Beijing shifts to monetary loosening mode but much stronger policy medicine is needed to stabilize the tottering property market
No central bank’s 2022 has been turned upside down more abruptly than Yi Gang’s People’s Bank of China (PBOC).
That’s saying a lot given the economic shocks complicating the year for US Federal Reserve Chairman Jerome Powell amid overheating risks. Or European Central Bank President Christine Lagarde struggling with a euro at 20-year lows. Or Bank of Japan Governor Haruhiko Kuroda confronted by a stagflation challenge no one saw coming.
Yet even amidst such disorientation, the dilemma facing PBOC Governor Yi looks the most challenging of all.
Until now, Yi’s team had tried to stick with a “stimulus-lite” strategy. Over the last two years, Yi’s team led President Xi Jinping’s assault on excessive leverage in the financial system. That meant adding liquidity here and there when needed but keeping a generally tight leash on the money supply.
The go-easy approach was on display last week when the PBOC announced a surprise 10 basis point cut to benchmark rates on medium-term lending facility loans to some banks to 2.75% from 2.85%. That signaled heightened but not overwhelming official concern about a shaky property sector and fallout from Xi’s “zero Covid” lockdowns.
Yesterday, though, the PBOC trimmed lending rates again – this time cutting its five-year loan prime rate by 15 basis points to 4.30% from 4.45%. It also lowered the one-year loan prime rate by 5 basis points to 3.65%.
That move sent “a strong message that policymakers are willing to take more forceful actions to stabilize the ailing market,” says David Chao, Asia-Pacific strategist at Invesco.
But are the rate cuts too little, too late?
Odds are the PBOC will be easing more assertively in the weeks ahead as economic growth flatlines. And Xi’s government will also be forced to supersize fiscal pump-priming efforts.
Though the cuts “may provide near-term relief, easing liquidity alone is unlikely to lead to a turnaround to the property market,” Chao says, noting a “lack of confidence” across sectors.
Nor will monetary steps alone be enough to put a floor under gross domestic product (GDP). Chao argues that “central and local governments have the financial tools to provide an excess of 3 trillion yuan, or $428 billion, to boost the property sector.”
Atilla Widnell, managing director at Navigate Commodities, notes that only an all-hands-on-deck response to worsening financial conditions will do. Until now, “fresh monetary easing/stimulus was seen as futile as ‘flogging a dead horse,’ given that China’s economy desperately needs consumers back on the streets spending money.”
This view appears to be changing in Beijing’s halls of power as headwinds bear down on Asia’s biggest economy.
“Given the lingering Covid restrictions and fragile economic recovery, we expect the government to continue increasing policy support in the rest of 2022,” says economist Wang Tao at UBS. “The path of economic recovery in the second half will be bumpy and uncertain, depending on Covid and related policies, developments in the property market and the strength of external growth.”
This, of course, requires a deft balancing act – one that might put Xi at odds with economy-focused Premier Li Keqiang.
Xi’s politics vs Li’s economics
Through the end of the year, Xi’s overriding focus is on securing a precedent-breaking third term as Communist Party leader. Nothing would smooth the road to that milestone faster than getting GDP as close to this year’s 5.5% growth target as possible.
The 0.4% year-on-year pace in the March-June period shows Asia’s biggest economy won’t even get close. Headwinds include rate hikes from Washington to Seoul, Beijing’s regulatory crackdowns on tech companies and Xi’s giant lockdowns. All are hitting key economic sectors, hard.
Li, meantime, argues that Beijing’s response to slowing growth shouldn’t be to encourage the bad behavior — runaway debt accumulation — that the party spent recent years trying to curb. As such, Li wants local governments to boost debt issuance programs “reasonably” and greenlight construction projects with “sound” fundamentals in mind.
Yet with the economic pressure on and the political clock ticking down, the call is Xi’s to make. This likely means more assertive fiscal and monetary stimulus is on the way.
“We think China entered a balance sheet recession in Q2, and policy needs recalibrating to fix it,” says Craig Botham, an economist at Pantheon Economics. “The combination of the property downturn, tech crackdown and zero Covid have hit asset values.”
These risks will sound familiar to students of Japan’s post-1980s lost decades. The study of companies and nations unable to grow their way out of crushing debt was most associated with Nomura economist Richard Koo.
When business and household assets crash in value, Koo argues, an economy consumes and invests less, leading to a chronic malaise that conventional tools can’t end.
All this explains why many long-time China watchers think Xi’s party is in for a rougher-than-usual challenge.
Yale University economist Stephen Roach, for example, worries that a Chinese recession can’t be ruled out.
“China is going to have a weak rebound and so it will remain vulnerable to another shock,” says Roach, former Asia chairman at Morgan Stanley. “It could be another lockdown. It could be any one of a number of possibilities that we can’t even imagine.”
The problem, Roach explains, is that “when you have a weak recovery, you lack the cushion that would enable you to withstand subsequent shocks.” As such, he adds, China might not see a “clean snapback” anytime soon.
Economist Iris Pang at ING Bank also expects a far more assertive effort by municipalities to ramp up stimulus efforts.
“Some local governments have started to lend to property developers to continue the construction of uncompleted homes,” Pang says. “The two measures together should reduce the concern of existing home mortgage borrowers.”
And not a moment too soon, as the mainland’s property crisis is estimated to have slashed more than $1 trillion off market value over the last year.
This, says economist Alicia Garcia Herero at NATIXIS, has the PBOC “stepping up to push banks to lend to the real estate sector and tech platform economy, two sectors that Chinese regulators have been chasing since August 2020.” She adds that “this shows how bad the situation is.”
As such, economist Ding Shuang at Standard Chartered predicts another 10 basis point cut to policy interest rates by the end of October.
Property panic incoming?
Some worry the PBOC risks going overboard and creating inadvertent confidence problems. Strategist Jeffrey Snider at Atlas Financial reckons that Yi’s team is already signaling “panic” by pivoting away from its stimulus-lite crouch.
Its rate moves, he says, are effectively “admitting that the reopening bounce didn’t bounce, the economy is in much deeper trouble than they had wanted to believe.” It is clear that “June was the best rebound they would get – and it wasn’t good.”
Economist Wei He at Gavekal Dragonomics worries that the sector that drives more than 30% of Chinese GDP has fallen and nobody can figure out how to get up it back on its feet. He says that clearly there is “mounting government concern about the property market slump.”
Following the 2020 pandemic lockdowns, real estate rebounded quickly, prompting policymakers to pivot to preventing home sales and prices from overheating. “This time,” He explains, “the property sector is in a prolonged recession and shows little sign of improving substantially in the near future.”
The latest 15 basis point easing move will likely push down mortgage rates. In this current cycle, though, mortgage rates have dropped less than in previous episodes.
In the 2014-2016 episode, average borrowing costs for first-time homebuyers fell more than 200 basis points in just 18 months. This year, they have fallen closer to 100 basis points.
“The central government needs to adopt strong and credible measures to restore homebuyer confidence and stabilize the housing market,” He says. “But officials have given no indication they will intervene decisively in the near term.”
Granted, true solutions are politically challenging, says Houze Song, a fellow at the Paulson Institute think tank.
“As of now, containing the problem has been left to local governments’ own devices,” Song says. “But they are increasingly…overwhelmed as the problem grows since incomplete projects are highly concentrated in cities with weak property markets and anemic growth. This means the size of bailouts needed are disproportionately large relative to these local governments’ fiscal capabilities.”
What’s more, Song says, the intensifying mortgage crisis — which has seen unprecedented mortgage boycotts by home buyers — will prove “much more significant” than China’s default troubles represented by indebted property developer China Evergrande Group.
“The solution requires Beijing to spend considerable political capital, rather than just financial capital,” he says.
Analyst Zoey Zhou Qianyun at CreditSights says that recent rate cuts and government-guided funding support “show that authorities are managing tail risks but are unlikely to immediately turnaround the sector or materially benefit bondholders.”
Qianyun’s team finds that state-backed bailout funds and policy loans are aimed at resuming unfinished projects rather than aiding the developers in servicing their debt obligations. Bond guarantee funds, meanwhile, are targeting developers that are viewed as of higher quality rather than those most in need of liquidity.
At the same time, the size of the bailout funds and the state guarantees are “minuscule compared to the outstanding debt of the property sector,” Qianyun says.
China continues to “stand firm on the bottom line that ‘housing is for living, not speculation’ as a state policy. We expect the property sector to continue to drag on China’s growth for the rest of the year.”
That could make for a busy second half of 2022 for Yi’s PBOC. But also for Xi’s fiscal managers and local government leaders as China’s stimulus machine ramps up for a bigger-than-expected economic battle.
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