Column – China’s Inability to Implement Bold Policy Measures May Keep Markets Stagnant: McGeever By Reuters

By Jamie McGeever

ORLANDO, Florida – China’s political and economic leadership is generally known for being historically aware, yet their subdued response to the current property crisis is perplexing. This crisis is stifling the nation’s growth and contributing to rising deflation.

Historical evidence suggests that effective recovery from significant housing market downturns requires bold and decisive measures involving extensive monetary and fiscal stimulus. However, Beijing has opted for a piecemeal strategy rather than a comprehensive approach.

Recently, the People’s Bank of China refrained from cutting benchmark borrowing rates, although it did inject cash into the banking system at a lower rate for the first time in months. Experts at the Institute of International Finance describe Beijing’s response as "slow, timid, and sometimes very vague," falling far short of the aggressive action needed to effectively tackle the situation.

FALLING BEHIND

The consequences of this muted response on China’s economy are significant. Predictions indicate that growth in 2024 is likely to fall below the government’s target of 5.0%, while deflationary pressures are escalating alarmingly. Investment levels are plummeting, and credit growth has reached record lows. Economists at Morgan Stanley are projecting nominal GDP growth of only 3.9% for this year and next, in contrast to the United States, where nominal GDP growth is around 5.5%.

China’s stock market has also lagged considerably. While global markets have seen gains, China’s blue-chip index has dropped 15% since May and has nearly halved since February 2021, nearing multi-year lows. Foreign investment has diminished, with Chinese equity funds attracting inflows in just two of the past 13 months and negative foreign direct investment flows reported.

While foreign investors have engaged in China’s bond market, the overall sentiment indicates a reluctance to invest until a clear economic recovery strategy is established—and that path remains unclear.

TRILLIONS NEEDED

The property sector is central to this crisis. Its collapse is undermining growth, financial stability, and household wealth. The resulting deflation is adversely affecting corporate profitability and investment, while simultaneously increasing real debt burdens.

Three years ago, the property sector represented a quarter of China’s GDP. Since then, housing investments have fallen by 30%, home sales have been cut in half, and housing starts have shrunk by two-thirds. Analysts from Jefferies estimate that to effectively reduce excess housing stock, Beijing may need to allocate at least 2 trillion yuan ($285 billion) this year. They also suggest that up to 7 trillion yuan ($1 trillion) may be necessary to bring housing inventory down to manageable levels.

EXCESSIVE CAUTION

Why then is Beijing hesitating to implement significant measures? First, although injecting liquidity could alleviate some immediate pressure, it may not tackle the underlying issue of oversupply in the housing market. Additionally, a substantial increase in market liquidity might lead to a depreciation of the yuan, exacerbating capital flight. Moreover, significant rate cuts could further squeeze already narrow bank profit margins. Overall, China’s leadership appears to favor a more cautious approach, rather than an aggressive one.

This hesitation carries significant consequences. By avoiding aggressive rate cuts, the People’s Bank of China has inadvertently strengthened the yuan during a time when a weaker currency would better serve the sluggish economy.

Beijing’s reluctance may stem from a desire to avoid repeating Japan’s lengthy deflationary struggle following its housing bubble burst in 1990—an event from which Japan has yet to fully recover. However, an overly cautious stance could potentially contribute to a similar outcome for China.

WISHING AND HOPING

Some optimists argue that Chinese assets remain appealing, under the belief that the government will ultimately do what is necessary to stimulate the economy. They highlight China’s status as a major consumer of key commodities and its vast savings pool worth trillions.

Yet, outside of bonds, Chinese assets are undervalued for good reasons. Thus far, Beijing has shown little willingness to provide the extensive monetary and fiscal stimulus that experts deem essential. While circumstances might change, there are currently few signs indicating a shift in strategy.

(The views expressed in this article are those of the author.)