Why global investors made the wrong bet on a big Chinese stimulus

China’s economic policymakers may have missed a major opportunity to capitalise on the frenetic response of sharemarket investors to the big monetary policy stimulus package its central bank unveiled a fortnight ago.

That barrage of measures – interest rates cuts and the equivalent of more than $100 billion of cheap funding for non-bank institutions to buy shares among them – set the mainland and Hong Kong sharemarkets alight, with the CSI 300 index of China’s largest companies soaring nearly 40 per cent.

The scale of the policy actions announced by the People’s Bank of China also created an expectation that those monetary measures would be followed up by something equally substantial in terms of fiscal policy.

China’s sharemarkets and commodity prices soared over the past fortnight in response to the major monetary policy stimulus package. Credit: Bloomberg

Speculation of a major fiscal stimulus package reached fever levels when the National Development and reform Commission (NDRC), China’s economic planning agency, announced it would hold a briefing this week.

Analysts from the major foreign investment banks were predicting the announcement of 2 trillion to 3 trillion yuan ($420 to $630 billion) of new spending, and some inside China thought it might be as much as 10 trillion yuan.

The NDRC held its briefing on Tuesday and it was a damp squib.

There was no announcement of significant new spending, only the bringing forward of about 200 billion yuan ($42 billion) of bond issues from next year to fund spending and investment, which is hardly enough to move the dial in a 126 trillion yuan economy.

The mainland and Hong Kong markets opened at 9.30am on Tuesday, a half hour before the briefing started. At the opening stocks soared, again, with the CSI 300 up 11 per cent. After it became clear there was no announcement of a big stimulus program the market fell back almost 6 per cent.

The Hong Kong market was down almost 10 per cent on the day.

Iron ore prices, always a good barometer of the perceived outlook for China’s economy, had also surged to five-month highs after the PBOC’s announcement. They, too, fell back as the disappointment flowing from the NDRC briefing spread.

The expectations may have been misplaced. The NDRC is a planning agency, not an implementation agency. It is the Ministry of Finance that could be expected to unveil any major new stimulus measures, and it remains possible that it could do so either later this month, or at least before the end of the year.

For Xi, “common prosperity” means less conspicuous income and wealth inequality.

While the NDRC did express confidence that China would meet its growth target of “around 5 per cent” for this year, the World Bank (also on Tuesday) maintained its projection of 4.8 per cent growth in GDP this year. It expects growth of only 4.3 per cent next year. There are a lot of private sector economists with similar expectations of slowing growth.

The policymakers in Beijing could capitalise on the excitement and paper wealth that the PBOC’s package has generated – the CSI 300 is up almost a third since that announcement, albeit still 27 per cent off its record level achieved in early 2021 – if they followed up with significant fiscal stimulus.

The PBOC not only ignited the sharemarket but, in the major cities, at least, there was a significant surge in high-end property market activity and spending during the “Golden Week” holiday to celebrate China’s national day that ended Monday was also up significantly on last year’s (although still lower than 2019’s pre-pandemic levels).

While it is China’s still-shrinking property sector that is the most significant contributor to its households’ risk-aversion, until a fortnight ago, the equally dreadful performance of China’s sharemarkets was also a major factor. The property and sharemarkets have been major repositories of households’ wealth.

The PBOC’s actions are the first by the Beijing policymakers that have had a materially positive effect in the three years since China Evergrande defaulted on its debts and triggered the continuing implosion of the property market.

Chinese President Xi Jinping is displayed on a screen during the evening gala evening on October 1 in 2019 held on Tiananmen Square for the 70th anniversary of the founding of the People's Republic of China.Credit: nna\ebennett

Until that monetary policy stimulus was unveiled Beijing’s measures had largely been cautious, small-scale, piecemeal and largely ineffective.

Xi Jinping and the rest of China’s leadership have been reluctant to embark on large-scale stimulus to rekindle household consumption because Xi believes such measures are wasteful and reward the lazy.

There are also memories of the last big stimulus package, in response to the 2008 financial crisis, which generated a property construction and investment and infrastructure investment boom, and the massive over-investment and excess inventory of housing and under-utilised and over-capitalised infrastructure that created the foundations of its economic challenges today.

Xi’s preferences lie towards “new quality productive forces”, or the big subsidies and non-financial assistance China has provided to its advanced manufacturing sectors such as electric vehicles, semiconductors, aviation, solar and biotechnology as part of its rolling five-year economic plans.

He wants China to export, rather than consume, its way to more robust growth while developing an independent capacity within China to produce and dominate the technologies central to economic and geopolitical leadership over the next several decades.

It is that strategy that has resulted in significant excess capacity across China’s economy, leading to increased industrial output and volumes of exports but slumping prices and profitability. It has also generated a growing protectionist backlash from China’s major trading partners.

The other side effect of centrally driven economic plans that favour large state-owned or directed firms is that it sidelines to some extent China’s entrepreneurial private sector companies, which represent about 40 per cent of Chinese business enterprises but have historically driven about 60 per cent of economic growth.

Xi’s crackdowns on the property, technology and financial service sectors have made those companies defensive and, like Chinese consumers, risk-averse. For Xi, “common prosperity” means less conspicuous income and wealth inequality.

One can understand why the leader of a communist party might have those convictions, but they, and the fear generated by his anti-corruption and national security drives, aren’t conducive to private sector confidence, risk-taking and investment.

Beijing needs to restructure its local governments’ finances, which are over-laden with debt, and restrict the ability of that tier of government to boost the education, health and social welfare spending that might provide some stimulus.

It also needs to recapitalise China’s weaker banks, deal more directly with the massive over-hang of unsold and uncompleted property and become more serious about measures to encourage its households to start tapping into their record levels of savings.

If it can address some of the more obvious threats to growth and stability, it might also be able to extricate itself from what might otherwise be a continuing deflationary spiral into, with a shrinking population, economic stagnation.

It needs a big fiscal stimulus package to capitalise on the big bounce in the sharemarket and generate some confidence among its battered consumers that the future looks brighter than the recent past.

The Business Briefing newsletter delivers major stories, exclusive coverage and expert opinion. Sign up to get it every weekday morning.