China’s Stimulus Surprise: A Turning Point?

In late September, China stocks rallied when authorities surprised markets with an announcement of significant stimulus measures. As investor sentiment turned, Chinese stocks posted strong gains, with the NASDAQ Golden Dragon, MSCI China, and CSI 300 indexes rising by 25.5%, 17.2%, and 16.4%, respectively, for the week ending September 27th. Despite the spectacular rally in such a short period, does the market's reaction accurately reflect a change in fundamentals?

China's economy struggled to regain its pre-pandemic momentum after COVID restrictions were lifted in 2022, particularly due to the downturn in the country's economically significant real estate sector. Despite growing calls from global investors and economists for more aggressive stimulus measures to jumpstart the recovery, the Chinese government remained cautious. President Xi Jinping's administration was hesitant to provide direct transfers to consumers or engage in large-scale fiscal stimulus, opting instead for a more measured approach compared to the expansive policies adopted by Western governments during the pandemic.

However, following a string of disappointing economic activity data and the ineffectiveness of the gradual approach in stemming the decline of the real estate sector, the Chinese government announced significant policy easing on September 24th to address weakening economic activity and the aforementioned struggling real estate sector.

The government's key policy measures include:

• Interest rate cuts: A 20bps reduction in the seven-day reverse repo rate, a 30bps reduction in the one-year medium-term lending facility (MLF) rate, and a 20-25bps reduction in the loan prime rate (LPR) and deposit rates.
• Reserve requirement ratio (RRR) reduction: A 50bps cut, injecting approximately 1 trillion RMB into the economy. The central bank also signaled potential for further RRR reductions.
• Mortgage support: A 50bps reduction in outstanding mortgage rates and a decrease in the down payment for second homes to 15%.
• Real estate sector support: An expansion of the re-lending program for state-owned enterprises to acquire unsold property inventories.
• Equity market support: RMB 500 billion swap facility for securities, funds, and insurance firms to purchase equities, and a specialized re-lending facility for listed companies to buy back shares.

These measures exceeded market expectations and bolstered investor sentiment, as they could potentially mitigate some deflationary pressures. Nevertheless, concerns remain about the long-term efficacy of the policies.

Following the announcement of these measures the government held an off-cycle Politburo meeting chaired by President Xi Jinping to address and recalibrate its economic strategy for the second half of 2024. The meeting outlined several objectives which aim to stabilize the economy, pledging higher fiscal support, aggressive implementation of rate cuts, and reaffirming the government's 5% economic growth target.

The Ministry of Finance (MoF) held a briefing on October 12^th to announce new fiscal support policies, including additional provisions for local government debt resolution, issuance of special Central Government Bonds to recapitalize large banks, and expanded special Local Government Bond (LGB) proceeds to support housing destocking and land purchases. To alleviate local government funding stress, the MoF also announced RMB 400 billion in additional LGB issuance. While the newly announced provisions aim to deliver targeted cash support for vulnerable groups, they lack broader measures to stimulate consumer spending. However, the government may introduce new policies in its 2025 budget plan at the December Central Economic Work Conference (CEWC).

Despite the recently announced policy initiatives, the Chinese economy remains vulnerable to several long-term challenges. These include a continued downturn in the real estate sector, elevated non-financial sector debt, and demographic headwinds. Furthermore, the private sector's risk appetite has markedly declined following the government's crackdown on tech companies, which began with the cancellation of Ant Group's IPO in 2020 and has since ushered in an era of increased state control. All this comes at a time when Western nations increasingly advocate decoupling from China due to pandemic-era supply chain disruptions and escalating geopolitical tensions.

The proposed package, while smaller than China's massive GFC-era stimulus, exceeded market expectations and signaled a shift toward pro-growth policies. Continued government support and the ability of Chinese companies to deliver earnings growth could further fuel gains in the near term. However, the proposed changes do not comprehensively address support for the demand side of the economy. Additionally, investors are facing increased uncertainty surrounding the upcoming US elections. Former President Trump's proposal to impose 20% tariffs on all imports into the US and 60% tariffs specifically on Chinese imports could have particularly detrimental effects. Although the likelihood of a Trump administration implementing these proposals is low, they contribute to the overall uncertainty in equity markets during this election cycle. We explore these themes further in our 2024 Q4 Outlook as well as in a recent paper examining historical financial market dynamics during election years.