Reuters: China stares hard at its own lost decade

China has good reason to hold back on unleashing big stimulus. The central bank has made small cuts to interest rates as everything from credit growth to exports disappoint.

Cutting aggressively as global interest rates rise would put too much pressure on the yuan but policymakers in the world’s second-largest economy are evidently uncomfortable with this year’s underwhelming 5 per cent growth target. For President Xi Jinping, it’s a hard choice between short-term gains and his long-term ambition to rebalance the economy, according to  Reuters.

The central government in Beijing has room to act; its leverage is just 21 per cent of GDP as of March, per the National Institution for Finance and Development. One idea it is considering is to issue about $140 billion of special treasury bonds outside the annual budget to help crank up investment in infrastructure, according to the Wall Street Journal. It has issued these instruments only thrice in history, the last batch at the height of the pandemic in 2020. Yet flashing such a high-profile card with no glaring crisis would set an unwelcome precedent.

Even if it does issue such bonds, funds may be indirectly used to help poorer provinces repay debt. They are squeezed because land sales accounting for nearly a third of fiscal revenue continue to fall. Only a fifth of local government financing vehicles (LGFVs) which collectively owe some $9 trillion in borrowings can pay their short-term debt, Rhodium Group estimates. Defaults of these would likely be unacceptable to Beijing.

Other potential levers would require authorities to take a leap of faith, such as cash handouts to households, a measure they worry would encourage laziness; or would come at the cost of reversing Xi’s flagship policies aimed at capping debt at local governments or in the property sector, which drives a quarter of GDP. Unwinding those measures risks speculators betting on houses again and local officials building more subways and roads that generate miserable returns. Worse, China’s housing glut and population decline make past stimulus strategies harder to justify this time around.

Yet doing too little may prove costly too. After Xi’s successive crackdowns and Covid-19, Chinese faith in the economy is shaken. Price growth for new homes, already tightly regulated by the government, moderated to 0.1 per cent on an annual basis in May from a 13 per cent peak in 2016. Those who thought property was a one-way winning bet are rushing to pay down mortgages. With industrial profits plunging, companies are exhibiting similar conservatism; private-sector investment fell in the year to May from the same period last year.

The double whammy of depressed consumption and investment is raising fears of long-term stagnation similar to Japan's "lost decade" in the 1990s following a real estate crash, when annual economic growth averaged just 1 per cent. Beijing has tighter administrative controls and it can probably avoid a sudden property price correction or messy bursting of debt bubbles. Yet without action China risks slowly slipping into the same outcome.

Context news

The People's Bank of China (PBOC) cut its benchmark loan prime rates (LPR) for the first time in 10 months on June 20, with a smaller-than-expected 10-basis point reduction in the five-year rate, which influences the pricing of mortgages.

China is planning major steps to revive its flagging economy, including possibly issuing roughly one trillion yuan ($140 billion) in special treasury bonds to help indebted local governments, and introducing looser rules to encourage property investors to buy more homes, the Wall Street Journal reported on June 15, citing unnamed people familiar with the matter.

China's cabinet met on June 14 to discuss measures to spur growth in the economy, pledging to roll out policy steps in a timely way amid signs that a post-Covid recovery is fading.

The Chinese government has set a modest GDP growth target of about 5 per cent for this year after missing its 2022 goal.