Global Courant
About the only thing falling faster than China’s economic outlook is the yuan.
China’s sliding currency is just the latest indicator pointing to a year that could turn out to be the hardest-ever of the Xi Jinping era. That seemed clear enough last week, when the People’s Bank of China surprised the world with a rate cut.
The PBOC eased again today, lowering the one-year prime rate by 10 basis points from 3.65% to 3.55% and the five-year prime rate by 10 basis points from 4.3% to 4.2%. Investors’ attention is now turning to how quickly and aggressively Xi’s government could move to pump additional stimulus into Asia’s largest economy.
The PBOC’s moves reveal “growing concerns among policymakers about the health of China’s recovery,” said Julian Evans-Pritchard of Capital Economics.
Even those betting that China could well surpass this year’s 5% economic growth target are lowering their forecasts. Case in point: Goldman Sachs cut its forecast from 6% to 5.4%, citing already high debt and Xi’s determination to limit real estate speculation.
Xi’s team now faces questions on two major fronts. One is whether Beijing’s slow rollout of stimulus measures has left Beijing behind so far. Second, whether officials are at risk of encouraging bad behavior that Xi’s team has tried to discourage in recent years.
“It is clear that Chinese policymakers have moved back to supporting growth after the recovery has been disappointing, but it is less clear whether they can do so without exacerbating old problems,” said economist Xiaoxi Zhang of Gavekal Research.
So far, Zhang argues, China’s “pivot to a more lenient policy has been less well telegraphed” than investors would like. “While expectations for a shift had increased over the past two weeks after early May indicators persisted, the disappointment of April persisted,” says Zhang.
The latest full set of monthly data “confirmed that a sharp turnaround in the real estate sector and a drop in exports had opened a gap in aggregate demand,” Zhang notes.
“By cutting short-term interest rates in response, the People’s Bank of China sent a strong signal as it rarely changes rates. Still, there is a strong consensus domestically that more direct demand support is needed through fiscal policy,” says Zhang.
On June 16, Xi’s leadership team discussed a package of measures at a meeting of the State Council, but kept the details close to the vest.
Li Qiang has his work done for him. Image: Screengrab/NDTV
There, the council, led by Premier Li Qiang, said that “in response to the changes in the economic situation, stronger measures should be taken to strengthen the momentum of development, optimize the economic structure and promote the continued recovery of the economy. “
As Zhang sees it, “increasing spending on infrastructure would be the easiest and quickest way to boost growth, although it would disappoint structural reform advocates.”
No reform is more important than tackling a growing crisis in China’s real estate sector. As data shows that a critical mass of mainlanders are reluctant to invest in anything other than real estate, stabilizing the market is key to boosting household confidence.
Getting China’s 1.4 billion people to save less and spend more is the main goal for Xi’s third term. If Xi is to mobilize serious savings, urgent attention needs to be given to revitalizing property, which can account for as much as 30% of gross domestic product (GDP). This means ending boom-bust cycles in the longer term.
The fragile state of the real estate sector is distorting the underlying mechanisms of the Chinese economy, US research firm Rhodium Group warns. The analysts found that, thanks to falling real estate values last year, more than 100 Chinese cities struggled to pay off their debts.
This alone threatens to lessen the impact of any fiscal stimulus that the PBOC or Xi’s team might unleash in the coming months.
In a recent report, Rhodium looked at trends in 205 mainland cities and financial data from nearly 2,900 local government funding instruments (LGFVs). These schemes raise money to power massive infrastructure projects aimed at boosting local GDP.
In a report last month, S&P Global Ratings warned that “China’s real estate faces another year of easing.” Even as conditions in some wealthier, upscale cities become “close to normal,” S&P argues that “weaknesses in China’s third and fourth tiers will keep the real estate recovery on an ‘L-shaped’ path. Conditions will leave developers with a large exposure to lower towns hit hardest.”
S&P notes that “we consider this the latest phase of a crisis that resulted in $52 billion in offshore bonds last year, with about one in four developers facing insolvency. The downturn in lower markets will affect much of the industry.”
The bottom line, says S&P, is that this “tense environment requires a close look at entity liquidity, particularly statements of unlimited cash and cash-generating opportunities. About 40% of rated developers could experience rating pressure if sales in tier three/tier 4 cities were to fall 20% this year.”
In November, Xi’s team began telegraphing a series of measures — 16 in all — to promote the industry’s “stable and healthy development”.
China has property problems. Image: Twitter
Chief among these were credit support for highly indebted developers, looser rules for first home purchases by new urban residents, deferred loan assistance for homebuyers, and financial assistance to ensure the completion and handover of projects to homeowners.
The plan “is much more comprehensive, ranging from addressing the liquidity crisis facing developers to a temporary relaxation of a signature restriction on bank loans, from treating private and state housing developers equally to restarting the financial funding channels for them,” notes economist Jinyue Dong at BBVA Research. “It marks all-round efforts to rescue the real estate market to secure a ‘soft landing’ after recent data showed some slight improvement.”
But it is imperative that Beijing remember that “sentiment matters,” says Dong. The 16-point plan, which aims to “prevent a real estate hard landing, is still behind the 2015 stimulus measures, while the easing of the zero-Covid policy is still slower than expected.”
“That means that, without the deluge of massive real estate stimulus to help restore confidence in house prices, it is still a question of whether and for how long continued housing market stimulus can lift the housing market out of the quagmire. 2023 could show a slight recovery, but the long-term robust recovery needs more endurance,” says Dong.
Economist Zongyuan Zoe Liu of the Council on Foreign Relations notes that “a healthy housing market is critical to China’s economic growth and financial stability, but slowing home sales, driven by pandemic constraints and demographic shifts, have upset real estate developers and homebuyers alike . ”
That’s why over the past year, the PBOC has “enacted a series of policies to cut mortgage rates in an effort to stimulate buyer demand and raise home prices,” notes Liu. It has taken the form of allowing Chinese banks to offer floating rate mortgages subject to a nationwide minimum interest rate.
Under normal circumstances, Liu explains, the mortgage interest rate is equal to the loan’s prime rate, or LPR, for new homebuyers and LPR plus 60 basis points for all other borrowers.
As of May 2022, the PBOC has “broken this convention lowering the rural floor on new mortgages up to 20 basis points below LPR for first-time buyers,” she says. Later in September, the PBOC announced that it was “relaxing”. the nationwide interest rate in some cities where house prices have been on a declining trend for the past three months.
But more than new stimulus, China needs comprehensive real estate market reforms that change incentives and make investment more stable and productive. This responsibility lies with the new Prime Minister Li, who took up China’s second job in March.
Its balancing act: easing fiscal policy to stabilize growth without fueling new bubbles in unproductive lending and leverage.
“China has plenty of room to push stimulus if it wants to,” said Michael Hirson, China economist at 22V Research LLC. “The main obstacles are concerns about financial risk and the reluctance so far to use the central government’s balance sheet to extend fiscal stimulus.”
Analysts say China has room to pump up economic stimulus. Photo: Facebook
Ting Lu, Nomura’s China chief economist, says it is reasonable to expect “more easing and stimulus measures”. Lu emphasizes that “in the midst of a deteriorating real estate sector, the potentially devastating impact on public finances and the rising risk of a double dip, we don’t expect Beijing to sit still.”
A priority should be to work faster to remove toxic and potentially soured assets from property developers’ balance sheets.
Indeed, in recent years, Beijing has created a network of funds that borrows some characteristics from the Resolution Trust Company mechanism used by the US to clear the savings and credit crisis of the 1980s. Japan did the same in the 1990s to end the bad loan crisis of the 1980s.
Li’s remit will be to step up efforts to ensure that financial institutions are constrained in their ability to create new “moral hazards” that increase reliance on public bailouts over the longer term.
For now, even the International Monetary Fund thinks China has room to ramp up its industrial stimulus complex.
“China has the policy space to keep monetary policy accommodative because inflation is very contained,” said Krishna Srinivasan, the IMF’s Asia-Pacific director. “It also has the fiscal space to provide support.”
But most importantly, says Citigroup economist Xiangrong Yu, is a burst of stimulus “centered on the real estate sector, with expansionary monetary and fiscal policies to maintain growth momentum.”
Yu added: “We think the overall policy tone for this sector could shift from stabilizing to cautiously stimulating. More efforts are needed to stop a downward spiral.”
Follow William Pesek on Twitter at @William Pesek
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