Weekly: China stimulus to the rescue?
- The stimulus package is already impressively large, amounting to over 5% of GDP
- Personal income tax cuts, infrastructure spending boost, and reserve ratio cuts are in train
- Corporate tax relief and consumer incentives for white goods purchases are next in line
- The stimulus may succeed in arresting growth slowdown for just a few quarters, in our view
Hoping for the China stimulus to work
A year and a half ago, when the global economy was on a synchronised upturn, growth momentum was so strong that periodic bad news about China’s slowdown or geopolitics was shrugged off by the markets. By contrast, just a couple of months ago, sentiment had become so poor that strong US labour market data or an easing of oil price was not sufficient to support the markets.
The pendulum has swung again in recent weeks, as the markets have been marching upward despite poor sales data worldwide, decline in earnings, and still no resolution out of trade wars or Brexit. Why such bullish sentiments? We think that not only is the market considering the US Fed to be its ally since the FOMC started making exceptionally dovish noise from December onward, expectations have soared that there will be some sort of resolution of trade wars and US government shutdown in the near term.
But perhaps most crucially, there is renewed optimism about China, with equity flows surging and the markets rebounding. This is remarkable, considering the very poor dataflow out of the world’s second largest economy. The latest trade data may have offered some solace, but that could be a one-off, and meanwhile data on sales, investment, and sentiment are very weak.
So, then what gives? we think that global markets are betting on China stimulus to save the day. The hope is understandable, given that China has accounted for 30-40% of global growth in the past decade. As the economy has become bigger, its 6% growth today provides more value added than it did when growth was 12%.
Tallying up the various measures announced over the past year, the stimulus package is already impressively large, amounting to over 5% of GDP spread over 2018/19:
• Last year, the authorities raised the slabs for income tax thresholds, widened the scope for a number of deductions (e.g. for payments related to elderly care, health, and education), and introduced some efficiency enhancing tax administration measures.
• Infrastructure spending, financed by large scale issuance of special local government bonds, is being ramped up. USD120bn worth of rail projects (both over-ground and subway) were announced recently. Related to this, a special bank financing facility for the private sector has also been announced.
• The PBOC cut banks’ required reserve ratio four times in 2018, and began 2019 with another cut. These cuts amount to releasing 3% GDP worth of liquidity to the economy.
We don’t think the authorities are done yet. There have been concerted calls for corporate tax relief in recent years, and the authorities are very likely to respond to such demand this year, in our view. Local media has already reported that small-and-medium-sized companies are likely to get a number of relief measures, including higher income threshold for VAT payment, reduced corporate income tax rate for some qualified businesses, and lower social security contribution rates for employees.
Also, incentives to purchase home appliances and cars are in the pipeline. Such subsidies have been popular in the past, and considering the weakness in the retail sector, are critical to stop further worsening of sales.
While the authorities are unlikely to relax lending standards drastically and push for yet another credit bubble, the recent spate of measures reflect their desire to prevent growth from slipping below 6%. The authorities have certainly succeeded in impressing the markets, as reflected by the bullish price movements in recent weeks.
Our expectations are somewhat modest though. Given the already-high household and corporate debt burden, likely disruption from tech war, and relatively weak domestic sentiments, the stimulus may succeed in arresting growth slowdown for just a few quarters, in our view. Policy multipliers diminish as debt burden rises, as seen in the case of Japan in recent decades. The Chinese economy could well face similar headwinds, in our view.
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