Reversing the downward spiral

CHINA’S 5% growth in the first half of the year may seem solid but key indicators show deeper challenges, signalling potential risks ahead. In fact, the economy has been on a gradual decline since the second quarter.

Money supply or M1 growth decelerated to a record low of 7.3%, pointing to extremely weak domestic demand.

Due to weak consumer and housing market demand, the household deleverage rate has accelerated with medium- to long-term loans adding only 1.3 trillion yuan in the first eight months compared to 3.3 to 4 trillion from 2018 to 2021.

To date, foreign direct investment in yuan terms has dropped 31.5% year-on-year (y-o-y) in 2024, a much sharper decline than the 8% fall in 2023.

Additionally, China’s gross domestic product deflator has been negative for five consecutive quarters, marking the longest deflationary streak in its modern history.

There are several reasons for this possible downturn.

First, consumer confidence is weakening, driven by stagnant income growth, negative income expectations, and a deteriorating wealth effect from both the property and equity markets.

Pay cuts have significantly dampened income expectations, while declining asset values have reduced the wealth effect, further curbing consumption.

Second, business confidence is faltering due to concerns about local governments chasing companies for taxes, some dating back decades. This uncertainty is causing many businesses to hold back on investments, worsening economic stagnation.

Third, recent policy interventions have largely failed to improve the economy’s outlook, putting the government’s ability to manage it into question. Compounding this is the financial strain on local governments, which have seen land sale revenues plummet by 25.4% y-o-y in the first eight months of 2024.

Much-needed boost

The Sept 24 joint press conference by China’s central bank and two major financial regulators introduced over 10 key measures to boost the economy, as the risk of China missing its 5% growth target is increasing.

The measures were structured around three main areas – traditional monetary stimulus, support for the property market and strengthening capital markets.

The market was surprised by some of the new initiatives which hinted at more direct intervention and support mechanisms.

In terms of monetary policy, People’s Bank of China (PBoC) governor Pan Gongsheng (pic) announced a reduction in the reserve requirement ratio (RRR) by 0.5 percentage points, which will inject about one trillion yuan of long-term liquidity into the financial market.

Depending on liquidity conditions, an additional RRR cut of 0.25 to 0.5 percentage points may be introduced later this year. Moreover, the central bank will lower the seven-day reverse repo rate by 0.2 percentage points, from 1.7% to 1.5%.

This adjustment is intended to guide both loan prime rates and deposit rates lower, while maintaining the stability of commercial banks’ net interest margins.

As anticipated, in the property market, PBoC announced a reduction in mortgage rates, with an average decrease of 0.5 percentage points.

The minimum down payment ratio for housing loans will be standardised nationwide, removing the distinction between first and second homes. Consequently, the down payment requirement for second homes will be reduced from 25% to 15%.

The PBoC will now fully cover loans under its re-lending policy for converting unsold homes into affordable housing, up from the previous 60%.

Finally, the government is considering using policy and commercial bank loans to support qualified enterprises in market-based acquisitions of real estate developers’ land. This is to activate idle land and alleviate financial pressure on developers.

Three measures involve the capital markets.

First is the introduction of two structural monetary policy tools: a 500 billion yuan swap facility for securities, fund and insurance companies; and a 300 billion yuan re-lending facility for stock buybacks.

The swap facility allows qualified institutions to use bonds, stock exchange-traded funds and CSI 300 index components as collateral for highly liquid assets, including government bonds and central bank bills.

Second, the National Financial Regulatory Administration will continue to support the stable and healthy development of capital markets by expanding the pilot programme for long-term insurance fund investments.

It will also allow other eligible insurance institutions to establish private equity funds.

Third, the China Securities Regulatory Commission will use a set of guidelines to promote long-term capital inflows into the market. These guidelines will focus on three key areas: the development of equity-based public funds, improving the regulatory framework for long-term investments, and continuously enhancing the capital market ecosystem.

China’s financial regulators will welcome the positive market reaction to the recent rate cuts, which contrasts with the lacklustre impact seen over the past year. The key question is what makes this round of cuts different?To understand this, we must revisit the underlying causes of the economic downturn. Despite helping stabilise the economy by reducing mortgage rates, the cuts cannot reverse the broader downturn.

What’s next?

The Sept 24 measures merely address half of the root causes of the economic downturn. The remaining issues will need to be tackled through fiscal and political measures.

The sustainability of the current market rally hinges on improvements in economic fundamentals, which in turn depend on fiscal policies beyond the scope of monetary interventions.

China is expected to miss its 5% growth target this year, with third-quarter growth likely around 4.6%. However, once market sentiment shifts, these figures will become less critical.