Global investors expect China to deliver a massive fiscal stimulus. Here’s why it may never arrive.

Many investors are clinging to hopes China will deliver a big fiscal stimulus in a bid to kickstart its ailing economy. They’re likely to be disappointed, according to longtime China watchers.

In the first half of 2023, Wall Street was optimistic about the economic recovery of the world’s second largest economy as the country emerged from COVID-19 lockdowns. Investors hoped a rebounding Chinese economy would help limit any global slowdown as central banks raised interest rates to combat inflation.

But economic data continues to suggest otherwise. Retail sales, industrial output and investment in July all grew at a slower-than-expected pace, fueling concern over a deep and long-lasting slowdown in growth. And now renewed worries over China’s property sector are further clouding the outlook.

China’s largest private real-estate developer Country Garden

missed payments on some of its bonds and warned it expected to post a record loss for the first six months of the year as sales and profit slump, putting the company on the edge of default and restructuring only two years after China Evergrande Group’s default sent shockwaves around the world. 

Now, investors’ new wish is for Beijing to deliver a massive fiscal stimulus package — a policy tool used by China to great effect in 2008 — but that hasn’t yet been put on the table. And it is possible that it may never arrive, economists told MarketWatch. 

“A big problem is markets have been trained on that approach of China tackling everything by throwing a lot of money at it, which is why there’s a lot of disappointment,” said Shehzad Qazi, managing director at China Beige Book. “Now, they [policy planners] are very guarded in how much stimulus they want to release. They’re doing it in very small doses along the way.” 

Difficulties in reviving the property sector

The property sector was long an important engine of China’s economic growth, accounting for as much as 30% of the country’s gross domestic product. But it is now a major source of distress in the wake of COVID.

Over the past two years, Beijing has identified the ballooning debt pile as a potential threat to its economic stability and tried to reduce the economy’s reliance on debt for growth. But giant property developers still ended up defaulting on their bonds while home prices continued to sink, sending the real-estate market into a slump and putting Beijing’s 5% economic growth target at risk. 

See: China tries to defuse fears after real estate developer’s debt struggle

Policy makers have announced a batch of policies in recent months to revive the property sector, which include easing home buying restrictions in the nation’s biggest cities, extending loan relief for developers, and considering reducing down payments in some non-core neighborhoods of major cities.

On Tuesday, the People’s Bank of China, or PBOC, unexpectedly cut key benchmark interest rates for the second time in three months. The central bank lowered the rate on its one-year loans — or medium-term lending facility — by 15 basis points to 2.5%, the largest cut in three years. 

However, recent tweaks to interest rates and some incremental steps to help the property sector have been largely viewed by economists and investors as mere “window dressing,” which may not reverse China’s economic downturn. 

“The government’s focus on property stimulus is not working because households lost confidence in property and no stimulus will change that,” said Gerwin Bell, lead economist for Asia at PGIM Fixed Income. “This stimulus is pushing on a string.” 

Qazi said the data compiled by China Beige Book shows that interest rates have been “a lot lower” throughout the course of 2023, while the credit supply has been “better.” However, the problem is that companies are not willing to borrow. “You [the government] can supply the credit, you can tell banks to lend, but if companies are unwilling to borrow because they are not yet confident enough to invest and expand, then your stimulus hits a wall,” he told MarketWatch in a phone interview. 

2008 redux?

Beijing has been reluctant to take action on massive-scale stimulus like they did during the 2008 financial crisis, when China pushed forward a $586 billion package as an attempt to keep the economy afloat. 

But one of the reasons behind the country’s lukewarm approach might be that Beijing is still confident the economy will achieve the 5% GDP growth target this year, said Qazi. 

“Beijing just does not see its 5% growth target for the year as being out of reach. If they think that they can hit their growth targets for the year, it will make them more conservative on how much stimulus they need to deploy,” he said.

China’s factory activity picked up in the first half of 2023, the Caixin/S&P Global services purchasing managers’ index showed, as a rise in new orders shored up a consumption-led economic recovery in the second quarter. However, it swung to contraction in July with supply, demand and export orders all deteriorating as firms blamed sluggish market conditions at home and abroad.  

Debt and local governments

Three years of strict COVID-19 lockdowns in China and real-estate turmoil have strained local governments’ balance sheets, leaving authorities across the country struggling with mountains of debt. Fears have grown over the potential for a public default on repayments of debt sold by local government financing vehicles (LGFVs).

Investment demand doesn’t come from investors or households, but from local governments, Bell told MarketWatch in a phone interview on Wednesday. “It’s absolutely critical that the investment focus, or the stimulus focus, now turns to local governments, and not just to refinance the debt, but to actually give them new money, otherwise they will have to stop making these investments that so far have supported growth.”

“I had hoped they [the government] had seen this in June. Hopefully they see it now… They can still do it, but it’s closer, closer to an accident,” Bell said. 

See: China’s shadow banking sector poses ‘rising risks of a financial crisis’: report

That’s why a “helicopter drop,” a type of monetary stimulus that injects cash into the economy through more spending, tax cuts or simply printing large sums of money as if it was thrown out of a helicopter, would aid local governments, Bell said. 

“China used to have by far the largest balance sheet, amounting to 70% of GDP, among major central banks in the world after the global financial crisis. That percentage has now come down… so they have space for ‘helicopter money’ and to finance a fiscal stimulus that would increase inflation and thereby mitigate the effect of the debt increase,” according to Bell.

China’s consumer sector fell into deflation in July for the first time in two years. The consumer price index dropped 0.3% year-on-year last month, the National Bureau of Statistics said last week, compared with the markets’ consensus of a 0.4% decrease. 

The top priority for policy makers needs to be stimulating household consumption, and it is necessary to use “all reasonable, legally compliant and economic channels to put money in residents’ pockets,” Cai Fang, a member of the monetary policy committee at the People’s Bank of China, said in an article posted late Monday. Earlier this year, Cai said a direct stimulus of $551 billion paid directly to Chinese households is an option to spur a recovery in consumer spending. 

“That would definitely help and it would also put money into the pockets of households that are severely cash strapped and make up for the fact that during the entire COVID episode, there was no income transfer payment made in China,” Bell said. 

See: Wall Street’s crystal ball is broken: Why financial markets’ big bet on China’s economic boom is going all wrong

Bets go wrong

Financial markets have been divided over whether China will roll out more tangible measures to spur growth. As economic data miss and default fears have some investors heading for the exit, others think it is time to “buy the dip” as stronger stimulus could power a multi-month rally in stocks.

“We are hopeful of a potential rally, and advise investors to ‘buy on the dip’ in the coming weeks,” said a team of strategists at BofA Global Research led by Winnie Wu, China equity strategist. 

Wu and her team believe the Chinese government needs to send clearer signals to support the economy and private sectors, to help rebuild confidence, and to prevent a downward spiral. However, Beijing’s willingness and ability to conduct a strong stimulus are both limited due to high debt leverage and pressure on the Chinese yuan’s exchange rate, she said in a research note dated Aug. 7. 

The yuan

was nearing a 16-year low against a broadly stronger U.S. dollar this week, sliding to 7.31 per U.S. dollar on Friday, according to FactSet data. The ICE U.S. Dollar Index
a gauge of the greenback’s strength against a basket of rivals that doesn’t include the yuan, rose 0.1% to 103.63 on Friday, and has rallied 0.8% this week and 1.7% so far in August.

However, investor expectations for China’s recovery in 2023 were “incredibly, wildly unrealistic,” said Qazi. Investors should not view China through the same lens that they did after the global financial crisis because the country is going through “a massive reset in its thesis and its approach towards the markets.” 

Policy makers have already changed their priorities to “eliminating risk in the economic system” from “robust economic growth,” Qazi said, a shift that has been “completely underappreciated by Western investors.” 

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