The writer is chief China economist and head of Asia economics at UBS Investment Research, and author of ‘Making Sense of China’s Economy’
After a promising start, China’s economic recovery has waned in the past two months. Investors have been disappointed by the lack of policy responses, with some questioning whether China’s government still cares about economic growth. In the past week or so, hope has grown for a major stimulus package. What should we expect?
I believe the government does care about growth and will intervene to stabilise the economy and the property market when necessary. Given the recent sharp deterioration in economic momentum, the time is ripe for action.
However, policy support is likely to remain modest and could include easing property restrictions, a muted increase in infrastructure spending, funding support for property developers and local governments, and targeted consumption subsidies. Those expecting a large fiscal package similar to that of 2008 or even 2015, a wholesale bailout of local government debt, major monetary expansion or measures to reinflate the property market may be sorely disappointed.
First, China has less fiscal room for manoeuvre. Total debt reached almost 300 per cent of gross domestic product in 2022, according to the Bank for International Settlements. We estimate government debt including that of local government platforms exceeds 90 per cent of GDP, with most of it at the local level where cash flow is usually insufficient to cover interest payments.
China’s high domestic savings and state-owned banking system limit the risk of a liquidity-driven debt crisis, so in theory the central government could borrow more to fund a generous fiscal stimulus. However, the country faces huge fiscal challenges including rising pension and healthcare costs to support its rapidly ageing population.
Second, while new property starts and sales have fallen excessively and need to be stabilised, shifts in supply and demand suggest a weaker housing market ahead. More than 127mn units of urban housing have been built since 2008. Most old city centres have been upgraded and shantytown dwellings replaced. Meanwhile, housing ownership reached 80 per cent in 2020. China’s population is declining, and most rural labour has already moved to work in cities. Household income growth has weakened too.
Third, there is no guarantee that significant monetary expansion would work given the weak corporate and household confidence and high debt in both sectors. With low private sector credit demand, monetary expansion could end up simply supporting local government spending, perpetuating an unsustainable growth model. The Chinese government may also worry about the risk to financial stability and inflationary consequences.
Most importantly, I think Beijing’s policymakers understand these economic woes are not just cyclical. Large stimuli cannot address deep-rooted structural issues. Willingly or not, China is transitioning away from growth led by property and local government, which is a painful process. Consumers lack confidence in future pension and healthcare coverage and continue to spend cautiously. Low investor confidence in the private sector is not just due to the weak economy but also the uneven playing field with state-owned enterprises (SOEs) and concerns about tighter regulation.
To make matters worse, Chinese firms are battling reduced access to advanced technology and decoupling from the US and its allies. China’s exports and inbound foreign direct investment are also feeling the effects of global supply chain adjustments.
Swift action is now needed to combat the sharp slowdown, especially in the battered property sector. But instead of sweeping spending, China should opt for a moderate stimulus package (1 to 2 per cent of GDP), accompanied by concrete structural policies.
These could include reducing entry barriers and enhancing legal protection for the private sector; a well-publicised increase in healthcare and social protection spending; and deepening hukou (household registration) reforms to increase labour mobility and rural migrants’ spending power. While big SOE reforms are unlikely, measures could be taken to increase efficiency and curb their monopoly.
While China may disappoint a market hoping for large fiscal stimulus, this need not harm its economy in the long run. A smaller role for the government in steering growth may lead to more pronounced economic cycles, but could also help clear inefficient market players, make more space for the private sector to develop, and boost resources for social spending. Such a realignment of the roles of the state and the market would be welcome.
