Getting China back on the path to sustainable growth

Talking Heads with Chi Lo on China macro

Daniel Morris: Hello and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in-depth insights and analysis on the topics that really matter to investors. In this episode, we’ll be discussing the outlook for China. I’m Daniel Morris, Chief Market Strategist, and I’m joined today by Chi Lo, Global Market Strategist. Welcome, Chi, and thanks for joining me.

DM: As it happens, I’ve been travelling over the last week, meeting clients in Beijing and Shanghai. Wonderful welcome and very interesting meetings. One of the concerns that came up, particularly for institutional investors, is the interest rate and inflation outlook in China. Could you talk a bit about what’s trapping China’s economy in deflation?

Chi Lo: It’s a combination of few factors. The first one was the draconian Covid policy. This factor hit Chinese confidence. Then we had the property market problems and, last but not least, government policy easing has not been able to turn around public confidence. With the loss of confidence [there] is little incentive to invest by the private sector, there’s little confidence for the Chinese consumers to consume. That’s why we have seen economic momentum weakening for the past 2/2 years.

DM: Another one of the comments that I heard was the worry that China would follow in Japan’s footsteps into a period of prolonged deflation. What is the risk of Japanification of the Chinese economy?

CL: The risk is certainly there. If you compare China with Japan, there are certainly similarities: loss of confidence, low or very weak growth momentum and government policy missteps. But there are also significant differences. That makes us more positive that Chinese still have time to manage this risk and minimise it. If I remember correctly, three years after the bubble burst in Japan, the Nikkei index lost accumulative 55% of its value. In China, there was a big drop in the stock market three years after Covid, 29-30% cumulatively. Importantly, the Chinese have about a quarter of their wealth in the stock market, which means the negative wealth effect on the Chinese consumer is much smaller than on the Japanese consumer.

When you look at Japan, the BOJ (Bank of Japan) didn’t cut rates until a year after the bubble burst.
And two to three years after the bubble burst, fiscal policy was still tight. That made the Japanese asset bubble burst’s impact on growth very bad. When that negative impact was entrenched in the system, people got this deflation expectation, and it goes into downward spiral. We had three decades of deflation, no growth in Japan. Now that is the risk that China is facing. But it seems that the Beijing authorities finally came to realise that past policy was not enough. It seems momentum has picked up recently.

One more point, which is also a big difference, in Japan, it was deleveraging after the bubble burst because Japan’s high debt. In China, we see deleveraging as well. Deleveraging is more of a government policy, which means the government does have some leeway to lessen up on the policy. When you put all these factors together, it seems the Chinese still have time to fix their problems.

DM: For clarification, could you describe when you’re talking about more aggressive easing, what are some of the measures?

CL: We have seen the PBOC (Chinese central bank) cut rates and the reserve requirement ratio over the past few months [and] more aggressive fiscal spending through government special bond issuance, provincial government bond issuance, and the property market measures. The Chinese now can buy homes or even third homes and  the down-payment was cut to now 20%, less than 20%. Beijing had also programmes put together to incentivise developers to finish the unfinished projects in the property market and turn them into rental and social housing projects so as to increase demand, increase affordability. As I said earlier, there are initial signs that the economy, the public market tries to stabilise.

DM: You’ve talked about some of the measures the government has already been taking. What are other things that the government can do to minimise this risk of Japanification?

CL: The government has to continue to employ the two-pronged approach. That’s how the Chinese economy can be put back on a sustainable growth path. Fiscal expansion, monetary easing needs to be aggressive to help demand expansion to offset some of the contractionary forces from reform. The last three years, Beijing didn’t do enough. Now it’s expanding more aggressively.

DM: Let me summarise some of the key points. We started with deflation. How did China get here? You started with the impact of the zero Covid policies, and that was exacerbated by the downturn of the property market. You highlighted some parallels with Japan and Japanification, but also some key differences, that the decline, for example, in the Chinese equity market was nowhere near as large as it was in Japan. And you were still cautiously optimistic about the outlook, highlighting that China still has time to fix its problems, is starting to take the measures it needs to take, more aggressive easing, more spending, structural reforms and deleveraging. Well, Chi, thank you very much for joining me.

CL: Pleasure.

DM; That’s it for this week’s episode of Talking Heads. If you would like to learn more about our capabilities in managing Chinese assets, please reach out to your BNP Paribas Asset Management contact or check out Viewpoint, our website for investment insights at viewpoint.bnpparibas-am.com. Viewpoint brings commentary and analysis in a variety of formats, from investment outlooks to asset allocation videos and podcasts to help investors make better informed decisions. You’ve been listening to the BNP Paribas Asset Management Talking Heads podcast with me, Daniel Morris, and Chi Lo, Global Market Strategist. Please do join me next week. Until then, take care.