Out of money or confidence? China’s decision to pump money into stock markets is a shot in the arm but Beijing must directly address the fears of entrepreneurs and consumers to get them spend again

My take on China's recent decision to launch the monetary and fiscal "bazooka" to fire up the economy and why it took Beijing so long to pull the trigger on a bold stimulus package.

“Our money is running out”.

That is the constant refrain I have heard from family members, friends, and business contacts on the Chinese mainland over the past one year and ten months ever since the end of 2022 when China suddenly lifted the zero-Covid restrictions which had hit the economy hard.

Over 1 million restaurants including many fine dining outlets reportedly shut down across the country in the first half of this year, close to the total for the whole of last year as  consumers scaled back known as “consumption downgrading”. Retail sales, rose only 2.1 per cent in August despite the summer travel peak, down from a rise of 2.7 per cent in July.

Pessimistic sentiment among businesses is widespread. In August, industrial output grew by 4.5 per cent, slowing from 5.1 per cent in July while industrial profits suffered the biggest slump this year, plunging by 17.8 per cent following a 4.1 per cent rise in July.

Local governments across the country which rely on shrinking land sales for revenues are also cash strapped.  Anecdotal evidence and mainland media reports suggested that regulators or traffic police are given mandatory targets to raise money through administrative or arbitrary fines on businesses. Non-tax revenues nationwide surged by 12 per cent to 2.4 trillion yuan in the first seven months. All these wanton acts of killing the goose that lays the golden egg has further depressed the business sentiment.

At first glance, all those episodes have combined to paint a picture of gloom and doom in the economy with people and businesses running out of money. But it is just half the story.  

It is true that China’s consumers feel the need to do some penny-pinching because of their shrinking wealth as home prices and the stock markets have fallen respectively by an average of 30 per cent this year.  But official data have shown that household yuan deposits rose to a record 146.3 trillion yuan at the end of June. That was bigger than the market capitalization of the mainland stock market, which was 73 trillion yuan, and gross domestic product, at 126 trillion yuan.

The real issue is not a lack of money but a lack of confidence to spend the money. Both consumers and private businesses have become risk-averse because of mounting uncertainties at home and abroad including China’s ideological shift to the left, a slowing economy, job security anxiety, falling home prices and Beijing’s clashes with Washington on almost all fronts.

More importantly, people have been perplexed and dismayed by the total lack of clarity over the thinking of China’s leadership on how to move forward with the world’s second largest economy.

Ever since the end of 2022, expectations and pressure have been mounting persistently on the leadership to unleash a bold stimulus program, a fiscal and monetary “bazooka” to fire up the economy and prevent the country from sliding into the Japanese-style stagflation. In 2008, China’s leaders fired “a big bazooka” during the global financial crisis.

 The current leadership had  resisted the calls for a big bazooka despite obvious signs of an ailing economy. That was until late last month when Beijing suddenly made another major policy shift just like it did in 2022 and released a series of bold measures to restore confidence,  including cutting interest rates, lowering banks’ reserve requirements, reducing the costs of existing mortgages, and more significantly introducing two new tools to enable institutional investors and companies to invest more and buy back shares in the equity market.

The size of stimulus has caught many people by surprise and triggered an explosive rally in the mainland and Hong Kong stock markets as well as China-linked stocks in the US.

Before we understand why the sudden change of heart and its ramifications, it is interesting to explore why the leadership has dragged their feet for so long.

One chief reason is that China’s leaders are still smarting from the aftermath of the 2008 stimulus package which saw the central government pump 4 trillion yuan into the economy. Counting in the investments by the local governments, the stimulus package totaled at least a whopping 30 trillion yuan. All those money quickly revived the economy with double-digit growth rates but it has contributed to enormous industrial overcapacity, wasteful elephant projects, and energy-intensive and high-pollution industries, with which the current government is still grappling.

Moreover, President Xi Jinping might have consolidated absolute power in his own hands over the past ten years but the fact remains that local provincial party chiefs still wield considerable influences over the makeup of  local economic and investment priorities. Another monetary and fiscal loosening similar to the scale in 2008 would lead to another intense round of poor quality redundant developments. Every  province or municipality wants to have their own electrical vehicle assembly or semiconductor plants.  

As a result, the government has stuck to relatively mild easing steps to stimulate the economic growth. In June, Premier Li Qiang publicly compared China’s economy to a patient recovering from a long illness, presumably referring to the battered economy after three years of zero-Covid controls. Citing traditional Chinese medical theory, he warned that strong medicine, presumably referring to bold stimulus, would be detrimental to the patient who instead should be allowed to recover slowly.  But the strategy has failed miserably.

The leadership’s intention to fix the long-term structural problems has been overtaken by the short-term crisis of confidence permeating in the economy. The dismal economic data in August has finally convinced the authorities to resort to the bazooka to create the feel good factor ahead of the elaborate efforts to mark the 75th anniversary of the founding of People’s Republic.

What happens next?

Stock market investors have whipped up another frenzy reminiscent of the bubble in 2015. The problems which prevented the authorities from undertaking bold stimulus much earlier are still clear and present. That probably explains why this year’s stimulus package is much smaller than that in 2008. Still there are concerns over whether economic growth would rebound enough to support the spectacular stock market rally.

How to reenergize the private sector will be the litmus test, not least because the private businesses account for more than 80 per cent of new jobs and contribute to 60 per cent of China’s GDP.

But confidence among the private sector has remained dismally low ever since Beijing’s widespread crackdown and enhanced regulatory and political constraints, beginning in 2019.  Since last year, however, officials tried hard to court the private sector by calling the entrepreneurs “one of us”. But support has been more rhetorical than substantive amid frequent reports of entrepreneurs arbitrarily detained or banned from leaving the country.  

Meanwhile China’s efforts to boost domestic consumption by providing subsidies to households to upgrade their electrical appliances and automobiles are welcomed but clearly not enough.

Taking decisive steps to stabilize the property market and inject massive liquidity into the stock markets is a much-needed shot in the arm, but only for the short term.

China needs more concrete actions, including relaxing regulatory and political constraints on private firms and boosting social security benefits for the low-income groups, to make consumers and entrepreneurs feel confident enough to spend again.

Reprinted from today’s South China Morning Post.

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