China Unveils Stimulus to Boost Economy

Spotlight: China

Over the past year, sentiment towards Chinese equities has shifted significantly. At the beginning of 2023, there was renewed optimism for an economic rebound following the end of China’s strict zero-COVID policies. However, this optimism quickly faded as the recovery proved more sluggish than expected. Since the start of 2024, structural challenges such as a weak property sector and high local government debt have persisted, weighing on investor sentiment. This month, the People’s Bank of China (PBoC) announced funding with the aim of boosting the stock market and supporting the struggling property sector. The authorities’ hands are tied to a certain extent by the US central bank (the Fed) – this stimulus they have announced quickly followed the Fed’s decision to cut rates by 50bps. Though we have seen Chinese markets rally this week, the long-term effectiveness of these measures remains uncertain. So far, the government’s measures have been largely monetary to date, which may help in the short-term but this support in isolation is likely to be ineffective in addressing the deeper economic challenges. To drive domestic demand further, China may need to rely on fiscal measures like increased government spending and tax adjustments.
 
So why have Chinese authorities not done more to stimulate the economy? The answer appears twofold: lack of willingness, and lack of ability. In terms of willingness, the government are cautious about increasing economic stimulus to avoid worsening the country’s debt problems by prompting credit growth. Also, the President (Xi Jinping) seems less concerned about stimulating demand and is more focused on different goals such as achieving industrial self-sufficiency in key sectors such as technology. The centralisation of power within the government and anti-corruption efforts may have led to risk aversion among local officials, who are incentivised to control risks (e.g. political or financial stability risk) and less incentivised to take risk to stimulate growth.
 
If we turn our focus to China’s long-term economic growth prospects, there are several structural issues which pose significant challenge:

•  Aging Population: China's rapidly aging population is shrinking the workforce, putting pressure on social services, and reducing productivity

• Youth Unemployment: High unemployment among 16-24 year olds.

• Debt Levels: Rising debt, especially in the property sector and among local governments, threatens financial stability.

• Property Sector: The struggling property market, burdened by overbuilding and falling prices, impacts overall economic growth.

• Lack of Growth Drivers: Transitioning from an export-driven economy, China faces challenges boosting domestic demand and innovation.

• Geopolitical Tensions: US-China trade and tech disputes, along with reliance on global supply chains, pose economic risks.

There are wide-reaching impacts of the Chinese economy slowing down. One interesting example is the luxury goods market in Europe is linked to China’s “common prosperity” drive (a political slogan and stated goal to bolster social and economic equity), which raises questions about the sustainability of benefits for European luxury companies. Historically, these companies have profited from China’s rising middle class. However, with the shifting economic environment and Chinese consumers discussing “consumption downgrading” rather than “upgrading,” the long-term sustainability of the benefit to brands like Louis Vuitton and Chanel comes into question and may be less impactful than it has been in the past.
 
It is clear that China’s current investment outlook presents a mix of opportunities and challenges. In terms of opportunities, Chinese equities are trading at attractive valuations, both historically and relative to developed markets, which may present a compelling entry point into the Chinese market despite the existing uncertainties. Despite these opportunities, investors can continue to expect uncertainty with investments in China, partly due to political and geopolitical risks, as well as a decline in confidence in the Chinese central bank’s ability to significantly improve economic outcomes. It appears further evidence is needed to support a sustainable long-term allocation.
 

Past Performance is not a reliable indicator of future returns. Source: MSCI, Morningstar.

According to the Chinese zodiac cycle, 2024 is the year of the dragon. In Chinese culture, the Dragon is revered as a symbol of good fortune and exceptional prowess, representing power, luck, and success. Time will tell if the Chinese economy lives up to these qualities over the remainder of the year.

The Noise

• The number of Americans filing new unemployment claims fell to a four-month low last week, showing that the labour market is still fairly healthy. Claims dropped by 4,000 last week to 218,000, lower than economist expectations of 225,000. The positive news was supported by other data this week that showed corporate profits increased at a stronger pace than initially calculated in the second quarter of 2024. The economy’s resilience may make it harder for the Federal Reserve to deliver another 50-basis-points interest rate cut in November, with investor expectations finely balanced between a 25 and 50-basis-points cut.

• The Organisation for Economic Co-operation and Development (OECD) has released its latest economic forecasts, upgrading UK growth forecasts for the next two years by more than any other Group of Seven nation. This comes despite lingering concerns around underlying inflation pressures in Britain, with the Bank of England likely to face the toughest job among the G-7 to keep inflation at its 2% target. The OECD mentioned that the UK had shown much stronger than forecast growth in the first half of 2024, though emphasised that the UK needs to create fiscal space to facilitate more investment. Chancellor of the Exchequer Rachel Reeves is said to be updating her fiscal framework to allow for more investment, however at the expense of tax increases.

• Colombia is preparing to unveil a $40 billion investment plan targeted at replacing fossil-fuel export revenues that are expected to fall following the country’s decision to end new oil and gas exploration two years ago. Environment minister Susana Muhamed said the money will go towards investing in nature-based climate solutions, clean energy, and electrification of transport. Projects that improve agriculture practices and protect biodiversity will also see investment as Colombia look to develop sectors that could replace the lost oil export revenue.

The Numbers

The Nuance

China’s central bank unveiled its biggest stimulus since the pandemic, with the ultimate goal of pulling the economy out of its deflationary funk and back towards the government’s growth target. The broader-than-expected package offering more funding and interest rate cuts marks the latest attempt from policymakers to restore confidence in the world’s second largest economy. Over the past 12 months we’ve seen weak data raise concerns of a prolonged structural slowdown in the Chinese economy.

The Chinese central bank will cut the amount of cash that banks must hold as reserve by 50 basis points. This is expected to free up about 1 trillion yuan (£106 billion) for new lending. There are concerns however that this stimulus will prove ineffective, given extremely weak credit demand from businesses and consumers at present. Calls have been made for further policies aimed at supporting real economic activity, which may come before China’s week-long holidays starting on October 1st.

Markets seemed to like the Chinese stimulus, with large-cap Chinese stocks experiencing their largest weekly rise since 2008. China-exposed assets have also performed well this week, with European mining and Luxury good companies seeing their share prices rise. Commodities are another benefiter, with metals broadly rising 2%. Though this latest stimulus looks strong in the short-term, more will need to be done to fully restore the Chinese economy.