Navigating China’s Economic Challenges: Will Stimulus Policies Work?
Navigating the complexities of China’s economic landscape has never been more critical. As the central bank implements bold stimulus measures to address significant challenges, we must examine the potential impacts on banks, markets, and the everyday lives of citizens. Are these policies the solution to bolster growth, or do they risk creating further instability? Join the conversation as we explore the implications of these changes and what they mean for the future of the Chinese economy.
What are the Recent Stimulus measures being Taken by the Central Bank?
China’s central bank is just now starting to take action against the ever slowing Chinese economy. The most recent actions are incredibly (and alarmingly) abrupt, and are summarised below.
- 20 bps cut to the reverse repo rate, down to 1.5%.
- 50 bps reduction to the reserve requirement ratio (RRR).
- ~50 bps reduction to mortgage rates.
- Reducing minimum downpayment for 2nd home buys to 15%.
- Financial institutions Central Bank borrowing pledges.
- Relending tool to fund share buybacks.
What does this all Mean for the Chinese Economy?
It is clear that China has some shortcomings economically, where it seemed the success and lucrative image of China was all smoke and mirrors. These hard and fast fiscal changes could be seen as evidence to the fact. However, in the next section I am simply going to state what the ‘textbook’ intended outcomes are meant to be. Once we’ve had an unbiased look, then we can worry about my professional opinion.
The Banks
Firstly, banks can ‘park’ money at the reserve bank with their reverse repurchase agreements (repos), where they buy central bank securities that will be bought back by the central bank at an agreed higher price. The higher the rate, the more money the central bank pays the banks for their securities back. This is designed to keep banks money within the central bank, to reduce liquidity.
To stimulate the economy, China reduced the rate to encourage banks to lend more money, as it is more profitable for the banks to do so. Then, decreasing the reserve requirement means that banks can now lend out more money despite not increasing the amount of money they have set aside as reserve, used incase of unprecedented liquidity requirements. With knowledge of the current amount in reserves, this can have an increased lending (if all banks lend as much as possible) of 1 Trillion RMB (approx. 200 Billion AUD).
The Market
Allowing financial institutions to borrow liquidity from the central bank by using asset pledges (collateral) to stimulate the stock market should boost investors’ confidence in Chinese equities. The share buybacks will reduce the amount of shares of a business in the market, increasing the EPS that the businesses possess.
The People
Following this is the 50bps reduction in mortgage lending rates. This will greatly reduce the cost of housing for Chinese citizens, along with the decrease in mortgage requirement for 2nd home buyers allowing for people to move into the 80 million empty units China over-built.
All these actions pump incredible amounts of liquidity into the markets, stimulate buying and investor sentiment, and provide the economy a chance to recover some of its recent losses.
Are China's Economic Policies A Recipe for disaster?
The economic policies were necessary for China to implement. China’s economy has overstretched so far, and whether this stimulus will stretch it further, or solidify their economic position, is hard to tell. However, I can’t help but feel that these newest changes are artificial.
If we quickly look at each section one last time, you notice that in The Banks, that no bank is required to own more cash, and simply will be granted higher lending amounts, at lower rates, increasing their leverage enormously, artificially improving ROE despite drastically increasing risk.
In The Market, the central bank simply asks banks to list collateral to borrow for the purchase of buying shares back to increase the EPS of the financial institutions and liquidate the stock markets. This is simply another way of increasing leverage further, but instead of keeping prudent requirements to ensure this borrowing is backed, these financial institutions are listing highly illiquid assets as collateral, which if the institution does go bankrupt and gives to assets to the central bank, they will simply be bought by other over leveraged investing institutions.
In The People, the reduction of the second home buying requirements is a smart way to get people to buy their (horribly built) mass apartment complexes that are simply unfilled and unused.
As we all know by now, the world economy is starting to feel like a recession is possible. Any first year finance student could tell you that now is not the time to allow firms to take higher leveraged positions. Yes, China’s hand is slightly forced from the central bank’s point of view; they couldn’t do nothing. I understand their ‘go big or go home’ mentality with the new policies, but at this point, can we call China a sinking ship? The Chinese economy and the Yuan is starting to feel like a game of jenga, nothing new is created, just recycled.
The information in this article is prepared by Isotta Prime Pty Ltd (ACN 664 008 824). It is general in nature as it has been prepared without taking account of your objectives, financial situation or needs.
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