Today’s extreme focus on the Bank of Japan is pivoting to how the People’s Bank of China plays the economic minefield that lies ahead in 2024.
Over the next 12 months, China will stress test Asian economies as rarely before. Beijing’s dueling priorities of stabilizing growth and reducing the frequency of boom/bust cycles will center on the actions of Governor Pan Gongsheng at PBOC headquarters.
Since taking the PBOC’s reins in July, Pan has been a study in monetary restraint. Even as the all-important property sector stumbles, Pan’s team has avoided channeling giant waves of liquidity into the market. Targeted blasts, yes. But Team Pan is foregoing the powerful easing moves that traders came to expect from previous PBOC leaders.
One reason is that the yuan is under growing pressure in global markets. Nothing would get China closer to this year’s 5% growth target faster than a lower exchange rate. Pan, though, is prioritizing yuan stability over stimulus in ways that continue to confound hedge funds betting on a weaker currency.
This patience is partly about China’s default-plagued property developers. Each drop in the yuan makes paying off offshore debt more expensive and challenging. It’s also about the PBOC’s determination not to reward bad behavior through moral hazard-encouraging bailouts.
Yet this balancing act may become more precarious as China’s domestic economy underperforms at the same time the external sector disappoints.
This isn’t the only way China will stress test Asia’s economies. Writing in the latest Global Polarity Monitor newsletter, Asia Times’ David Goldman argues that China will engage in “limited, stylized probes of Asian governments’ pain threshold” in naval and military matters.
Questions about the region’s economic pain threshold vis-a-vis China’s slowdown loom large as 2024 approaches.
Though the US has beaten the odds and avoided a recession, this luck might be running out. The cumulative effects of 11 US Federal Reserve rate hikes in 18 months – and the highest Treasury debt yields in 17 years – are generating intensifying headwinds. Europe is facing a treacherous 2024 as the German economy contracts.
“The fiscal woes of the last month have clearly left their mark on the German economy, with the country’s most prominent leading indicator showing just how difficult it will be for the economy to bounce back,” says ING Bank economist Carsten Brzeski.
Japan, meanwhile, may already be in recession. Data since the economy’s 2.9% contraction in the July-September period offers little hope Japan isn’t ending 2024 in the red. The sense of fragility was buttressed by the Bank of Japan’s decision on Tuesday (December 19) to leave quantitative easing in place.
Following the no-action on rates announcement, BOJ Governor Kazuo Ueda said it would be “inappropriate to think that we will rush to change our policy because the Fed is likely to move within the next three to six months.” That, he added, means the BOJ will “observe the situation for a little longer.”
To economist Krishna Guha at Evercore ISI, this means the BOJ will “methodically” prepare the ground for a first hike to exit negative rates rather than shock markets with a surprise exit, perhaps by April.
Yet that might depend more on how China fares in the months ahead than any other variable. As China’s economy loses altitude, “the case for early [BOJ] normalization is in jeopardy,” says Carlos Casanova, senior economist at Union Bancaire Privée.
As of now, the “conditions for [a] BOJ to pivot” away from QE “have not yet been met,” Casanova says. The first condition, he adds, is for 10-year Japanese government bond (JGB) yields to be at or slightly above the “new upper bound” of 1.0%. The second is for inflation to remain above the BOJ’s 2.0% target for an extended period. Both conditions remain uncertain.
Here, the BOJ isn’t operating in a vacuum. Economist Louis Gave at Gavekal Dragonomics notes that “assuming that the Fed is sounding dovish more for political reasons than any genuine concerns, the next few months should see a weaker US dollar.”
If, at the same time, Gave says, the “Bank of Japan eventually abandons its negative interest rate policies and China’s stimulus attempts start to gain a modicum of traction – and the People’s Bank of China has ramped up liquidity injections of late – we could end up with a setup that is bearish for long-dated bonds across OECD countries. Most, but especially, in the US.”
Among these central banking powers, the PBOC is a real wildcard in 2024. Odds are the BOJ will be forced to “taper” a bit in the months ahead, says Kelvin Wong, senior market analyst at OANDA. “It seems that mounting pressure from the public and private sectors has arisen.”
Wong notes that prominent Japan business lobby Keidanren head Masakazu Tokura is urging the BOJ to “normalize monetary policy as early as possible.” Intriguingly, Economy Minister Shindo attended the BOJ’s December 19 meeting as a representative from the Cabinet Office.
“It’s rare,” Wong says, “for a Cabinet minister to attend BOJ monetary policy meetings as such ‘attendee roles’ are usually assigned to deputy ministers. In the past meetings that cabinet ministers attended had resulted in major monetary policy changes such as the launch of the mega quantitative asset-buying program in April 2013.”
Headwinds from China are among the forces complicating BOJ rate decisions.
The same goes for Bank of Korea officials in Seoul. Sputtering mainland demand has caused an about-face in South Korean exports. In recent months, the BOK cited weak global demand, led by China’s slowdown, as depressing demand for tech goods, undermining the country’s outbound shipments.
Taking a longer-term perspective, economists are mulling what China’s downshift means for the region.
“The Chinese economy has grown at an unprecedented pace since the 1980s, gaining importance globally, particularly after the country joined the World Trade Organization in 2001,” notes economist Sewon Hur at the Federal Reserve Bank of Dallas.
However, Hur notes, “the pace of growth is likely to slow as China’s economy matures because of its demographic structure and its increasing proximity to economic and technological frontiers.”
Additionally, Hur argues, “China may face more significant headwinds than would be typically expected. Notably, the country’s growth in total factor productivity — the efficiency of production — the largest contributor to China’s growth, has steadily declined since 2000. This trend is projected to continue over the next decade and beyond.”
As Chinese President Xi Jinping and Premier Li Qiang get a handle on the economy’s troubles, Southeast Asia might come into its own as a regional growth engine, argues Eunice Tan, a credit analyst at S&P Global Ratings.
“This shift could constrain the medium-term upside for China’s issuers while improving those of issuers in India, Vietnam, the Philippines and Indonesia,” Tan says.
S&P projects that China’s gross domestic product will slow to 4.6% by 2026 after growing at a 4.8% pace in 2025. By comparison, S&P sees India growing 7.0% by 2026, while Vietnam grows 6.8%, the Philippines expands 6.4% and Indonesia accelerates at a roughly 5% pace.
“Despite stimulus,” Tan says, “China’s property sector remains stressed. Constrained access to credit support and high corporate debt leverage are denting liquidity profiles, particularly of property developers and heavily indebted local government financing vehicles.”
At the same time, Tan adds, “we expect regional interest rates to likely stay high, given the US Federal Reserve will maintain a tight monetary policy to bring inflation within target. Our base case sees the US and Europe avoiding a recession in 2024, but the risk of a hard landing remains, which could affect Asia-Pacific’s exports to these regions.”
Photo: CNBC Screengrab / Zhang Peng / LightRocket / Getty Images
Making matters worse, China’s stumble could generate any number of downside surprises in the year ahead. The problem is that the government still hasn’t “addressed the most important issue: credit risk related to developers,” analysts at Macquarie Bank write in a report.
“Without a lender of last resort, a self-fulfilled confidence crisis could easily happen as falling sales and rising default risks reinforce each other,” Macquarie argues. “Indeed, some large developers have recently seen their credit risks rising rapidly.”
Economists at Nomura add that “China’s property sector has yet to bottom out. Markets appear to have been a bit too optimistic about the property stimulus policies over the past two months.”
If there’s any good news in the short run, write economists at Citigroup, Beijing’s “continued emphasis on supporting real estate financing and local government financing vehicle (LGFV) debt resolution will continue [to help] prevent risks [from] escalating.”
Citi analysts note that “as fragile growth continues to call for an accommodative monetary environment” by the PBOC, “more supports are still needed to boost private sentiment.”
Last month, Moody’s threatened to cut China’s credit rating, highlighting concerns over the slow pace and cost of bailing out highly indebted local governments and state firms slammed by the property crisis.
The specter of an actual downgrade of the second-biggest economy only adds to the ways China will stress test Asia in the year ahead.
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