The Chinese economy has experienced a lot of volatility in 2023. Initial hopes were high for China after authorities announced the abandonment of pandemic controls and restrictions in late 2022 and equities and credit did indeed react very positively, with the economy performing well in the first quarter of 2023. Relatively quickly, however, the recovery began losing steam and the second quarter delivered a pale 0.8% quarter on quarter growth figure.
Foreigners seem to have taken a more cautious approach after how authorities dealt with the largely self-induced property developers’ crisis. Foreign direct investment (FDI) is falling at close to 10% year-one year. Part of this is likely to be down to western companies slowing their investments due to geopolitical concerns, part might be just due to a poor economic outlook, and part may be due to western companies repatriating earnings given rates in China seem to be in a “lower for longer” environment, the exact opposite of what is taking place in the west.
Domestically, things are not looking much better. The ongoing property crisis is denting the confidence of consumers and companies. Housing is a large portion of consumers’ wealth given Chinese people face restrictions when investing abroad. Not only have house prices declined but there are also doubts about the ability of developers to deliver properties that have been partly prepaid. This is certainly not a great environment for buying property and for spending generally speaking, which is reflected in record increases in household deposits.
Authorities have been reactive. Monetary policy has been relaxed, which, although welcome, is unlikely to help much. There is more consensus about the necessity for fiscal stimulus to provide a much-needed backstop to the property sector issues in order to allow for a return of consumer, business (and maybe foreigner) confidence. After a number of timid headlines since the property crisis started, the measures announced in the second half of the year seem to have a higher probability of actually having an impact. Some are yet to be confirmed but include incentivising banks to fund developers’ needs, which would include unsecured short-term loans for working capital (as opposed to secured loans on land or property in construction) and financial support for urban village renovation and social housing construction.
In addition, there have been measures announced for dealing with local government financing vehicles (LGFV) outsized debts. The authorisation for local governments to issue special refinancing bonds will allow the refinancing of at least some of their LGFV debts. This is an important development as it shows that the assumed implicit guarantees in those debts actually work. Consequently, there has been a rally in spreads in the sector.
What is interesting to us is that global markets seem to have largely ignored these problems and their potential/partial solutions. Market drivers in the west continue to be Federal Reserve, European Central Bank and Bank of England policies and the impact those have on G7 government bond curves. However, China is likely to contribute close to a third of 2024’s global growth based on Bloomberg consensus forecasts. In a year where the US and Europe will likely grow well below potential, it becomes imperative that Chinese authorities actually sort their problems out, or at least stop the bleeding. A negative surprise in Beijing might mean global growth winds up being significantly lower than forecast with no one coming to the rescue. While we are not forecasting such a scenario, we do think stakes are high and we do forecast that western investors might pay a lot more attention to developments in Chinese property and LGFV next year.
The challenges in achieving this have been highlighted in Moody’s recent actions. Earlier this month, they put China’s A1 sovereign rating on negative outlook citing “rising evidence that financial support will be provided by the government and wider public sector to financially stressed regional and local governments and state-owned enterprises”. They also mention structurally lower growth and property sector issues. In an economy where many of the banks and large firms are government-owned it follows that a deterioration in the sovereign credit quality will have a direct impact in those companies' funding prospects.
This highlights the difficulty in providing the needed fiscal stimulus and reassuring investors that LGFV do have some sort of guarantee from local governments or the central government. In a way, the change in outlook is because the government is dealing with the problems and preventing them from escalating, and indeed, overnight, China’s politburo emphasised that fiscal policy would be used to boost domestic demand. It is a fine a balance indeed.