China Announces Stimulus Package, We Predict Gradual Approach and Urgent Need for Reforms

China's New Stimulus Package: Gradual Approach Amid Calls for Structural Economic Reforms

China has announced a new economic stimulus package aimed at addressing its growing economic challenges, including declining market confidence, a property sector slump, and rising local government debt. However, while the stimulus indicates the government’s intention to bolster the economy, the lack of specific details has left analysts uncertain about the true scale of the intervention. The announcement aligns with China’s historical approach of gradual policy implementation, while also reinforcing the urgent need for structural economic reforms to ensure long-term stability.

Stimulus Announcement: Scale and Uncertainty

China’s Finance Minister Lan Fo’an announced that there is "fairly large" room for increased spending to stimulate the economy, yet no precise figures were provided. Market estimates for the scale of potential fiscal policies range from 4 to 5 trillion yuan, but some analysts predict that up to 10 trillion yuan ($1.4 trillion) may be necessary over the next two years to effectively stabilize the economy.

Despite the scope of these estimates, the absence of a clear funding amount has led to market uncertainty. Some speculate that the package could be smaller than expected, with the government potentially holding back on a large-scale stimulus to maintain flexibility in response to future global economic challenges, including potential shifts in U.S. monetary policy.

Key Policy Measures: Debt Management and Market Stabilization

The new stimulus includes a series of targeted policies aimed at addressing both local government debt and instability in the property market:

• Increased Local Government Debt Quotas: To alleviate the pressure on local governments, the package proposes increasing debt quotas and offering one-off quotas to swap “hidden debt” for explicit, government-backed debt.
• Support for State-Owned Banks: Special treasury bonds will be issued to reinforce the core tier-1 capital of large state-owned banks, ensuring financial stability.
• Real Estate Market Support: To stabilize the struggling real estate market, local government special bonds and other financial measures will be used, including converting unsold homes into affordable housing.
• Targeted Social Support: The package also includes financial support for key population groups, such as students and low-income earners, to boost consumption and shore up domestic demand.

These targeted measures reflect China’s cautious approach to fiscal stimulus, emphasizing specific sectors of the economy, particularly local government debt and real estate, where the need for intervention is most acute.

Economic Context and Market Reaction: A Fragile Recovery

China’s economic outlook has been clouded by multiple challenges, including a prolonged slowdown in the property sector, falling household confidence, and market volatility. Recent government crackdowns on industries such as technology and education have further undermined investor confidence. Although stocks initially surged on the announcement of the stimulus, markets quickly tumbled due to the lack of detailed information, with both mainland China and Hong Kong stock indexes ending the week negatively.

One of the most pressing issues addressed by the stimulus package is local government debt, which has reached alarming levels. Estimates suggest off-the-books debt could range from $7 trillion to $11 trillion, with around $800 billion considered high-risk. The government’s plan to increase debt quotas and swap hidden debt represents the strongest effort in recent years to resolve this mounting financial burden. By easing local government debt pressures, the stimulus package aims to free up resources for broader economic development.

Historical Context: Lessons from Past Stimulus Efforts

China’s current strategy is informed by lessons learned from past efforts to manage local government debt. From 2015 to 2018, China conducted a large-scale debt swap, converting 12.2 trillion yuan in hidden local government debt into government bonds. In 2023, an additional 2.2 trillion yuan in bond quotas was arranged to continue addressing local debt. By the end of 2023, China had reduced its hidden debt balance by 50% compared to 2018 levels, and for 2024, a further 1.2 trillion yuan in debt quotas has already been approved.

This historical context highlights the government's ongoing efforts to manage local debt while keeping fiscal policies in check. The gradual debt resolution approach taken in recent years is expected to continue, balancing the need for economic stimulus with long-term fiscal discipline.

Legal Procedures and Timeline for Approval

Any new debt quotas will require approval from the Standing Committee of the National People’s Congress (NPC). The NPC is expected to discuss these issues during its 12th meeting, scheduled for October or November. This timeline suggests that while the stimulus measures have been announced, they may not fully take effect until late 2024, leaving the markets in a state of anticipation.

Economic Impact Predictions: Boosting Growth Amid Fiscal Constraints

While the lack of specifics has led to mixed reactions, some experts predict that the overall scale of the incremental fiscal policies could exceed 4 trillion yuan. Key components of the stimulus include:

• Q4 Local Government Refinancing Bonds: Expected to range between 2 and 3 trillion yuan.
• Special Treasury Bonds: These are likely to exceed the original 1 trillion yuan allocation.
• Real Estate Market Support: An estimated 200 billion yuan will be directed toward supporting the struggling real estate market.

These measures are projected to boost fourth-quarter GDP growth to over 5.0%, helping China meet its annual growth target.

Expert Opinions: Mixed Reactions and Calls for Structural Reforms

Economists have responded with a range of views on the stimulus announcement. While some see this as a significant shift in China’s economic strategy, others have expressed disappointment over the lack of detailed information. Analysts predict that the country’s fiscal deficit will likely rise above 3% of GDP next year, marking a departure from China’s previous fiscal conservatism. The additional issuance of government bonds is expected to help finance the stimulus.

However, many experts argue that short-term stimulus alone will not be enough. Structural economic reforms are necessary to ensure long-term stability. These include reforms to state-owned enterprises, constitutional amendments to provide stronger guarantees for private businesses, and efforts to address wealth inequality through fiscal policy changes, such as property taxes.

Gradual, Trial-and-Error Approach: A Strategic Decision

A more gradual, trial-and-error approach to economic stimulus is increasingly likely in China, given the country's current economic challenges and historical policy preferences. This strategy aligns well with China's traditional "crossing the river by feeling the stones" approach to economic management, allowing for careful assessment and adjustment of policies as they are implemented.

The Chinese government may opt for this incremental method for several reasons. Firstly, it reduces the risk of overstimulation and asset bubbles, particularly in the volatile real estate sector. With major developers like Evergrande and Country Garden facing financial distress, a large, one-time stimulus could potentially exacerbate existing problems in the housing market. A gradual approach allows policymakers to fine-tune their interventions, stabilizing the market without reigniting speculative frenzy.

Furthermore, this strategy provides greater flexibility in responding to changing economic conditions, both domestically and internationally. China faces numerous uncertainties, including global economic slowdowns, trade tensions, and internal structural shifts as it transitions from investment-led growth to a more consumption-driven model. By implementing stimulus measures in phases, the government can adapt more dynamically to evolving challenges, scaling up or down as needed.

A gradual stimulus approach may also be more politically feasible. Large-scale stimulus measures typically require approval from the National People's Congress, especially if they involve increasing the fiscal deficit or issuing special treasury bonds. Smaller, incremental packages can often be justified within the regular budget cycle, avoiding the need for sweeping changes to the fiscal landscape. This approach also allows the government to maintain the perception of careful, responsible economic management, learning from the long-term debt accumulation and imbalances that resulted from the massive stimulus during the 2008 global financial crisis.

Moreover, a trial-and-error model enables more targeted support and fine-tuning of policies. The government can focus on specific sectors or regions based on real-time needs, adjusting the level of support over time. This precision allows for more efficient use of resources and ensures that stimulus reaches the areas of the economy that need it most.

However, this gradual approach is not without challenges. It may lead to a slower economic recovery compared to a large, one-time stimulus. There's also a risk that markets and the public might perceive this strategy as hesitation or indecisiveness, potentially affecting investor confidence. The government would need to manage expectations carefully, clearly communicating the rationale behind this incremental approach.

In conclusion, while a gradual, trial-and-error stimulus presents some challenges, it appears to be a prudent and feasible strategy for China in the current economic environment. This approach allows for greater flexibility, better risk management, and more targeted support, aligning well with China's preference for incremental reform. By carefully implementing and monitoring smaller stimulus measures over time, the Chinese government can work towards economic recovery while minimizing the risks of financial instability and unsustainable debt accumulation.

Structural Economic Reforms: A Call for Long-Term Stability

The current economic situation in China calls for a nuanced approach that combines targeted stimulus measures with deeper structural reforms. While there is a need for economic support, the focus should be on quantitative, concrete measures rather than broad qualitative statements. The effectiveness of previous policy emphases, such as income redistribution, has been limited, highlighting the necessity for more decisive action to address underlying economic issues.

A key challenge lies in stimulating internal demand. Despite extensive discussions on this topic, the most effective solution remains clear: increasing the purchasing power of lower-income groups through direct financial support. This approach, while potentially controversial, is seen as necessary to boost consumption and drive economic growth.

Encouraging private and foreign investment requires rebuilding trust and confidence. This is particularly crucial given the current global economic landscape, where China faces increasing challenges. The potential for increased trade protectionism in Europe, the possibility of a Trump presidency in the U.S., and the impact of the Russia-Ukraine conflict on China-Russia trade all contribute to a more complex and challenging external environment.

While stimulus measures are necessary, they must be accompanied by fundamental reforms to be truly effective. Without addressing core economic issues, even substantial stimulus packages risk being ineffective or potentially causing localized inflation. The current economic system needs to be streamlined to ensure that any boost to the stock market translates into real benefits for the broader economy, rather than leading to capital outflows or stagnation.

There's a notable disconnect between central government rhetoric and local implementation. For instance, while the central government emphasizes support for the private sector, local actions such as passport confiscations and retrospective investigations of private entrepreneurs undermine confidence. Similarly, initiatives to encourage population growth are hampered by concentrated educational resources and ineffective educational reforms.

Recent economic data presents a mixed picture. While China's GDP growth in 2023 and the first half of 2024 shows some positive signs, the gap with the U.S. economy has widened. The yuan's depreciation has impacted dollar-denominated GDP figures, masking some of the underlying growth. However, the combination of rising CPI and falling PPI is concerning, potentially signaling early stages of stagflation.

To address these challenges, several structural reforms are proposed:

Constitutional amendments to provide stronger guarantees for private enterprises, coupled with reforms to state-owned enterprises to enhance economic efficiency.

Fiscal reforms, including strengthened property tax collection to address wealth inequality and boost effective demand.

Increased subsidies for technological products on the consumption side, using market-oriented policies to optimize resource allocation.

Streamlining government processes and encouraging self-governance in various sectors to reduce social management costs.

These reforms, alongside carefully calibrated stimulus measures, are seen as essential for addressing China's economic challenges and positioning the country for sustainable growth in an increasingly complex global environment.

Conclusion: Balancing Stimulus with Long-Term Reform

China’s latest stimulus package reflects a delicate balance between short-term economic support and the need for long-term fiscal responsibility. While targeted measures are necessary to address immediate challenges, such as local government debt and a weak property market, deeper structural reforms are critical to ensure sustained economic growth.

As China moves forward, its gradual, trial-and-error approach to economic stimulus allows for flexibility and precision, but without addressing core structural issues, even substantial fiscal interventions may fall short. The success of China’s economic policies will depend on how effectively the government can combine immediate stimulus with long-term reforms to secure a stable and prosperous future.