The author holds the position of chief China economist and head of Asia economics at UBS Investment Research, and is also the author of ‘Making Sense of China’s Economy’
China’s economic recovery, which started off promisingly, has shown signs of weakening in the past two months. This lack of policy response has disappointed investors, leading to speculation about the government’s commitment to economic growth. However, there is now growing hope for a significant stimulus package. So, what can we expect?
It is my belief that the government does indeed care about growth and will intervene to stabilize the economy and the property market as necessary. Given the recent decline in economic momentum, the time is ripe for action.
However, the policy support is likely to be modest. It may include easing property restrictions, a restrained increase in infrastructure spending, providing funding support for property developers and local governments, and implementing targeted consumption subsidies. Those who are expecting a large-scale fiscal package similar to those of 2008 or 2015, a complete bailout of local government debt, extensive monetary expansion, or measures to reinflate the property market may find themselves disappointed.
First, China has limited fiscal maneuverability. According to the Bank for International Settlements, the total debt reached almost 300% of the gross domestic product in 2022. We estimate that government debt, including that of local government platforms, exceeds 90% of GDP, with the majority at the local level where cash flow is often insufficient to cover interest payments.
China’s high domestic savings and state-owned banking system mitigate the risk of a liquidity-driven debt crisis, theoretically allowing the central government to borrow more for a generous fiscal stimulus. However, the country faces significant fiscal challenges, including rising pension and healthcare costs associated with supporting an aging population.
Secondly, although new property starts and sales have declined excessively and need stabilization, supply and demand dynamics suggest a weaker housing market in the future. Since 2008, more than 127 million units of urban housing have been constructed. Most old city centers have been renovated, and shantytown dwellings have been replaced. Furthermore, housing ownership reached 80% in 2020. China’s population is declining, and the majority of rural labor has already migrated to work in cities. Household income growth has also weakened.
Thirdly, there is no guarantee that significant monetary expansion would be effective, given the weak confidence of both corporations and households, as well as the high debt levels in both sectors. With low demand for private sector credit, monetary expansion may end up primarily supporting local government spending, perpetuating an unsustainable growth model. The Chinese government is also concerned about the risk to financial stability and potential inflationary consequences.
Most importantly, I believe that Beijing’s policymakers understand that these economic challenges are not solely cyclical. Deep-rooted structural issues cannot be addressed with large-scale stimuli. China is undergoing a painful transition away from growth driven by property and local government. Consumers lack confidence in future pension and healthcare coverage, leading to cautious spending. Additionally, low investor confidence in the private sector is not only due to the weak economy but also concerns about an uneven playing field with state-owned enterprises (SOEs) and tighter regulation.
To exacerbate matters, Chinese companies are contending with reduced access to advanced technology and decoupling from the US and its allies. China’s exports and inbound foreign direct investment are also experiencing the impact of global supply chain adjustments.
Now, swift action is necessary to combat the sharp economic slowdown, particularly in the struggling property sector. However, instead of implementing sweeping spending measures, China should opt for a moderate stimulus package equivalent to 1 to 2% of GDP, accompanied by tangible structural policies.
These policies could include reducing entry barriers and enhancing legal protection for the private sector, increasing healthcare and social protection spending in a well-publicized manner, and deepening hukou (household registration) reforms to enhance labor mobility and boost the spending power of rural migrants. While major SOE reforms are unlikely, measures could be taken to improve efficiency and curb monopolistic practices.
While China may not meet the market’s expectations for a large fiscal stimulus, this does not necessarily have negative long-term implications for its economy. Reducing the government’s role in driving growth may lead to more pronounced economic cycles, but it can also facilitate the removal of inefficient market players, create more space for the private sector to flourish, and increase resources for social spending. Such a shift in the roles of the state and the market would be beneficial.
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