Beijing has finally moved to fight the rising risk of a debt-deflation spiral with aggressive stimulus measures. Markets are taking this pivot seriously: Chinese stocks have rallied sharply and could have further to run in the short term. What is needed to sustain the recovery in the economy and asset markets is a real sense of conviction – among consumers and investors.
What are the signs of a growing conviction for a sustained turnaround to watch for? And what global impact will this policy pivot have?
Touching a nerve
The shift from the ‘incremental easing’ policy which Beijing has pursued for two years to massive reflation is a serious one. We believe it shows that China’s economic woes — such as the youth unemployment rate hovering at around 20% and surging numbers of loss-making Chinese companies since Covid-19 (see Exhibit 1) — may have reached a ‘pain point’ that has touched political nerves.
Big moves
For the first time ever:
- China’s three super-regulators — the People’s Bank of China (PBoC), the China Securities Regulatory Commission (CSRC) and the National Financial Regulatory Administration (NFRA) — announced the policy shift jointly
- The PBoC cut policy rates and banks’ reserve requirement ratio (RRR) and injected Tier-1 capital into the state banks all in one move
- Both the Politburo (including President Xi Jinping) and the State Council followed up with special meetings endorsing the ‘mega’ stimulus package shortly after the super-regulators’ announcement.
The wide-ranging package also includes
- Financing support for small and medium-sized enterprises
- Property market stimulus
- The creation of a fund and a swap facility to help financial institutions to buy stocks.
Furthermore, Beijing doubled down on this package by offering one-off cash handouts to people in extreme poverty ahead of the National Day holiday on 1 October.
However, whether this will be the turning point for the Chinese equity market remains to be seen. The package does not directly address either lack of consumer confidence or the inventory overhang in the property market. Crucially, assertive fiscal easing measures are absent.
Even the cash handouts to consumers are too small to have much macroeconomic impact. Only around RMB 150 billion (USD 21.3 billion) was budgeted to alleviate extreme poverty this year (fewer than five million people fall under that definition).
Japan’s experience in 2010-12 showed that measures to boost stock purchases do not turn the market around without an improvement in the macroeconomic environment. The Bank of Japan bought exchange-traded funds in each of those years, but there was no sustained rise in investor confidence.
Signals to monitor
China needs to sustain its easing efforts for a while longer to turn around both investor sentiment and the economy.
Indicators to watch for include:
- More stimulus measures in the coming months
- Stabilisation in property market transactions and prices
- Recovery in consumption and private sector investment
- A sustained recovery in the credit impulse (which has yet to show any lasting bounce).
What to do now?
The market rally early this year lasted for three months (see Exhibit 2). Tactically, the rally could have further upside, even in the short term.
Large-cap companies, growth companies and those that pay good dividends and have strong cash flows, as well as dual-listed H-shares in Hong Kong that are traded at a discount to their A-share counterparts, should benefit the most, both tactically and strategically.
The wider impact
China had experienced five quarters of deflation, as measured by the GDP deflator, by the second quarter of 2024 (see Exhibit 3). Despite the recent stimulus, the economy will not turn around quickly because the impact of the measures will take time to filter through.
The current disinflationary conditions thus look set to continue into 2025. This could have a global impact. China’s underlying excess capacity means it will continue to export disinflation, especially to its developed market trading partners.
One analysis estimates that China’s deflation helped lower core inflation in the eurozone and the US by about 0.1 of a percentage point (ppt) and core goods inflation by about 0.5 ppt.1
Even such a small amount matters because the European Central Bank and the US Federal Reserve are trying to squeeze out the last few tenths of a percentage point of local inflation; this ‘last mile’ of reducing inflation is seen to be the most difficult. The ECB recently revised up its core inflation forecast by 0.1 ppt for 2024-2025. The annualised three-month core PCE inflation in the US is about 1.9%.
In this context, while the pass-through of China’s deflation to the eurozone and US’s core inflation is small, it is relevant in terms of increasing the scope for monetary policymakers to cut interest rates.
If the Fed accelerates its monetary easing, the US dollar could weaken, bolstering the renminbi exchange rate. This could in turn prompt more aggressive easing by China without Beijing having to worry about currency weakness.
China’s efforts to stabilise economic growth should help bolster the market for industrial commodities. Although Beijing is only aiming to stabilise, not boost, the property market – a source of heavy commodity demand – China is still the biggest consumer of several commodities and energy.
Finally, asset markets in Europe and the US should benefit, albeit indirectly, as a stronger Chinese economy would boost earnings growth for multinational companies operating there.
[1] Morgan Stanley, “The Weekly Worldview: Why China’s Deflation Matters,” 16 September 2024
