China - Bar For Large Consumption-Focused Fiscal Stimulus Remains High (2024)

Chinese policymakers have thus far largely relied on targeted, limited and incremental policies to support economic rebalancing away from real estate sector focussed growth, and it would require a significant worsening of the growth outlook, greater deflation and an increasing risk of a debt-deflation spiral for the authorities to opt for a large, largely consumption-focused fiscal stimulus. In an attempt to tackle macroeconomic imbalances (overinvestment in the real estate sector) and reduce related financial vulnerabilities (over-indebted real estate developers and impact on banks’ balance sheets), the Chinese authorities in 2022 introduced measures to rebalance the economic away from real estate sector investment with the goal of redirecting investment toward other, higher-productivity economic sectors. The rebalancing process, which is not yet complete, led to weakening real estate prices and led to, or at least coincided, with softening domestic consumption and declining economic confidence. Economic growth has decelerated from 6-7% during the years leading up to the COVID-19 pandemic in 2020 to around 5% in 2023-24. The deceleration in economic growth can also in part be attributed to a structural decline in productivity growth, less favorable demographics, increasing government intervention in the economy and increasing regulatory uncertainty and, more recently, geopolitical tensions and declining foreign direct investment inflows. Nonetheless, China did exceed its five-percent growth target in 2023 and is set to meet its 2024 target of “around 5%”, even if the final full-year print comes in slightly below 5%. Concerns about the growth outlook in the context of seeming deflationary pressure have increased over the course of 2024. In response, the authorities have taken a gradual, incremental and largely targeted approach to support rebalancing through selective measures targeting the housing market and limited macroeconomic stimulus. Policymakers have also remained committed to promoting so-called “new productive forces” aimed at supporting productivity growth, largely through manufacturing-focused industrial policies and government-supported investment, rather than through a large-scale macroeconomic, including consumption-focused fiscal measures.

> China’s economy grew 5.2% in 2023 and 5% during the first half of 2024. Chinese policymakers seem to view the measures they have taken thus far as sufficient to meet the 2024 growth target. They have also stated to be willing to take a more “proactive” fiscal stance in 2025 depending on economic developments.
Fiscal support for the real estate sector has been targeted to affordable housing and completing pre-sold, yet uncompleted housing projects. The government also issued a special bond worth RMB 1 trillion to finance projects and help support investment as well as help local governments finance real estate purchases to clear the market. 

> Despite some very limited measures encouraging consumption, additional spending has been focused on investment rather than consumption. Most recently, the government announced its intention to bring forward the issuance of RMB 200 bn worth of bond issuance from 2025 (or less than $ 30 billion), which amounts to less than 0.2% of GDP and may not even constitute additional spending if it ends up being subtracted from next year’s spending. Fiscal measures directly targeting consumption rather than investment, housing-related objectives or support for financially distressed local governments have been quite limited. In general, fiscal and quasi-fiscal policy remains strongly focused on technology investment and manufacturing development in the context of the Made in China 2025 strategy. Policymakers view public investment rather than private consumption as the key driver of economic growth.

 
> The PBoC has provided some macroeconomic support, most recently on September 24 in the guise of simultaneous and larger than usual reserve requirement and policy rate cuts, but the central bank has been careful not to ease up too much for fear of weakening the RMB in the context of the large China-US interest rate differential and possible out of concern for banking sector profitability in the context of increased real-estate-sector-related credit risk. The PBoc also lowered the mortgage rate to support the housing market and it has introduced policy tools to support the equity market. None of these measures are game-changers and fail to address more directly the immediate problem of limited domestic demand, especially household consumption. The relative efficacy of an easier monetary policy and supportive credit policy will be much more limited than fiscal measures targeting public or household consumption. 

> The PBoC has repeatedly intervened in the foreign-exchange market, not just through its daily fixing but also in offshore markets to prevent RMB weakness. The limited monetary stimulus is reflected in the fact that real interest rates remain high and financial conditions are tight. The PBoC has also provided support through so-called structural credit policy measures targeting the housing market. Overall, macroeconomic support through monetary policy has been modest.

While economic growth has held up so far, deflation has persisted and the outlook for economic growth may be weakening, which has led the government to announce a fiscal stimulus” flanked by other supporting measures in late September. Since then, the government has failed to offer a detailed plan as to the kind and size of fiscal stimulus. There is likely a lively debate taking place in the Chinese government over the size and type of fiscal stimulus that is required. But the September 24 announcement strongly suggests that policymakers’ worries about the outlook for economic growth and continued deflation is increasing. A sufficiently strong fiscal stimulus would help reduce the risk of deflation, stimulate the economy and revive consumer confidence, and thus help put a floor under economic growth while economic rebalancing is proceeding and while deflation continues to points to continued spare capacity, itself partly a consequence of strong manufacturing investment, but also of weaker commodity prices and relatively subdued domestic consumption. A permanent drift into deflation raises the risk of an adverse feedback loop between falling prices, including asset and property prices, and an emerging debt overhang, raising fears of a Japan-style economic deflation and depression. But policymakers likely remain fairly strongly wedded to investment-focused industrial policies and remain somewhat reluctant to increase government spending to support “unproductive”, non-productivity-enhancing consumption, consumption not being investment. A large fiscal stimulus is likely seen as costly in the context of high general (augmented) government debt, which limits the appetite for a large-scale, consumption-oriented fiscal stimulus among parts of the government. The bar for a large, consumption-oriented stimulus remains high, but not(?) insurmountably so.

> The IMF has highlighted the risk of significant property market downturn, deflation and negative feedback loop of high debt level and deflation, making debt less sustainable. A combination of falling prices, declining consumer confidence and lower economic growth risk denting the economic outlook. However, price decline in major urban centers has been relatively limited, so it is far from clear that marginally weaker home prices are the major factor explaining less rapidly growing consumption. Deflation has also been affected by lower good and commodity prices. In line with the authorities commitment to “new productive forces”, public sector investment has increased, while private investment has been relatively stagnant, although it has increased in manufacturing while declining in the real estate sector. 

> Total non-financial debt exceeds 300% of GDP, which is very high even though it is underpinned by a very high national savings ratio. Corporate debt exceeds 130% of GDP. While general government debt amounts to a seemingly manageable 60% of GDP, augmented debt (incl. LGFVs) is approaching 130% of GDP. Meanwhile, the augmented fiscal deficit remains very high in the context of sharply lower nominal GDP growth, which leads to a continuous increase in government debt, absent major fiscal reform. This is likely one reason why parts of the government are reluctant to support large fiscal stimulus, particularly if it does not look necessarily urgent given that China has been able to meet its growth targets.

China will remain wedded to an incremental approach to supporting growth rather than opt for a major fiscal stimulus, unless the economic growth were at risk of slowing down significantly and deflation risks accelerating further. For a start, an incremental approach is more likely because the economic outlook, unlike in 2008-09, will deteriorate gradually rather than suddenly. However, if full-year growth projections were to fall below 4% in the near term and deflation to reach 1% on a year-on-year basis for more than a quarter, the cost-benefit calculus would change in favor of a larger fiscal stimulus, including one with a significant consumption-oriented component.This is our best guidance in an increasingly opaque policy environment. We define a large fiscal stimulus as additional full-year fiscal spending measures, at least half of which needs to target household consumption, exceeding 5% of GDP. Such a scenario would not prevent policymakers from continuing to introduce targeted measures aimed at stabilizing real estate prices, as well as provide further monetary stimulus, particularly in the context of declining U.S. interest rates, thus creating more supportive domestic financial conditions. 

> The IMF projects real GDP growth of 5%, 4.5% and 4.1% in 2024-26. Officialunemployment remains low at just over 5%. The IMF also projects real GDP growth to slow from currently 5% to 3.3% by 2029 due to slowing productivity growth and adverse demographics as well as increasing international economic fragmentation. 

> China’s producer price index has been in negative territory for almost two years, pointing to both weak demand and continued significant (over) investment. The last time China’s consumer price inflation was negative on a year-on-year basis was in January. More recently, it has been helped by higher food prices. The last time core consumer price inflation was negative was in January 2021 at the beginning of COVID-19, but in August core inflation fell to 0.3%, or less than half than a year earlier. 

> The 2008-09 fiscal and quasi-fiscal (credit policy driven) stimulus in response to the global financial crisis was predominantly focused on investment, such as public infrastructure investment, rural development and industrial upgrading and reconstruction (in the wake of the Sichuan earthquake) and a relatively small share going towards social spending. It exceeded 10% of China’s 2009 GDP. It raised concerns about mal-investment, financial write-downs and unbalanced economic growth, which continues to shape policymakers’ attitudes towards another large-scale stimulus in a context where such a measure does not necessarily appear necessary. 

>Private-sector economists put the total stimulus required to reflate the economy at Rmb5-10tn (Macquarie, HSBC). Morgan Stanley estimates puts the number at Rmb10tn over 24 months to reflate and return to stable growth. This is roughly equivalent to 7-8% of GDP annually and would lead to a massive widening of the fiscal deficit.

If a large consumption-oriented fiscal were stimulus were implemented, it would help reduce the risk of a debt-deflation spiral and might help put China on a path toward more sustainable economic growth. However, longer-lasting sustainability would require structural fiscal reform (e.g. health, pension and social expenditure) to support domestic consumption rather than a one-off, potentially time-limited fiscal stimulus. A successful stimulus would not necessarily raise China’s medium-term economic growth substantially. This would require wide-ranging structural economic reform, including reducing the role of the government in the economy, reducing regulatory uncertainty and providing for a more market-directed allocation of savings and investment. China’s focus on national security and increased government involvement and the more prominent role played by SOEs compared to more efficient private companies, the economy will continue to weigh on the medium- to long-term growth outlook. Stronger consumption-driven economic growth would help reduce China’s trade surpluses and provide a demand stimulus to the global economy and especially countries relying on exports to China. But a smaller Chinese trade surplus would only marginally reduce trade tensions with the US, the EU and RoW. As long as China continues to rely on industrial policy, including public investment in strategic industries, the outlook for international trade tension would improve and will be limited. If China manages to move toward a more consumption-oriented economic model, the risk of a broader systemic crisis or broader economic stagnation would diminish. But this world requires broader structural economic and fiscal reform that provides sufficient incentives to households to reduce their savings rate.