China's authorities show signs of life
After years of decline in China’s property market and limited, uncoordinated, and ultimately unsuccessful attempts by the country’s authorities to provide some sort of solution, details have emerged over the last few weeks of a more coherent plan to stop the bleeding. While we acknowledge China’s economic imbalances will not be solved via press release, we do think the steps taken in recent weeks are positive and reduce the probability of a much worse “tail event” outcome. While the latter was not our base case, it is fair to say that its chances were increasing.
By way of background, China’s property crisis stems from a years-long construction and investment boom that began to turn to bust in 2020 when the government tightened regulation for property developers, sparking widespread defaults in the sector and a significant contraction in real estate activity. Local governments in China get a lot of their funding from land sales, which are not exactly in vogue when large property developers are in default. Consequently, the financial situation of local governments has worsened and they have had to tighten their belts. Because Chinese consumers have a lot of their wealth tied to real estate, as the property market has crashed so has consumer confidence. In parallel, the government has also taken hostile measures against private education, gaming and internet companies, which has not helped private investment in the domestic economy. The result of this toxic cocktail has been general deleveraging, significant deflationary pressures, and slower growth with little signs of a recovery, which as a side effect hurts tax revenues.
The more coherent plan to tackle the growing crisis began to emerge in late September, when The People’s Bank of China (PBOC) announced a series of measures that exceeded market expectations. Various policy rates were reduced, as well as the reserve requirement ratio for banks. Downpayments for second home mortgages were cut, as were rates on existing mortgages, and a new facility to backstop the equity market was created. A couple of days later at the September politburo meeting, there were statements that hinted at a bigger sense of urgency from authorities regarding the economic situation and potentially upcoming fiscal stimulus targeted at the housing market.
This weekend it was the Ministry of Finance’s turn, and while there were no direct measures targeting consumption announced and markets were still somewhat hungry for more detail, there were a few important points worth mentioning.
Most importantly, the government will raise local governments’ debt ceiling, allowing them to issue fresh debt and refinance debt at their local government financial vehicles (LGFV). This is not the first debt swap exercise China has done, but while there was no concrete number regarding the size of this programme, the tone indicated it will be big. As a result of the swap, interest costs should decrease, maturities should be extended, liquidity at the local companies that will see their debt stack reduced should improve and local contractors should get their late invoices paid. In addition, local governments will be allowed to issue special bonds to buy housing inventory in the market. There was also confirmation that the Ministry of Finance will issue special bonds with the aim of increasing capital at the six largest government-owned banks. We do not think these banks were in urgent need of capital, but better capitalisation of course helps with appetite for lending, even if it won’t solve the lack of demand for borrowing. It could also mean banks are more willing to recognise losses earlier and move on, as opposed to “extending and pretending” loans that will have to be restructured at some point anyway. Finally, Minister of Finance Lan Fo’an said the central government has ample room to increase deficits and issue more debt, which is a strong sign that the government is both worried and willing to act with the aim of providing some sort of floor to the economy.
Chinese assets have seen wild swings as markets digest the latest measures, which even for those without direct exposure to Chinese assets are still very relevant. Though China’s GDP is smaller than that of the US in nominal terms, its growth is much higher in spite of the malaise in certain areas. China represents roughly 18% of global GDP, but it is likely to account for around a third of global growth in 2024. The fact that Chinese authorities are finally coming up with a more coordinated and sizeable plan is most definitely good news for the global economy, and for those that, like us, believe the global economy is not headed towards a hard landing. At the margin, we think this gives further ammunition to buyers of credit and other risky assets.
