But much remains to be done, and the lack of clarity is holding back markets. If policy focuses on shoring up balance sheets – such as via debt swaps – stimulus will likely fall short of turning China’s fortunes around.

Following a long period of incremental and piecemeal policy easing, Chinese policymakers suddenly shifted gears and announced a raft of new measures.

Three key changes offer hope that this policy pivot – which should be built on with further announcements – will help turn the Chinese economy around:

Indeed, while the market was somewhat disappointed by the Ministry of Housing and Urban-Rural Development (MOHURD)’s press conference, the proposed renovation scheme could provide crucial support for the construction sector, especially as new builds will be ‘strictly monitored’ and are likely to be held close to recent run rates. Given the considerable upgrading potential across China’s housing stock, MOHURD should be easily able to scale this up as more projects are identified.

What impact has policy easing had so far?

The policy pivot immediately impacted financial markets, boosting equities by around 25% since 23 September and pushing up long-dated yields by around 20bps, seemingly achieving what the PBOC’s mini ‘reverse operation twist’ had failed to do.

Several recent policy rate cuts will only be captured from next month’s Chinese Financial Conditions Index (CFCI). Still, those enacted in September – combined with the market moves and ongoing efforts to issue the remaining government debt quota – were enough to push the CFCI 0.08 pts higher to 1.03 in September (Chart 1).

An improvement in the Money & Credit sub-component was a key driver of the index’s monthly increase. M2 money supply growth surprised the upside in September, printing at 6.8% year over year against consensus expectations of 6.4%.

The drag from Money & Credit appears to have bottomed out and has begun to turn, partly due to the ramp-up in government debt issuance through the month (RMB 1.5 trillion). Robust debt issuance over the past two months may also help explain improving fixed asset investment, which totaled 3.4% year-over-year.

Has the bazooka been brought out of retirement?

Several key elements of the policy pivot remain unknown, particularly concerning the size and composition of fiscal easing. Suppose the PBOC cuts its main policy rates by roughly the same magnitude again. In that case, fiscal policy eases by around RMB 3 trillion, and the policy boosts business sentiment and broader private sector credit demand. The CFCI could be pushed higher by around one standard deviation. This would leave the CFCI higher than in 2016 but well below the level reached when stimulus was issued following the global financial crisis (GFC).

The risk is that the policy fails to follow through sufficiently. Indeed, if fiscal support for households and corporates is relatively restrained and policy largely aims to shore up local governments and banks (via debt swaps and recapitalizations, respectively), then these measures are unlikely to revive China’s fortunes. They fail to capture the potential synergies across the policy levers, which could overcome the multiple headwinds the economy faces.

Strong headwinds will be hard to overcome

It is too soon to expect any discernible improvement in Chinese activity. The latest activity data continue to illustrate the cyclical and structural headwinds that policy needs to target and more than offset.

Property indicators in continued to slide in September. Most real estate activity indicators remain deeply in negative territory on a year-over-year basis, and, while new starts and building volumes have stabilized over the past four months in levels terms, most other indicators continued to inch down on the month.

House prices, in particular, continue to fall rapidly across almost all cities (Chart 2). Since equities account for a relatively small share of wealth for most households, even the 25% jump in stock prices still leaves household net wealth lower than it was a year ago.

Of course, policy could be in the early stages of putting property onto firmer foundations. If the authorities are successful at stabilizing real estate, this would then help spur stronger household consumption. But the difficulty of countering the negative wealth effect – which is made slightly worse by cutting deposit rates – in the near-term is a reason to be cautious about the immediacy of any policy-induced rebound.

Additionally, while the policy mix should improve (i.e., aiding consumption and leaning less on investment), the nominal environment is likely to remain weak. The GDP deflator stayed in negative territory in Q3 and is likely to remain there in Q4, thereby tying the previous record for whole-economy deflation set in the late 1990s when the authorities’ reforms ‘smashed the iron rice bowl’.

CPI data at least remain above zero, but the fall in core inflation to a mere 0.1% year over year in September is concerning. Indeed, we now expect it to oscillate around zero for the next six to nine months (Chart 3).

Inflation expectations should get support from the policy switch, but there is some risk that policy is blunted by the still weak nominal environment and the support measures still heavy reliance on investment.

Policy fog may not lift any time soon

It is possible that we gain some clarity on the size and composition of China’s fiscal stimulus at the National People’s Congress meeting around the end of October. However, it is also possible that we remain in the dark for longer.

The policy machinery may be primed, but the authorities may wish to wait until the outcome of the US election before committing to a specific course of action. In the case of a Trump victory, the authorities will be motivated to ease further, but even then, they may also want to reserve some policy optionality until US trade policy is revealed in 2025.

Our latest forecast assumes the Chinese policy pivot is reasonably successful in firming growth and reducing downside risk.

Weak sequential GDP growth over Q2 and Q3 – which averaged only 2.8% annualized – implies that near-term risks are still skewed to a lower annual growth rate than our 4.8% forecast for 2024. But we judge that easing is likely to boost the level of GDP by around 0.5% over the forecast, pushing growth up to 4.6% in 2025 (+0.2 ppts). Given the potential for the authorities to ease more aggressively, we now consider risks to be broadly balanced, even accounting for the potential shock of a second trade war.

Structural headwinds and the policy mix are, however, still likely to contribute to a far from stellar nominal environment. It remains to be seen not just how big fiscal transfers to households will be but whether China’s growth model is really moving away from an investment- and export-dominated approach.

¹ Japanification refers to the stagnation that Japan’s economy has faced over the past three decades and is typically applied in reference to the concern among economists that other developed countries will follow along the same path.

Important information

Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

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