In a recent Q&A, we looked at how China fits within the emerging markets context, what’s ahead for China, and targeted strategies to help investors gain exposure to this developing market. The excerpt below focuses on China’s current stimulus plan and its impact.
How are China’s current stimulus efforts different from previous measures?
In the past, Chinese policymakers have employed a variety of stimulus measures that were often relatively large and consequential to maintain a high level of economic growth. A consequence of these measures has been high debt levels, as evidenced by various ratios such as total debt-to-gross domestic product (GDP) and private debt service coverage. Although not necessarily an immediate cause of concern, we believe this high level of debt could lead to problems down the road if interest rates go up.
Policymakers have introduced measures to address excess leverage, with a particular focus on the financing provided by the “shadow banking” sector, which generally refers to financial intermediaries that facilitate the creation of credit across the financial system but whose members are not subject to regulatory oversight. Unlike state-owned enterprises (SOEs), private companies have long relied on the shadow banking sector for financing, as banks have been more reluctant to lend to these higher-risk companies. Removing this financing channel has resulted in a credit crunch in the private sector, resulting in a higher cost of financing since the deleveraging drive began. We believe, given the importance of the private sector in China’s transition to a consumer-led economy, this lack of credit could have significant repercussions on growth. Meanwhile, SOEs, which themselves generally exhibit high debt levels, have continued to access credit through the banking sector at funding costs that have remained steady.
Deleveraging Has Raised Borrowing Costs for Non-SOEs
Source: VanEck, Bloomberg LP
China Lending: New Loans Up, Shadow Financing Down
Certain stimulus measures that were once effective no longer appear to be having the same impact. This too may be a reflection of the evolving structure of the Chinese economy, from one led by investment and large SOEs to one driven by consumption and the growing importance of a more dynamic private sector. For example, financial conditions have not eased despite multiple cuts to banks' required reserve ratio (RRR). Credit supply to the private sector has not increased, and funding costs have remained elevated.
China's Policy Moves are not Having the Same Impact as in the Past
The good news is that authorities appear to be aware of the issues that these imbalances have created and are addressing the most pressing issues through a variety of mechanisms. Unlike previous stimulus efforts, policymakers appear to be using a “drip” method rather than a “big bazooka.” They have taken a multi-layered approach and appear to be willing to experiment with different initiatives. Recently, they announced bank lending targets and increased limits for loans to small companies, and a medium-term lending facility that links the provision of funding for banks to their supply of loans to small and medium enterprises. They have also introduced a central bank bill swap that is meant to improve the liquidity of banks’ perpetual bonds and support additional issuance in order to replenish capital, with the aim of spurring lending to private companies.
In addition, the structure of recent stimulus measures has been different, particularly on the fiscal side. In the past, fiscal stimulus relied primarily on additional government spending. Recent measures center around tax cuts. This is a more orthodox approach, which may provide longer-lasting impact and recognizes the growing role of consumption and services in China’s economy today.
If China is successful in stimulating growth, what could be the impact on broader emerging markets and global growth?
Recent stimulus efforts appear to be having an impact on Chinese economic activity, with rebounds in manufacturing investment and new orders in recent months. Growth forecast revisions are no longer declining. In our view, this stabilization and rebound in economic activity has significant repercussions for global growth. Given China’s contribution to global growth, it may likely be the main driver in a global cyclical recovery.
China Has Been a Major Contributor to Global Growth
Source: VanEck; Bloomberg.
*Although not shown, China accounted for 100% of Global Real GDP in 2009.
On the other hand, the direct impact on other emerging markets is less clear, particularly given the changing nature of China’s economy. For example, a consumer-led economic model driven by services may not have the same impact on commodity prices, which tend to be a driver of many emerging markets’ economies. If China’s current account surplus continues to shrink, its role as lender to the world may likely change as it competes with other emerging markets for a share of global capital. This dynamic will only become more pronounced as China’s onshore markets continue to open up to foreigners.
Please note that Van Eck Associates Corporation serves as investment advisor to investment products that invest in the asset class(es) included in this commentary.
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