China: analysis of current developments

Influence of China and the US dollar on the Emerging Markets index

Looking at the price movements of recent weeks, it is clear that the MSCI Emerging Markets Index reached its previous annual high at the beginning of October and has since fallen sharply. While the increase in value was still around 21% on October 2, it was only around 12% most recently. This decline is partly due to the US dollar having strengthened since then (stock prices in local currency become less valuable in US dollars and MSCI calculates its index in US dollars). To some extent, the markets anticipated or reacted to Trump's election victory. A third reason for the price declines in recent weeks was a correction in Chinese equities. Several market participants and observers have expressed disappointment with the measures announced so far to support the Chinese economy and financial markets.

Debt swap in China: impact on local governments and the financial system

The most financially extensive aspect of a debt swap is the partial refinancing of existing liabilities of China's local governments (e.g. provincial governments), some of which are highly indebted. On the one hand, they receive more favorable interest rates, and on the other hand, debt that previously existed as “hidden debt” outside the official balance sheets of local governments are brought into the balance sheets.

The program is set to run for the next three to five years and is expected to total up to 10 trillion yuan (around 840 billion US dollars). To put it into context: Local governments have currently accumulated around 14 trillion yuan in off-balance-sheet debt and a further 52 trillion yuan in on-balance-sheet debt. While the measure will improve the financial leeway of local governments, it is “only” a debt swap and therefore does not involve any net capital inflows. The magnitude also shows that only a limited portion of the total debt of 66 trillion yuan is affected. The direct market impact of these measures is likely to be limited for the time being. There is also no major stress in China's financial system at present, not even for the debt of the vast majority of local governments.

Help for banks and the real estate market

Another measure planned by Beijing is to provide the six largest banks with fresh capital. It is assumed that this is intended to push the consolidation in the Chinese banking system, because it is not the large banks that are suffering from a lack of funding, but rather smaller institutions. However, there is no sign of stress or crisis in the banking system at present. In mid-October, the Chinese central bank attracted attention with two financing packages of initially around 112 billion US dollars, which are intended to enable certain institutional investors to buy shares and allow companies for share buybacks.

In order to put an end to the long-simmering real estate crisis more quickly, local governments will be allowed to buy up unsold houses and apartments in the future and make them available to Chinese citizens. The primary aim is to enable real estate companies to complete construction projects that have already begun.

Market participants and observers were mostly disappointed by the fact that, contrary to widespread expectations, there has been no new package of fiscal stimuli so far. This is all the more remarkable given that government spending is currently well below the budgeted figures. To avoid a negative fiscal impulse, central and local governments would have to at least catch up on the spending already budgeted in the coming months.

Fiscal restraint: Waiting for Trump?

Most analysts assume that Xi Jinping's leadership has deliberately held back on fiscal measures to maintain room for manoeuvre for possible countermeasures if Donald Trump comes up with new sanctions, tariffs, and other trade restrictions.

Taken together, the measures announced so far are substantial, but hardly any fresh money is flowing into China's financial system and economy. The planned programs are primarily monetary in nature and less fiscal. Nevertheless, the real estate industry could emerge from its long crisis if local governments buy up more real estate. The debt swap will at least give them a little more leeway to do so.

China's economic policy: optimism despite initial disappointment

The disappointment among many observers and in the financial markets could nevertheless be exaggerated and premature. Since Beijing is now openly prepared to intervene and take action, with the focus on stock markets and the increase of the attractiveness for the accumulation of wealth among the Chinese. This intervention could prove to be almost more serious than the measures announced thus far.

If the measures taken so far prove insufficient, further ones are likely to follow. Possibly also ones that not only affect the supply side, but also address the demand side more strongly. In this regard, China does not lack purchasing power among the population per se, but there is too much saving compared to consumption. In a way, this could be China's moment of “whatever it takes”.

Predicting the future is notoriously difficult, but there is a good chance that a bottom has now been reached in both the real economy and the stock market. Considering the very favorable valuations of many Chinese stocks, there is some reason to be optimistic about the coming years. The immediate impact of China's stimulus programs on other emerging markets is likely to be limited for the time being. This could change, however, if larger steps are taken in fiscal policy as well.