China’s authorities are doubling down on their insistence that they will not relax policy aggressively to boost economic growth. Yi Gang, head of the People’s Bank of China, was the latest to deliver the message, telling reporters that, despite pressure on the economy, the central bank was “not in a rush to have relatively big rate cuts or quantitative easing, like some other central banks have”.

While US president Donald Trump believes China’s slower growth is a result of the punitive actions of his administration, it actually reflects structural shifts such as rising labour costs, compounded by long-overdue moves to rein in the financial system and the property market.

This may be bad news for German machinery makers, Australian commodities exporters and Guangdong real estate moguls, but it could equally be a long-term good for China’s development. However, the risks associated with slowing economic growth may also prove too difficult to manage, requiring a more forceful approach.

The current policy approach was captured by last week’s 5 basis point cut to the one-year loan prime rate (LPR), which the PBoC is pushing as its new benchmark. That paltry response to the US Federal Reserve’s latest 25 basis point cut — the underlying rate on the PBoC’s medium-term lending facility was left unchanged — followed another disappointing set of monthly data, which dashed hopes for a near-term recovery in Chinese growth.

August data on exports, retail sales, output and investment raise the possibility that third quarter growth, which is scheduled to be announced on October 18, will fall to around 6 per cent, marking another deceleration from the previous quarter to the lower bound of this year’s 6 to 6.5 per cent targeted range.

More economists see growth slipping below 6 per cent next year, even though this would imperil a long-standing Communist party goal of doubling per capita GDP by 2021.

No more flooding

Markets can no longer confidently rely on the Chinese government to announce aggressive stimulus measures whenever growth numbers disappoint. While steps have been taken to guide interest rates down and to unwind the reserve requirement ratio, these have been moderate.

The leadership under Xi Jinping says that tackling financial risk remains the priority, rebuffing calls for larger-scale efforts to boost economic activity. It is refusing to act more aggressively to arrest the slowdown because the costs of resorting to what it calls “flood irrigation” stimulus are still considered too high. Nearly a decade of panic-fuelled stimulus has seen Chinese debt levels push above the equivalent of 300 per cent of GDP.

Managing the slowdown is proving challenging. Although the government wants banks to lend more for productive investment, the property sector is still the most important source of loan demand in China.

In lieu of trying to engineer another property boom, the government is leaning on infrastructure investment to support growth, including allowing local governments to issue more bonds to fund these projects. The result has been muted so far — infrastructure investment grew just over 4 per cent in January-August, compared with nearly 20 per cent just two years ago.

A key constraint may be a shortage of worthy investment opportunities. Guosheng Securities, a domestic brokerage, estimated just six projects had taken advantage of relaxed financing requirements for infrastructure investing, making use of just Rmb3.4bn in funds from sales of special bonds, or 0.2 per cent of the Rmb1.1tn issued in June-August.

The government may want to encourage investment in anything that does not involve the property sector, but bricks and mortar is where the returns are. Increasingly cash-strapped local governments were previously incentivised to pump money into infrastructure because better infrastructure allowed them to sell land at higher prices. With the housing market off-limits, new infrastructure projects cannot generate enough cashflow to justify the investments (the six projects highlighted by Guosheng based their revenue forecasts in part on accompanying land sales).

No help from consumers

Either China’s economy grows more slowly or the government encourages more wasteful investment to keep growth ticking over. The latter approach would mean racking up more debt and generating more financial risk until new technologies emerge that could allow China to grow out of its debt burden.

But a hands-off approach to policy making presents its own risks. Small bank blow-ups and bond defaults are a byproduct of policy changes thus far. Bond defaults by value were up 60 per cent year on year in the first eight months of 2019.

Consumer sentiment is holding up for now, and income tax cuts will gradually transfer more wealth to households from the government. However, consumers are nervous and more inclined to save any extra income.

Real estate runs through everything — Chinese consumer sentiment hinges on the health of the real estate market, because most urban households own at least one property. A sustained fall in house prices would hammer their confidence but also create widespread problems in the financial system, where perhaps half of all outstanding loans are backed by some form of real estate collateral. (Chinese officials, having spent years warning of the need to learn from Japan’s experience of the 1990s, are coming perilously close to living it.)

Ultimately, the Chinese government’s stance may have to become more interventionist because of the risks associated with allowing growth to fall too quickly. Reform in key areas is not moving quickly enough to take up the slack, while the government faces the challenge that a gradual slide in growth could morph into something more dangerous. 

This is why Mr Yi’s defiance comes with caveats.

— He Wei, Finance Researcher, FT Confidential Research

FT Confidential Research is an independent research service from the Financial Times, providing in-depth analysis of and statistical insight into China and south-east Asia. Our team of researchers in these key markets combine findings from our proprietary surveys with on-the-ground research to provide predictive analysis for investors.