China’s policymakers are facing an old dilemma in a new slowdown. It is increasingly clear that the world’s second largest economy needs a kickstart, but not one that rekindles a borrowing binge.
Faced with slowing growth, the Chinese central bank has since July 2021 trimmed an array of rates in an accelerating effort to free up liquidity in the country’s banking system. The latest spate of easing measures came in late January, and we think more cuts are likely.
For global investors, the growth cycle contrasts between China and the rest of the world couldn’t be sharper. Most major economies, including the US and Europe, are moving to hike rates and phase out stimulus in order to battle inflation. In China, where inflation remains tepid, policy is being eased and the broad-based, construction-fueled stimulus that Beijing sought to avoid in the last two years is suddenly back on the cards.
Acting soon enough?
The risks of policy missteps are high all around. In the US, debate is ongoing on whether the Federal Reserve is doing too little too late to tame inflation.
In China, a similar quandary bedevils Beijing in the opposite direction: doubts remain over whether policy makers can move quickly and effectively enough to revive key growth drivers - especially in the property sector, which together with construction and related industries accounts for upwards of a third of economic output. On the other hand, opening the spigots too widely has in the past saddled the economy with lingering industrial overcapacity, bad debt, and other systemic imbalances that could still destabilise its financial system over the longer term.
Digging into the details, the timing of the government’s recent moves is telling of how it is trying to gain the initiative without overplaying its hand. The mid-January rate cuts, though widely anticipated, came earlier than expected. The central bank, better known for even-keeled communications, said the next day it would act to avoid “credit collapse.” The stark language appeared designed to shore up confidence in how Beijing will handle the slowdown.
As a year-end decline in the property market and land sales dragged on growth, Chinese banks received “window guidance” to speed mortgage approvals. They are complying. But property sales continue to be weak, indicating a deeper problem in deteriorating demand. Recent Chinese policy, such as cracking down on ownership of multiple homes, may have overshot in curbing buyer appetites. Issuance growth of local government debt of the type that finances infrastructure development has slowed significantly.
Policy makers are now weighing wider measures to support developers, such as freeing access to their presale funds previously locked in escrow. Some of these measures will require extraordinarily close coordination between central, local and city governments to be effective. Should such regulatory adjustments fall short, we think further rate cuts are likely in the first half of the year. Still, the property-driven slowdown belies pockets of resilience in the Chinese economy, including in exports, manufacturing, services, to name a few areas.
Implications for investors
For investors, who are heavily scrutinising China’s fixed income markets, Chinese government bonds provide an increasingly investable and appealing opportunity.
China is moving in a starkly different direction than the rest of the world. China’s 10-year government bond yields continue to decline and prices rise in recent weeks - even while yields on US treasuries have moved sharply higher. In the year to date, Chinese government bonds (CGBs) have been the best performing among core sovereign debt markets globally. And there could be more to come.
Coordinated policy loosening in China would pave the way for more infrastructure projects and construction, further supporting CGB yields. The Chinese currency is largely expected to remain stable. While the Fed hiking rates could exert some downward pressure on the renminbi, any weakening would likely be tempered and could help Chinese exports extend their recent strength. China’s central bank has said it intends to keep the renminbi largely stable against the dollar over the longer term.
For now, the more pressing conundrum for the government is how to keep macro leverage in check while trying to revitalise growth. It’s a risky balancing act, but one China has faced before.