announced included a 20-basis-point cut to the seven-day reverse repo rate (RRR; the policy interest rate), a 50-basis-point cut to the reserve requirement ratio (RRR), a rate cut on existing mortgages, capital replenishment of large state-owned banks and some significant measures aimed at supporting the housing and stock markets. The measures to support the housing market included a 5-basis-point reduction in the down payment needed to 15%, and a central bank re-lending programme in support of the acquisition of the unsold properties owned by developers. The measures to support the capital markets include creating a swap facility in which financial institutions can obtain liquidity from the central bank, and a relending tool to support stock repurchases.

Two days after announcing monetary easing measures, the Politburo of the Chinese Communist Party convened an out-of-cycle meeting focused on economic policy to advocate for additional fiscal expansion. The objectives are to “strive to” achieve the growth target, facilitate the bottoming out of the property market and enhance employment. The stimulus measures also include one-off direct cash transfers, funded by central government resources and targeted at ultra-low-income groups, with implementation expected before the national holiday commencing on October 1st.

We are currently expecting the central government to issue no less than Rmb1trn (US$140bn) in additional special sovereign bonds as early as October. The current stimulus efforts, while bold, are not on the scale of the Rmb4trn package rolled out during the global financial crisis. Back then, China’s economy was significantly smaller, and the stimulus accounted for more than 10% of GDP. The cash-out policy (to vulnerable social groups) has been implemented before, and although this iteration is larger in scale, it is highly targeted at low-income households that have a high marginal propensity to consume.

These measures take a page from the playbook of Western central banks’ response to the property crisis that caused the global financial crisis in 2008. Although these measures will not fundamentally reverse the low appetite for credit in the economy by households and firms in the near term, they will at least bolster lending in support of public investment and help to shore up financial institutions. In other words, they should stop the bleeding. While the announcement was well received by domestic and international equity investors, much like the results of the actions of the Federal Reserve (the US central bank) in the wake of the global financial crisis where equity markets entered a multi-year rally, the path of consumption and growth was characterised as tepid.

When economic agents are focused on paying off debt, it is challenging to get the real economy going via monetary measures alone. With the additional fiscal measures, China now provides an interesting natural experiment simultaneously testing Friedman’s permanent income hypothesis (PIH) and Richard Koo’s balance-sheet recession hypothesis. The PIH posits that household consumption is smoothed to mirror expected or normalised income over long periods. Empirical data show that lower-income households have a greater marginal propensity to consume, but as was seen during the US covid stimulus measures, low-income households used the stimulus in part to shore up their balance sheets and pay off debt. This behaviour dovetails with Mr Koo’s analysis that China is experiencing a balance-sheet recession with similar features to past balance-sheet recessions seen in Japan after its commercial real estate bubble burst, or in Western economies after the global financial crisis. The behaviour of low-income households in response to the stimulus measures will provide important empirical information about the extent to which the balance-sheet recession and the LIH affects households’ behaviour.

In terms of capital markets, it is important to emphasise that the two largest economies are now engaged in monetary policy stimulus. This is likely to keep equity markets buoyed, and the contaminant wealth effects will have some influence on consumer sentiment and spending. Thus, while China’s policy bazooka needs more bullets to achieve all its targets, markets are feeling the full force of the ammunition unleashed.

Find out more here.

Constance Hunter

Chief economist

EIU

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