China’s mystery stimulus package

3rd September 2012

Speculation abounded that the Chinese government was primed to undertake an 8 trillion Yuan (£800 billion) spending spree to boost confidence in the country's cooling economy. To put that in perspective it is double the size of the package passed by the Communist Party in the wake of the collapse of Lehman Brothers in 2008.

Despite the news the Shanghai composite index continued to slide, falling 6.91% so far this year, suggesting investors were sceptical. James Weir, Asia Investment specialist at Guinness Asset Management, says the announcements should be viewed as part of the build-up to the leadership handover  at the 18th national party congress in October.

"It looks to me like local bureaucrats are recycling old news to boost confidence but I don't think anything is going to happen until the new leadership is in place. What we're seeing with these announcements is local politicians jockeying for position."

Known unknowns

As it stands it is unclear how the trillions of Yuan proposed by local authorities in Guangdong, Chongqing, Tianjin and Guizhou will be funded. This lack of information is perhaps a key reason why investors have remained unwilling to commit their capital on the back of the announcements.

The Financial Times was quick to pick holes in the figures. As Jamil Anderlini, a reporter for the paper based in Beijing, wrote: "Provincial and regional governments hoping to boost growth in their regions are facing diminished financial resources and already very high levels of debt left over from the last round of stimulus launched in 2008".

It is unsurprising that with changes looming party officials would want to flaunt their credentials and ambition in the hope of promotion. Much of the supposed stimulus, however, was not only unfunded but repeats of already released policy.

However, though it may have been a publicity stunt, the stimulus rumours further highlight the reality of slowing Chinese growth. This means that while the current proposals lack credibility some form of fiscal package this year is not wholly unlikely.

Slowing growth, not contraction

In discussions about China it is all too easy to conflate a reduction in the rate of growth with economic contraction. While 7.6% growth over the second quarter was the country's slowest rate of growth in three years, it is still an impressive figure considering the backdrop of the eurozone sovereign crisis and a sluggish American recovery.

Yet it is a worry for those who predicted that China could maintain high single-digit growth rates over the longer term. The difficulties faced by many of so-called developed countries are undoubtedly impacting demand for Chinese exports – indeed the PMI index for August hit a 9-month low – but perhaps a slower rate of growth can provide the incentive for the government to shift focus to industries higher up the value chain.

"You can certainly see a demand shortfall in the export figures," says Weir, "and the majority of that has come from Europe. We are of the view that Chinese growth needs to slow but the problem has been how the realisation of that will affect equity prices. We have already seen widespread downgrades of earnings."

The structural shifts required for China to maintain a decent pace of growth over the long term will require a degree of pain in the adjustment. Perhaps this cooling-off period offers the new administration the chance to invest in industries that can safeguard the country's future and help to foster innovation by funnelling government money into non-traditional areas.

Not only would this accomplish an improvement in the current economic climate but a forward thinking programme could also boost confidence in the government's commitment to look out beyond the export-led boom. Weir strikes a note of caution here:

"It would make sense to funnel some money towards high-tech industries but the problem is that they've not been very successful at this in the past. Large investments in the semiconductor and LED industries have struggled to prove their worth."

Perhaps policymakers will shy away from taking bold decisions after October. After all, the Communist Party will be loath to squander its hard-earned credibility among the international partners for economic management.

There is little doubt that the market now expects some form of fiscal stimulus, perhaps supported by looser monetary policy, but the government will have to demonstrate that they can get good value for their money. To achieve this they will need to weigh necessary long term structural reforms against supporting existing revenue streams. No matter what is decided it will be a delicate balancing act.


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