China’s biggest stimulus since the pandemic has caught everybody’s attention and lifted equity valuation, but the considerations for a great deal have quickly evaporated as the government has, by no means, confirmed its real intention, Therefore, we believe that the program will fall short of pulling the economy out of its slump.
Key Takeaways
- China’s recent stimulus package, the largest since the pandemic, has boosted equities but may not be enough to reinvigorate growth which is expected to be in the region of 4 % for 2024.
- The country’s crashing residential property market is the source of the deflationary spiral that some experts believe can only be cured by a massive government rescue.
- The Chinese central bank and the political set-up may need to take more precise action to ease the high cost of capital which is crushing growth.
- Investors may want to stay prudent with new allocations into the region. Alternative solutions, i.e. global, non-U.S., and non-China emerging market equities offer better risk-adjusted expected returns.
Chinese equities have surged following the announcement of a massive rescue plan. This comes after more than three years of consecutive market corrections. The ambitious stimulus package aims at pulling the economy out of a slump and back toward its growth target. But global investors now face the question: Will it be enough to ease the country’s deflationary debt spiral and reinvigorate growth?
The is expected to do the following: The People’s Bank of China to
- cut bank-reserve requirements, which leaves banks more cash available to lend to businesses and individuals. It also lowered interest rates,
- reduce mortgage rates and minimum down payments on second homes, to help stabilize home prices and spur demand,
- provide hundreds of billions of yuan in liquidity support for markets and to help local governments spur job creation and household consumption.
Reasons for Caution
According to the data sets obtained, more policy action is likely needed. While Beijing’s recent efforts are a step in the right direction it is by far not enough to address the lagging market conditions as the economy is truly facing numerous structural issues.
The key areas of concern are:
- A beleaguered residential real estate market: Excess supply and collapsing confidence have led to declining home prices. This, in turn, has contributed to a deflationary spiral—in which prices fall and the burden of mortgage debt rises.
Generally speaking, deflationary market conditions make it harder to repay debt, because even though prices are falling, so is the value of assets, while the amount owed remains the same.
- A high cost of capital: In the past, the central bank was reluctant to aggressive rate cuts and that to avoid a lag to the “real” cost of capital. While nominal rates have fallen and now are around 3.6%, they are closer to 5% when adjusted for deflation. In comparison, U.S. real rates have stabilized around 1.5% to 1.75% in the last year.
This dynamic has kept the renminbi’s value relatively high versus the U.S. dollar and EURO, yet a weaker domestic currency would likely be more beneficial by making China’s exports cheaper to foreign buyers, but at the same time, imports of raw materials such as energy (oil & gas) and iron ore, would increase. The overall impact of a weaker domestic currency could make things even worse.
Beyond these macroeconomic challenges, China also struggles with poor consumer sentiment, disappointing youth employment prospects, and confusing messaging around the government’s support of equity markets, not to mention more immediate threats from geopolitical rifts with the U.S. around Taiwan.