Sure A Not

About the only thing falling faster than China’s economic prospects is the yuan.

China’s sliding currency is but the latest indicator pointing toward a year that could be the hardest yet 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, cutting the one-year loan prime rate by 10 basis points from 3.65% to 3.55% and the five-year loan prime rate by 10 basis points from 4.3% to 4.2%. Investors’ attention is now on how quickly and aggressively Xi’s government might act to pump additional stimulus into Asia’s biggest economy.

The PBOC moves reveal “growing concerns among policymakers about the health of China’s recovery,” says Julian Evans-Pritchard at Capital Economics.

Even those betting China could well exceed this year’s 5% economic growth target are lowering their forecasts. Case in point: Goldman Sachs cut its forecast to 5.4% from 6%, citing already elevated debt levels and Xi’s determination to limit property speculation. 

Xi’s team now faces questions on two key fronts. One is whether Beijing’s slow stimulus rollout so far puts it behind the curve. Two, whether officials risk incentivizing bad behavior that Xi’s team spent the last few years trying to discourage.

“It’s clear China’s policymakers have shifted back to supporting growth after the recovery disappointed, but less clear if they can do so without worsening old problems,” says economist Xiaoxi Zhang at Gavekal Research.

So far, Zhang argues, China’s “pivot to more dovish policy was less well telegraphed” than investors would prefer. “Though expectations for a shift had been building over the last two weeks after early indicators for May continued the disappointment of April,” Zhang says.

The latest full set of monthly data “confirmed that a sharp reversal in the property sector and a decline in exports had opened up a hole in aggregate demand,” Zhang notes.

“By cutting its short-term policy rate in response, the People’s Bank of China sent a powerful signal, as it moves interest rates only rarely. Still, there is a strong consensus domestically that more direct support for demand is necessary through fiscal policy,” Zhang says.

On June 16, at a State Council meeting, Xi’s leadership team discussed a package of measures, but has kept the details close to the vest.

There, the council, led by Premier Li Qiang said that “in response to the changes in the economic situation, more forceful measures must be taken to enhance the momentum of development, optimize the economic structure and promote the continuous recovery of the economy.”

As Zhang sees it, “more spending on infrastructure would be the easiest and quickest way to stimulate growth, although this would disappoint advocates of structural reform.”

No reform is more important than addressing a growing crisis in China’s property sector. Since data show 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 top goal for Xi’s third term. If Xi is serious about mobilizing savings, then revitalizing property, which can account for as much as 30% of gross domestic product (GDP), requires urgent attention. This means ending boom-bust cycles in the longer run.

The fragile state of the property sector is warping the underlying mechanics of China’s economy, warns US policy research firm Rhodium Group. Its analysts found that, thanks to cratering property values, more than 100 Chinese cities had difficulty servicing debts last year.

This alone risks deadening the impact of any fiscal stimulus that either the PBOC or Xi’s team might unleash in the months ahead.

In a recent report, Rhodium looked at trends in 205 mainland cities and financial data of nearly 2,900 local government financing vehicles (LGFVs). These schemes raise money to drive giant infrastructure projects aimed at boosting local GDP.

In a report last month, S&P Global Ratings warned that “China property is set for another year of softening.” Even as conditions are coming “close to normal” in some richer, upper-tier cities, S&P argues that “weaknesses in China’s tier three and four cities will keep the property recovery on an ‘L-shaped’ path. Conditions will hit the developers with heavy exposure to lower-tier cities the hardest.”

S&P notes that “we view this as the latest stage of a crisis that resulted in US$52 billion in offshore bond defaults last year, with about one in four developers brushing against insolvency. The downturn in lower-tier markets will hit a large section of the industry.”

Bottom line, S&P says, is this “strained environment will require a hard look at entities’ liquidity, especially declarations of unrestricted cash, and cash-generating capabilities. About 40% of rated developers could experience rating pressure if sales in tier-three/tier four cities fell 20% this year.”

In November, Xi’s team began telegraphing a series of measures – 16 in total – to promote the “stable and healthy development” of the sector.

Key among them was credit support for highly indebted property developers, looser purchasing rules on first homes by new city dwellers, assistance for deferred-payment loans for homebuyers and financial support to ensure completion and handover of projects to homeowners.

The plan “is much more comprehensive, ranging from addressing the liquidity crisis faced by developers to a temporary easing of a signature restriction on bank lending, from equally treating private and state-owned housing developers to re-initiating the financial funding channels for them,” notes economist Jinyue Dong at BBVA Research. “It marks all-round efforts to bail out the real estate market to secure a ‘soft landing’ after recent data showed some mild improvement.”

But it’s imperative that Beijing remembers that “sentiment matters,” Dong says. The 16-point plan, which aims “to avoid a real estate hard-landing, is still lagged behind the stimulus measures back to 2015 while the easing of zero-Covid policy is still slower-than-expected.”

“That means, without the deluge of massive stimulus on real estate to help rebuild the housing price increasing confidence, whether and how long the ongoing housing stimulus could bring the housing market out of quagmire is still questionable. 2023 might witness some mild recovery, but the long-term robust recovery needs more stamina ahead,” Dong says.

Economist Zongyuan Zoe Liu at 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 restrictions and demographic shifts, has unsettled both real estate developers and home buyers.”

That’s why the PBOC over the last year “has taken a series of policy actions aimed at lowering mortgage interest rates in a bid to spur buyer demand and shore up home prices,” Liu notes. It’s taken the form of Chinese banks being allowed to offer adjustable-rate mortgages subject to a nationwide minimum interest rate floor.

Under normal circumstances, Liu explains, the mortgage interest rate floor is equal to the loan prime rate, or LPR, for first-time homebuyers and LPR plus 60 basis points for all other borrowers.

Beginning in May 2022, the PBOC “broke this convention by lowering the nationwide floor on new mortgages to 20 basis points below LPR for first-time buyers,” she says. Later in September, the PBOC announced it was “relaxing” the nationwide interest rate floor in some cities where housing prices had been trending down for the previous three months.

Yet more than fresh stimulus, China needs comprehensive property market reforms that alter incentives and make investments more stable and productive. This responsibility falls to newish Premier Li, who took China’s No 2 job in March.

His balancing act: loosening fiscal policy to stabilize growth without fueling new bubbles in unproductive borrowing and leveraging.

“China has plenty of room to boost stimulus if it so chooses,” says Michael Hirson, China economist at 22V Research LLC. “The key obstacles are concern over financial risks and the reluctance so far to leverage the central government’s balance sheet to expand fiscal stimulus.”

Ting Lu, Nomura’s chief China economist, says it’s reasonable to expect “more easing and stimulus measures.” Lu stresses that “amid a deteriorating property sector, its potentially devastating impact on government finance and the rising risk of a double-dip, we do not expect Beijing to sit idle.”

One priority needs to be working faster to get toxic and potentially sour assets off property developers’ balance sheets.

In recent years, Beijing has indeed created a network of funds that borrow some features from the Resolution Trust Company mechanism the US used to clean up the savings and loan crisis of the 1980s. Japan did the same in the 1990s to end the 1980s bad-loan crisis.

Li’s charge will be to intensify efforts to ensure that financial institutions are limited in their ability to create fresh “moral hazards” that increase reliance on public bailouts in the longer run.

For now, even the International Monetary Fund thinks China has room to ramp up its stimulus-industrial complex.

“China has the policy space to keep monetary policy accommodative because inflation is very much muted,” says Krishna Srinivasan, the IMF’s director for Asia Pacific. “It also has the fiscal space to provide support.”

Yet the important thing, says Citigroup economist Xiangrong Yu, is a stimulus burst “centered on the property sector, with expansionary monetary and fiscal policies to keep up growth momentum.”

Yu adds that “we think the overall policy tone for this sector could transfer from stabilizing to cautious stimulating. More efforts would be needed to stop a downward spiral.”

Follow William Pesek on Twitter at @WilliamPesek

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