This week's announcement by the Chinese leadership and the People's Bank of China (PBoC) to cut interest rates, provide support to the property market, and inject liquidity into their financial markets was widely hailed as China's 'Whatever-It-Takes' Moment.
So, why are most market analysts not buying it?
China's 'Whatever-It-Takes' Moment
In the post-COVID world, China has become 'uninvestable' for most American and European investors. Capital fled. Companies pulled out of the country, relocating their production and assembly lines to countries like Vietnam or India. The country expected a quick return to their past growth rates, but over the last two years, Chinese stocks have been trading at depressed values, consumption is depressed, the demographic profile is slowly beginning to resemble the aging crisis of developed countries, and the housing market debt is stifling any nascent rebound.
Still, the efforts to stimulate the Chinese languishing economy are real. This week's announcements address the most thorny problems the country is grappling with:
- Interest Rates - reserve ratio requirement cut by 50bps, lower 7-day reverse repo rate
- Property Markets - minimum downpayment cut to 15% for second-home buyers, lower mortgage borrowing costs, consumers allowed to refinance at lower mortgage rates
- Financial Markets - at least 800 bn yuan (~$115bn) of liquidity support, market stabilization fund considered
Given all that, the bounce in Chinese assets this week was more than justified. The sentiment was so poor and the valuations so low that there was basically no one left to sell.
But if this is to produce real change, and for it to be sustainable, much more is needed.
The Peril of Japan's Lost Decades
The People's Bank of China has always been rather orthodox and conservative in that it never intervened in the Chinese economy in a meaningful way. The 800 bn yuan lending facility is a mere 1.8% addition to the PBoC's balance sheet. When compared to how the FED or the ECB acted when truly deploying their bazooka, the current measures are a drop in the bucket. In fact, there is no correlation between PBoC assets and the equity market performance.
Chinese analysts are rightly worried about following the experience Japan lived through from the early 90's until 2012. Japan's equities were in prolonged decline during those 20 years as long as their GDP deflator remained negative. That's exactly where China's been since the end of 2022.
In Japan, it's only when Abenomics–former PM Shinzo Abe's policies–helped the GDP deflator recover in the positive territory that Japan's equities came back to life.
China is currently effectively exporting deflation to the rest of the world and much of this is driven by the extremely poor sentiment in the housing market. Goldman Sachs estimates the cost to lower the excess inventory in the country at 8 trillion yuan ($1 trillion). Yet, the funding currently available to help achieve that equals only about half of the needed amount.
Structural Reforms - Help Needed
With the announced measures, China still expects to hit its 5% GDP growth in 2024, which by all means is a respectable number. But with the Chinese retail sales now hovering around 2-4% y/y versus the pre-COVID 7-9% y/y and an economy in deflation, significant GDP growth in 2025-2026 is in question, simply because an economy in deflation almost always experiences falling GDP rates and falling consumption.
The current measures are a useful band-aid to real problems the country is facing. It's however not a long-term solution. Real structural reforms are needed to modernize the economy, attract foreign capital, and provide a stable, reliable, non-arbitrary judicial system that guarantees rights to property, ownership, and long-term wealth building.
The street is split as to whether this is the beginning of a long-term recovery in China's economic prospects. Hedge fund managers like David Tepper have publicly declared they are buying EVERYTHING they can touch, exceeding their risk management parameters in terms of % allocation to the country.
Others are much more skeptical, weary of the geopolitics issues that have for now been ignored. Not a week passes by without a skirmish in the South-China Sea between Filipino vessels and Chinese fishing boats. The Taiwan issue is looming over investors' heads and most of these concerns are for now ignored because the focus is on the Middle East and Ukraine.
From a risk-management perspective, it makes sense to book at least partial profits on whatever long exposure in China you were lucky to have. Whether this is a more sustainable move higher and the beginning of real recovery in China is yet to be seen.