Global investors expect a massive economic stimulus from China. Because of this, it may never come to pass.

By Isabel Wang

China’s officials may still be confident of hitting the growth target

Many investors are clinging to hopes that China will unleash big fiscal stimulus to boost its struggling economy. They will likely be disappointed, according to longtime China watchers.

In the first half of 2023, Wall Street was optimistic about the economic recovery of the world’s second largest economy after the country emerged from COVID-19 lockdowns. Investors hoped that a rebound in the Chinese economy would help stem a global slowdown as interest rates were raised to fight inflation.

But economic data continues to suggest otherwise. Retail sales, industrial production and investment all grew more slowly than expected in July, fueling concerns about a deep and prolonged slowdown in growth. And now renewed worries about the Chinese real estate sector continue to cloud the outlook.

China’s largest private real estate developer Country Garden missed payments on some of its bonds and warned it was posting a record loss for the first six months of the year as sales and profits fell, which would only bring the company to the brink of default and a restructuring for two years after China Evergrande Group’s default on payments sent shockwaves around the world.

Investors’ new desire is for Beijing to enact a massive stimulus package – a policy tool China used to great effect in 2008 – but which has not yet been put on the table. And it may never happen, economists told MarketWatch.

“A big problem is that the markets have been trained to take on everything by throwing a lot of money into China, so there is a lot of disappointment,” said Shehzad Qazi, executive director of China Beige Book. “Now, you [policy planners] are very careful about how many incentives they want to release. They do it in very small doses along the way.

Difficulties in reviving the real estate sector

The real estate sector has long been a key engine of China’s economic growth, accounting for up to 30% of the country’s gross domestic product. But in the wake of COVID, it’s now a major source of stress.

Over the past two years, Beijing has recognized mounting debt as a potential threat to its economic stability and has sought to reduce the economy’s reliance on debt for growth. But giant real estate developers still ended up defaulting while house prices continued to fall, sending the real estate market into a downturn and jeopardizing Beijing’s 5% economic growth target.

See: China tries to allay fears after property developer’s debt battle

Policymakers have announced a slew of measures to revitalize the real estate sector in recent months, including easing restrictions on home buying in the country’s largest cities, extending credit breaks for developers and considering making down payments in some non-core businesses belonging districts of the big cities.

On Tuesday, the People’s Bank of China (PBOC) unexpectedly cut interest rates for the second time in three months. The central bank cut the rate on its one-year loans — or term lending facilities — by 15 basis points to 2.5%, the biggest cut in three years.

However, recent interest rate cuts and some incremental measures to support the real estate sector have largely been viewed by economists and investors as mere “window dressing” that may not reverse China’s economic slowdown.

“The government’s focus on housing stimulus is not working because households have lost faith in property and no amount of stimulus will change that,” said Gerwin Bell, senior economist for Asia at PGIM Fixed Income. “This economic stimulus is driving in the same direction.”

Qazi said data compiled by China Beige Book showed interest rates had been “much lower” over the course of 2023, while credit supply had been “better”. The problem, however, is that companies are unwilling to borrow. “You [the government] “If businesses can provide the credit, you can direct banks to lend, but if businesses are unwilling to borrow because they are not yet confident enough to invest and expand, then your stimulus plan is stretched.” , he told MarketWatch in a phone interview.

2008 Redux?

Beijing was reluctant to embark on massive stimulus measures, as it did during the 2008 financial crisis, when China enacted a $586 billion package to keep the economy afloat.

However, one of the reasons for the country’s dovish stance may be that Beijing is still confident the economy will meet the 5% GDP growth target this year, Qazi said.

“Beijing simply doesn’t see its 5 percent growth target for the year as unachievable. If they think they can meet their growth targets for the year, they will be more conservative about how much stimulus they need to deploy,” he said.

China’s factory activity picked up in the first half of 2023, the Caixin/S&P Global Services Purchasing Managers’ Index showed, as a surge in new orders underpinned a consumption-led economic recovery in the second quarter. However, July saw a decline as supply, demand and export orders all deteriorated as companies blamed sluggish market conditions at home and abroad.

debt and local government

Three years of strict COVID-19 lockdowns in China and housing riots have weighed on local government balance sheets and left agencies across the country struggling with mountains of debt. Fears of a potential government default on debt repayments sold by Local Government Financing Vehicles (LGFVs) have increased.

Investment demand is not coming from investors or households, but from local governments, Bell said in a phone interview with MarketWatch on Wednesday. “It is absolutely critical that the investment or stimulus focus is now on local governments and not just to refinance the debt but actually give them new money, otherwise they will have to stop making these previously supportive investments.” Growth.”

“I was hoping that she [the government] saw this in June. “Hopefully they’re seeing it now … They can still do it, but it’s getting closer and closer to an accident,” Bell said.

See: China’s shadow banking sector poses ‘rising risks of financial crisis’: report

That’s why a “helicopter drop,” a type of monetary stimulus that injects money into the economy through more spending, tax cuts, or simply printing large sums of money as if it were dropped from a helicopter, would help local governments, Bell said.

“After the global financial crisis, China had by far the largest balance sheet of any major central bank in the world at 70% of GDP. That percentage is now down…so they have room for ‘helicopter money’” and to fund a fiscal stimulus that would increase inflation and thereby mitigate the impact of debt growth,” Bell said.

China’s consumer sector went into deflation in July for the first time in two years. The consumer price index fell 0.3% year-on-year last month, the National Bureau of Statistics said last week, while the market consensus called for a 0.4% decline.

Stimulating household consumption must be the top priority for policymakers, and it is necessary to “use all reasonable, legal and economic channels to put money in the pockets of residents,” said Cai Fang, a member of the People’s Bank’s monetary policy committee In a Bank of China article published late Monday, Cai said earlier this year a $551 billion direct stimulus paid directly to Chinese households is one option to stimulate a recovery in consumer spending to boost.

“It would definitely help and would also put money in the pockets of households suffering severe cash shortages and make up for the fact that no income transfer payment was made in China throughout the COVID episode,” Bell said.

See: Wall Street’s crystal ball shattered: why financial markets’ big bet on China’s economic boom is a complete failure

bets go wrong

Financial markets are divided on whether China will take more concrete action to boost growth. With the lack of economic data and fears of a default causing some investors to seek exit, others say it’s time to “buy on the downside” as stronger stimulus could trigger a multi-month stock rally.

“We are hopeful of a possible rally and advise investors to buy on downsides in the coming weeks,” said a team of strategists at BofA Global Research led by China equity strategist Winnie Wu.

Wu and her team believe the Chinese government needs to send clearer signals to support the economy and private sector, restore confidence and prevent a downward spiral. However, Beijing’s willingness and ability to implement strong stimulus measures is limited due to high debt levels and pressure on the Chinese yuan exchange rate, she said in an Aug. 7 research note.

The yuan neared a 16-year low this week against a broadly stronger US dollar, according to FactSet data, slipping to 7.32 per US dollar on Thursday. The ICE US Dollar Index DXY, a measure of the greenback’s strength against a basket of peers not including the yuan, was steady at 103.42 on Thursday but is down 0.6% this week and in August up 1.5% so far.

However, investor expectations for China’s recovery in 2023 are “incredible, totally unrealistic,” Qazi said. Investors shouldn’t look at China through the same lens as they did after the global financial crisis, as the country is undergoing “a massive realignment of its thesis and approach to markets.”

Policymakers have already shifted their priorities from “robust economic growth” to “de-risking the economic system,” Qazi said, a shift that has been “completely underestimated by Western investors.”

– Isabel Wang

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently of Dow Jones Newswires and The Wall Street Journal.

(ENDS) Dow Jones Newswires

08/17/23 1640ET

Copyright (c) 2023 Dow Jones & Company, Inc.