Monitoring China's Economic Policy Shift

Our Chief China Economist Robin Xing and Chief China Equity Strategist Laura Wang discuss how markets have responded to rate cuts and commitments to government spending, and what they could mean over the long term.

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Laura Wang: Welcome to Thoughts on the Market. I'm Laura Wang, Morgan Stanley's Chief China Equity Strategist. 

Robin Xing: And I'm Robin Xing, Morgan Stanley's Chief China Economist.

Laura Wang: All eyes have been on China this past week, and today we'll discuss why recent news from China's policymakers have commanded the attention of global markets.

It's Thursday, October the 3rd, at 4pm in Hong Kong.

So, Robin, China has been wrestling with the triple macro challenge of debt deflation and demographics -- what we call the three Ds -- for some time now. Last week, China's central bank, PBOC, announced a stimulus package that exceeded market expectations. And then later in the week, top China Communist Party officials, known as the Politburo, focused their monthly meeting on economics, which is not their usual practice.

This meeting was a positive surprise to both us and the market. Let's start with the PBOCs easing package. For listeners who haven't been following China's economy closely, what's our current view on China's economy and can you walk us through the policy measures that the central bank introduced?

Robin Xing: China's economy has been struggling lately and that's pushed the Beijing to pivot approach. Over the last 18 months, they have tried smaller, reactive measures. But now, they are doing something much bigger. On September 24, the People's Bank of China, PBOC, made a bold move, cutting interest rates and introducing new tools to support the stock market.

Now, these cuts might sound small, just 20 basis points, but they are pretty rare in China. They also cut the reserve requirement ratio, which is a fancy way of saying banks can lend more money by 50 basis points. And for the first time, the central bank gave forward guidance, signaling even more cuts could come by year end.

On top of that, the PBOC launched two big programs, a 500 billion yuan fund to help investors buy stocks, and a 300 billion yuan program to help companies buy back their own shares. These moves gave a much-needed boost to both the markets and consumer confidence.

Laura Wang: And how about the Politburo meeting that came on the heels of the PBOC announcement? What exactly did it focus on?

Robin Xing: The Politburo meeting was a rather critical moment. Normally, they don't even talk about the economy in September. But this year was different. It really signaled how urgent things have become.

They made it clear they are ready to spend more. The government is pledging to increase public spending because other parts of the economy, like corporates and consumers, are holding back. There is also a big focus on the housing market, which has been in decline since 2021. They are promising to stop that slide, and it's the strongest commitment we have seen so far.

Laura Wang: So, given everything we've seen from the PBOC and the Politburo, do you think this is a ‘whatever it takes moment’ to address the macro challenges facing China's economy?

Robin Xing: Not quite, but it's close. We are seeing the start of what's going to be a bumpy recovery. The deflation problem, where prices are falling and people are not spending, is complicated.

Beijing seems open to trying different approaches, but fixing the deeper issues -- like the struggling housing market and the local government debt -- it’s going to take a lot. In fact, we think China might need to spend about 1-1.5 trillion dollars over the next two years to really turn things around.

Right now, the measures they have announced are smaller than that. That's because these are new policies. And they still need to build consensus and work out the details. So, while this isn't a ‘whatever it takes moment’ yet the mindset has definitely shifted in that direction.

Laura Wang: In this case, what are the next steps you are monitoring for China's policymaker and how long will the various measures take to implement?

Robin Xing: We expect to see a supplementary budget of 1-2 trillion yuan announced at the upcoming NPC Standing Committee meeting in late October. This budget should focus on boosting consumer spending, increasing social welfare, and helping local governments managing their debt. We will likely see more monetary easing too.

As well as tweaks to the Housing Inventory Buy Back program. These steps should help the economy grow slightly faster, possibly hitting a 5 per cent quarter on quarter growth over the next two quarters, compared to the 3 per cent we have seen recently.

Looking ahead, we will get more clues at the December Central Economic Work Conference. That's when we might see the first signs of plans to use central government funds to tackle housing and local government debt issues. The full details could come in March 2025. If things don't improve quickly, and especially if social unrest starts to rise, Beijing may have to act even more aggressively.

We are keeping an eye on our social dynamics indicator, which tracks how people feel about jobs, welfare and income. If that dips further, it could push the government to ramp up stimulus measures.

Laura, turning it over to you. How are stock markets reacting to all this policy signaling from China?

Laura Wang: I would say to say that the market has responded very enthusiastically is an understatement. I'll give you some numbers.

On the first day of the PBOC announcement, the Shanghai Composite Index, as well as the Hong Kong Market Hang Seng Index, were both up by more than 4 per cent in one single day. Then with the further boost from the surprise Politburo meeting -- by now, both the Shanghai Composite Index and the Hang Seng Index have already been up by more than 21 per cent in just one week's time.

Robin Xing: Within the China stock market, which sectors and industries do you think will most benefit from the shift in policy?

Laura Wang: There are a few ways to position to benefit from this major market condition change. We have a list of companies that we believe will directly benefit from the PBOC market stabilization funding, given the funding's low cost compared to these companies implied re-rating opportunity, just by tapping into the funding and enhancing their shareholder returns.

For the potential reflationary fiscal efforts suggested by the Politburo meeting, as more details come out, I think sectors with good exposure to reflation, particularly the private consumption, will benefit the most -- given their still relatively low valuation, large market cap and high liquidity.

Robin Xing: Finally, Laura, what are your expectations for the markets in China and outside of China for the next few weeks and months?

Laura Wang: Clearly this rally so far is reflecting significant sentiment improvement and capitals that are willing to take a leap of faith and preposition for physical reflationary efforts ramp up. If the government can deliver these measures in a timely fashion, and more importantly, on top of that, communicate their commitment to winning this uphill battle against deflation, I think further valuation re-rating is quite possible for both the Asia market and the Hong Kong market by another 10 to 20 per cent.

To go beyond that level, we need to see clear signs of a corporate earnings growth reacceleration, which would require incrementally more easing to come along in the next few months. We should also monitor the housing market inventory level very closely because any earlier completion of this inventory digestion could suggest less drag on demand investment.

Obviously, there are still a lot of moving parts and it's still a very much evolving story from here. Robin, thanks for taking the time to talk.

Robin Xing: Great speaking with you, Laura.

Laura Wang: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.