Weekend Long Read: What’s Left in China’s Economic Policy Tool Kit?
By Jin Yi
Since April, a variety Chinese economic and financial data points have come in below expectations. To prevent a slowdown in growth, it is highly probable that policymakers will have to take action. So what tools do they have at their disposal and which ones will they employ?
We believe there are six main tools that policymakers will make use of in the second half of this year: monetary policy easing, policy financial tools, local government special bonds, consumer spending stimulus from fiscal funds, special treasury bonds, and the relaxation of property market restrictions in some cities accompanied by a boost in financing support from the central bank.
The potential effectiveness and probability of each one’s use varies depending on the tool.
Further monetary policy easing
Historically, the liquidity cycle runs opposite to the mid- and long-term loan cycle. For the People’s Bank of China (PBOC), when the economic recovery momentum weakens and the speed of mid- and long-term credit issuance slows, it’s standard operating procedure to issue short-term loans and bills to encourage commercial banks to curtail the decline in credit growth. Therefore, because the growth rate of mid- and long-term loans more or less peaked in May and June, it is unlikely that the central bank will tighten liquidity. Therefore, we believe that the short-term liquidity situation will remain relaxed in the second half of the year.
Over the medium term, however, we expect interest rate and reserve requirement ratio (RRR) cuts.
In the PBOC’s monetary policy implementation report for the first quarter of 2023, the central bank said that “currently, deflation has not appeared in our economy” and “there is no basis for long-term deflation or inflation.”
This language indicates that stabilizing inflation expectations is one of the central bank’s core tasks. However, with the decline in exports and a lack of domestic consumption stimulus, internal demand remains weak and inflation is expected to remain subdued in the second half.
The real interest rate (the difference between the nominal interest rate and the 12-month average CPI) has fluctuated over the past few years. Due to the near-continuous decline in CPI this year, the real interest rate remains relatively high, which will suppress investment demand to a certain extent. If inflation is slow to recover, we expect RRR and interest rate cuts in the fourth quarter.
Policy financial tools (政策性金融工具) — a convenient choice
At the end of 2022, the Central Economic Work Conference recommended that “policy finance should increase financing support for major projects in line with national development plans.”
To boost infrastructure spending and overall economic growth, it remains necessary to continue to expand developmental financial tools. Judging from the issuance of two batches of policy financial tools in 2022, it is highly probable that a new batch will be implemented between June and August, with a quota of more than 700 billion yuan ($98.2 billion).
Moreover, compared with special bonds, which are also sources of funds for infrastructure, policy financial tools have four advantages:
·The disbursement of funds does not require legislative approval because the decision-making power comes from the State Council, which makes for a more streamlined process
·The central government will take on the added leverage, so it won’t increase local governments’ debt burdens
·Policy financial tools can be used as capital for infrastructure projects, and the profitability requirements for projects are lower than those for special bonds, making them more flexible
·Their direct connection with the central bank’s Pledged Supplementary Lending (PSL) policy results in minimal disruption to financial markets.
Housing market support — a different kind of easing
Based on residential housing sales data from 30 cities, there has been a noticeable seasonal weakness in transactions in major Chinese cities since May. The emergence of this trend may accelerate a “city-specific” relaxation of housing market restrictions.
Mortgage rates for first-time homebuyers in the first-tier cities of Beijing, Shanghai and Shenzhen are currently higher than the loan prime rates (LPR). Considering that the residential price index for first-tier cities has turned negative year-on-year, there is room for mortgage rate cuts in these cities.
In second- and third-tier cities, a round of measures designed to stabilize the real estate market led to a relaxation of purchase and sales restrictions as well as lower down payment requirements. For example, on June 2, the local government in Qingdao, East China’s Shandong province, introduced new measures that relaxed sales restrictions and lowered the down payment ratio in some areas, which may attract other cities to follow suit. However, it is less likely that there will be a full relaxation of purchase restrictions because doing so could create a siphoning effect on surrounding cities, violating the government’s oft-repeated principle that “homes are for living in, not for speculation.”
Lower-tier cities have limited room to cut mortgage rates and do not have many purchase and sales restrictions in place. The space for stabilizing the property market is limited, which means nationwide policies are needed.
Since 2022, much of policy to support real estate has been targeted to help first-time homebuyers, causing a drop in mortgage rates for first-time homebuyers. The spread between mortgage rates on first and second homes has expanded to a historically high level. Consequently, we believe there is still room to cut mortgage rates for second homes.
Fiscal policy at the central government level will likely continue to focus on strengthening financing support. In the first quarter of 2023, the PBOC added quotas for two structural monetary policy tools — special re-lending for real estate company relief and the rental housing loan support plan. These tools were aimed at supporting the acquisition of real estate company projects and existing housing in pilot cities. In addition, a loan of 500 million yuan was also issued in the first quarter to guarantee the delivery of homes still under construction.
Local government special bond balance quota (地方专项债结存限额) — sitting idle
On Aug. 24, to increase effective investment and address the problem of insufficient loan demand, the State Council proposed using the more than 500 billion yuan special bond local balance quota to expand the scale of infrastructure investment this year.
Almost a year has passed, and there is still nearly 1 trillion yuan of the quota left.
Still, we believe it isn’t all that likely that the remainder will be used, primarily for two reasons:
·The State Council has not proposed any explicit requirement this year to use up the quota
·If the quota is used for infrastructure investment, it might crowd out the refinancing bond quota used by local governments for hidden debt swaps, and local governments may be less willing to use it
Fiscal-backed consumer stimulus (受政府补贴的消费刺激) — an unlikely option
China has introduced two major consumer stimulus policies supported by central fiscal subsidies. The first was the Home Appliances Going to the Countryside policy, which was fully implemented in 2009. The other was the new-energy vehicle (NEV) subsidy policy, which was implemented nationwide in 2016.
The home appliance policy provided a 13% subsidy for certain products, with 80% of the cost borne by the central government and 20% shouldered by local governments. The NEV policy provided a fixed subsidy per vehicle according to standards set by the central government.
Looking back, we can see that large-scale consumer stimulus policies have two characteristics:
·The government announced both consumer stimulus policies several months before they were implemented across the country. For the home appliance policy, the document that arranged the funding was issued almost a year in advance, and there was a similar lead time for arranging the NEV subsidy funding.
·Although the central government subsidized most of the stimulus measures, in actual practice, local governments had to cover the funding gaps whenever the amount spent on subsidies exceeded the budget. The central government would eventually repay the local governments, but the process sometime took years.
China’s 2023 fiscal budget has been announced, but no large-scale consumer stimulus spending has been arranged. So, it will be difficult for any large-scale consumer subsidy measure to come out this year.
Special treasury bonds (特别国债) — for emergency use only
Special treasury bonds have been issued three times in China. The first time was in 1998 to shore up the capital reserves of major state-owned banks. The second was in 2007 to set up the sovereign wealth fund, China Investment Corp. And the last was in 2020 to combat Covid-19. Past issuances have had the following two characteristics:
·Issuing special treasury bonds follows a top-down process. For instance, the 2020 issuance of special treasury bonds was first proposed at a Politburo meeting before the Ministry of Finance sent a proposal to the National People’s Congress, which finally approved it. The process took about four months.
·In terms of purpose, special treasury bonds are generally only issued during major crises or when they are need to accomplish major policy goals.
Currently, the domestic economy is not facing any problems comparable to the aforementioned events, and a pattern of deep recessions overseas has yet to emerge. From a procedural perspective, if the Politburo does not make a request at its July meeting, there is only small possibility that special treasury bonds will be used as a tool to help shore up growth this year.
To sum up, in the short term, due to weak credit growth, a broad fiscal policy is still needed. We believe that the implementation of policy financial tools and some marginal easing of real estate market policies are highly probable to stabilize growth. These will move the bond market, but whether they can restore confidence in the real economy remains to be seen.
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