Big, but not enough: China's stimulus package may not be effective

The government of China has finally admitted that there are structural problems holding back the world’s second-largest economy. The process of “rebalancing” economic activity away from being investment-led to being consumption-led has been underway for a while. But there are significant issues, particularly the state of China’s oversized real estate market and the linked issue of local-government indebtedness, which must be addressed as well. The country’s top decision-making group, the Politburo, ended its recent meeting with a call to meet growth targets and a promise to support the beleaguered property sector, saying it would not fall any further. This is due to be backed up by greater spending from Beijing. The exact size of this stimulus is unclear. But reports examining plans for new borrowing suggest it could be about a quarter of a trillion dollars or so. This is not a small amount by any standards. But compared to the size of the hole China is in, it may not be sufficient. Most large financial institutions have revaluated their forecasts for Chinese growth this year to below the central government’s target of “about 5 per cent”.

Vehicles financing local governments in China are a major driver of both urbanisation and the bond markets. Because the state has control of land, unlike India, the usual driver for property development and infrastructure building is the capture of that land value by local governments and their enterprises or special purpose vehicles. The amount of debt that these have taken on is estimated at $12-13 trillion at the moment. This has vast systemic implications. About a fifth of formal bank lending is to such vehicles, and they are almost half the corporate bond market. Ensuring that local governments can manage this debt is therefore of paramount importance. To that end, the People’s Bank of China cut interest rates from 1.7 per cent to 1.5 per cent on Friday, alongside lowering the applicable reserve ratio. The central bank also pledged to support the purchase by financial institutions of struggling real estate companies’ land banks. The monetary loosening had an immediate impact on the markets. Chinese stocks did remarkably well on Monday, posting their best single-day numbers in 16 years. The benchmark index went up 8.5 per cent before close.

China’s policymakers continue to address the symptoms and not the disease. The only way to cure the economy’s overdependence on high-investment real estate is by speeding up the process of rebalancing towards household demand, and ensuring that household income is a larger proportion of gross domestic product. Raising wages, opening up the domestic consumer market to foreign goods, and enhancing the social welfare net are the usual recommendations of economists. Freeing up internal movement so that prosperity can be spread to rural households and those in smaller towns is also important. Meanwhile, some local governments must of course take a haircut on their unprofitable investment. But all these actions require political adjustment and seem to be a step too far for the Chinese Communist Party. China’s economy will certainly chug on with a little more dynamism following this stimulus package. But its basic problems will not be addressed until Beijing is willing to spend more political capital on fundamental reform.