The Structural Limits of China’s Stimulus

“What the stimulus can achieve is triggering enough short-term momentum that creates a space for the pursuit of reforms. However, this requires a change in mindset from the top leadership, and nothing in the past weeks suggests this will happen soon.”

China’s post-COVID economy has come to be characterized by persistent confidence weakness, restrained private consumption, intense price-based competition from local players, and harder-to-make profits.

While this situation was triggered by the impact of China’s zero-COVID strategy and the downturn of its property sector on the balance sheets of households, businesses and local governments; it is critical to understand that it is underpinned by deep-rooted structural imbalances generated over the past decades due to China’s over-reliance on exports, credit and investment.

Generating a turnaround in this situation will be especially challenging for two key reasons:

• First, for confidence levels to return to where they were pre-COVID, China needs to implement major structural reforms aimed at reducing people’s need for precautionary savings to unlock their spending power; at building an enabling environment for the development of the private sector to drive social mobility, innovation and economic dynamism; and at strengthening the financial sustainability of local governments to improve the provision of public services. For a country of more than 1.4 billion people, this will be a massive and complex endeavor, and will therefore take time.
• This brings me to the second reason of why this is a key challenge for China. Undertaking the necessary structural reforms requires a shift in mindset. The Chinese government is currently prioritizing support to the supply-side of the economy, especially manufacturing, high-tech and strategic sectors, largely because of national power and geopolitical considerations. This need to change.?

This is the backdrop against which I assess the stimulus measures that China has been implementing.?

Up until very recently the government had kept a cautious attitude towards stimulating the economy, which was reflected in the series of piecemeal stimulus which continuously failed to meet market expectations.

But it appears that China’s top leadership finally realized the criticality of taking a more proactive and strong approach to support growth. This is what led to the measures that have been announced since last month, including:

• The PBOC’s cut of the reserve requirement ratio by 50 basis points, which is expected to add RMB 1 trillion in long-term liquidity to the interbank market; and its lowering of interest rates on existing mortgages, which can potentially help households save about RMB 150 billion per year. More recently, the PBOC also cut the one-year and five-year loan prime rates, respectively from 3.35% to 3.1%, and from 3.85% to 3.6%.
• The NDRC announced the frontloading of RMB 200 billion from the 2025 central budget to support investment and strategic construction projects while seeking additional support for the property sector.
• The Ministry of Finance announced that there would be a significant increase in support to local governments to address hidden debt and to stabilize the property sector by leveraging government bonds, tax policy, and other policy tools.
• The Ministry of Housing and Urban Rural Development announced the launch of one million urban village and housing renovation projects and that the loans for “whitelist” project would be raised from the current RMB 2.23 trillion to RMB 4 trillion by the end of the year.

The latest news is that the Standing Committee of the National People’s Congress – China’s top legislative body – will meet on 4-8 November to approve a series of fiscal stimulus measures which headlines are suggesting will be worth over USD 1.4 trillion.?

The key question is whether these measures will be sufficient to generate a turnaround in the current situation? I don’t think so. As I explained before, China’s current economic headwinds are underpinned by structural imbalances, and without addressing them I don’t see a sustainable improvement in confidence levels. Absent this, the PBOC’s injection of liquidity in the market and its lowering of interest rates won’t spark a huge increase in demand for new loans. The savings on mortgage payments are likely to be deposited into banks or invested in WMPs rather than being spent.?

What the stimulus can achieve is triggering enough short-term momentum that creates a space for the pursuit of reforms. However, as said before, this requires a change in mindset from the top leadership, and nothing in the past weeks suggests this will happen soon. Such change in mindset is more likely to be a gradual process given the state of the geopolitical landscape – EU’s recent confirmation of its tariffs on imported Chinese NEVs is but one example of this.

What does this mean for MNCs?

Our discussions with senior executives reveal that Chinese customers (people and businesses alike) are more price-sensitive than ever, and are seeking less expensive alternatives to the goods and services they used to buy.

This is shifting market competition to lower price points where Chinese firms are more competitive, including because nowadays they present “good enough” alternatives to the goods and services of foreign MNCs, and “good enough” sells in a downgrading market.?

Moreover, local firms are lowering prices to capture as much of the available spend in the market as possible. For most, China is their only market, so they’re willing to bear decreasing profit margins to survive.?

This new competitive reality has emerged against the backdrop of a structural downshift that will take time to be addressed. This means that the changes we are seeing in local competition, spending trends and consumer behavior won’t cease anytime soon.

As I argue in a recent op-ed published in Barron’s: “Taking a wait-and-see approach against this backdrop risks hard-earned market share.”

Instead, MNCs need to be proactive in defending their profitability in China by sharpening their competitive edge and building their positions to ensure continued success. This requires head offices and their China management teams to reassess and align on growth, profitability, and risk expectations. Investments need to be made in strengthening core competencies and in building defensible market niches, while the business tail ends that the market is currently not rewarding need to be cut.

More importantly, as I argue in the Barron’s op-ed ”China management teams need the resources and authority to develop, customize, and deliver products and services attuned to Chinese customer requirements—and do it better than local competitors.”

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Well, this is it for this month. Let me know if you have any comments and/or questions about my views above.

Alfredo