China: an evaluation of policy attempts to spur growth

China: an evaluation of policy attempts to spur growth
Dave Jubb from Invesco’s Henley Multi Asset team assesses China’s use of monetary and fiscal policy to spur growth and whether it is enough to reverse the trend.

The most recent slowdown in the Chinese economy has been in the spotlight for much of the past year. While much of the conversation has focused on relief from trade wars with the US, a resolution in trade alone is unlikely to correct Chinese economic growth. 

As the world’s second largest economy and an epicentre for global trade, China’s growth has wide implications for the global economy. China accounted for nearly a third of global growth in 2018 and, if Chinese exports and consumption fall, the ripple effects will put downward pressure on economies across the globe. 

Since the Global Financial Crisis (GFC), China has primarily relied on credit, both bank and non-bank lending, to stimulate growth. Non-bank lending, of which a large component is known as “shadow banking”, allows regulated institutions to issue unregulated assets with little oversight, while bank lending typically requires lenders to have stricter risk tolerances, approval processes and payment policies. 

As shown in Figures 1 and 2, 2009 saw China engage in a massive credit boom, which helped to stimulate GDP growth. During this time, Total Social Financing, defined as bank and non-bank lending, rose to above 100% of GDP as China flooded the market with stimulus. The sustained rise has been met with growing concerns over credit quality in recent quarters, prompting the Chinese government to reassess measures it can take to spur growth. This can be seen most clearly in Figure 1, where non-bank lending is falling while the issuance of bank loans continues to rise. 

Figure 1
Source: Macrobond as at 16 April 2019
Figure 2
Source: Macrobond as at 16 April 2019

China’s most recent efforts to ease policy, which started in mid-2018, were subdued. The People’s Bank of China (PBOC) ensured a more targeted approach would be taken relative to the debt and infrastructure binge they used in 2009. This held true through the end of the year, as China ramped up efforts via government bond sales and indicated there may be tax cuts to follow.  In 2019, Chinese policies have continued to loosen. The PBOC cut banks’ reserve requirements for the fifth time in a year and a plan to provide roughly 2 trillion yuan (227bn GBP) in tax cuts was announced. 

This marks a notable shift, as the use of fiscal policy is a big step for an economy that has been heavily reliant on monetary policy over the past decade. This new fiscal approach intends to soften the blow from the loss of stimulus from non-bank lending, however, it remains to be seen if this approach will be enough to reverse the rate of economic slowdown.  

In recent weeks, there has been a new wave of optimism surrounding China, as several indicators such as the Purchasing Managers’ Index (PMI) and M1 (total amount of currency in circulation and held in bank’s checking accounts) posted turnarounds. While this is a step in the right direction, it is still too early to tell if Chinese economic growth is turning a corner, and the renewed confidence brought on from positive surprises in economic data may be overdone.

Additionally, it is important to dissect Chinese data as it is released. Having a large informal economy requires China to rely on estimates and surveys for much of its data. This in turn requires analysing and corroborating data to avoid relying on indicators that may not tell the whole story. 

The underlying trend of slowing growth has not yet changed. China has ruled out a “flood” of stimulus as used in the past, but it remains to be seen if their latest effort, using a more targeted approach, will be enough to truly rebound their economy. One major issue remains; the success of accommodative policy is dependent on Chinese companies and consumers electing to use it. If companies and consumers lack confidence in the economic recovery, will there be any demand to use the cheap bank lending being offered?