China finally fires its stimulus bazooka

Beijing has given up on piecemeal stimulus. The property slump shows no sign of ending, deflation is deepening and growth targets are slipping away. At a coordinated press conference on 24 September, the People's Bank of China cut reserve requirements by 50 basis points and lowered benchmark lending rates, along with rates on existing mortgages. It also put up RMB 800 billion of direct liquidity to prop up the stockmarket.

The line-up was part of the message. Pan Gongsheng, the central bank's governor, shared the stage with the heads of the financial regulator and the securities regulator, agencies that usually announce measures one at a time. The seven-day reverse repo rate, now the main policy rate, is to fall by 20 basis points to 1.5 per cent. Banks are to cut rates on existing mortgages, and the minimum down payment on second homes drops to 15 per cent from 25 per cent. The governor added that a further cut in reserve requirements was possible before the end of the year.

How the slump took hold

The crisis has been four years in the making. In August 2020 regulators imposed the "three red lines", caps on developers' leverage meant to deflate a debt-fuelled building boom. They worked too well. Country Garden, once the largest developer by sales, defaulted on its dollar bonds last year, and in January a Hong Kong court ordered Evergrande to be liquidated. Sales of new homes have fallen steadily since their 2021 peak, and prices of existing homes keep sliding.

Earlier attempts at relief were small and slow. Mortgage rates were trimmed in stages, buying restrictions were lifted city by city, and in May the central bank set up a relending facility to help state firms buy unsold flats. Take-up was thin. Meanwhile the economy grew by 4.7 per cent in the second quarter from a year earlier, short of the official target of around 5 per cent, and the GDP deflator, the broadest measure of prices in the economy, has been negative for more than a year.

Why the timing works

The Federal Reserve made the move easier. Its half-point cut on 18 September narrowed the gap between American and Chinese yields and eased the pressure on the yuan that had long restrained the PBoC. With the dollar softer, Beijing can loosen money without inviting heavy capital outflows. That constraint had kept earlier Chinese rate cuts small and infrequent.

Winners and losers

The banks pay first. Cutting rates on existing mortgages takes income directly from lenders whose interest margins were already at record lows, and the lower policy rate compresses them further. The big state banks will absorb this because they are told to, but a weaker banking system is less able to lend when demand finally returns. Savers lose too, since deposit rates will follow the policy rate down.

Outside China, the likeliest beneficiaries are exporters of raw materials. Iron ore and copper prices rose on the announcement, and the currencies of commodity producers such as Australia firmed with them. Those gains depend on construction in China reviving, which is the part of the economy the measures are least likely to reach.

Stocks jump, shoppers stay home

Chinese equities had their best week in sixteen years as trading desks rushed to cover short positions. Seasoned macro watchers were less excited. Monetary easing does little for a balance-sheet recession, since households that have watched their flats lose value do not borrow more because loans are cheaper. Unless Beijing follows with large fiscal transfers straight to households, the bazooka will probably misfire.

The equity money works through two channels. Of the RMB 800 billion, 500 billion is a swap facility that lets brokers, funds and insurers pledge assets in exchange for highly liquid securities they can use to raise cash, and 300 billion is relending to banks for loans that finance share buybacks by listed companies. Both are designed to put a floor under prices. Neither raises household incomes. The approach echoes the summer of 2015, when state-directed buying by the so-called national team slowed a crash in Shanghai but did little for the economy beneath it.

A lesson from Tokyo

The term balance-sheet recession was coined by the economist Richard Koo to describe Japan after its asset bubble burst at the start of the 1990s. Firms with damaged balance sheets used spare cash to pay down debt, so ever-lower interest rates failed to revive borrowing. Japan eventually found that only government spending could fill the hole left by private saving, and that the longer it waited, the more entrenched deflation became. Chinese households, most of whose wealth sits in property, are behaving in a similar way, paying off mortgages early and piling up bank deposits instead of spending.

A cheaper mortgage offers little to a family that expects its flat to be worth less next year. The cut on existing loans does put some cash back in borrowers' pockets each month, which will help at the margin. It does nothing for the renters, migrant workers and young graduates whose spending China most needs, because they hold no mortgage to refinance.

What would change the call

The optimists' case is that this is a first round. The finance ministry has room to borrow, since central government debt is modest by international standards, and this year's budget already includes RMB 1 trillion of ultra-long special bonds. If the National People's Congress standing committee approves a large extra issuance aimed at consumption, pensions or child benefits, the monetary measures would finally have something to amplify. The signals to watch are any statement from the finance ministry, monthly figures on home sales and household lending, and whether consumer prices climb away from zero.

Until then, the risk is that cheap money feeds speculation instead of spending. A rally built on short-covering and state-funded buybacks can reverse as quickly as it began, as 2015 showed. Households that buy late would then add stockmarket losses to property losses, deepening the caution the stimulus is meant to cure.

Cheap credit will keep Chinese share prices up for a few weeks at most. Consumers will stay away while house prices fall, and only money from the finance ministry is likely to change their minds.