Key Points:

  • Many domestic loosening policies have been introduced since last month, but we maintain our view that there would not be a large fiscal stimulus coming out soon. Current policy stance focus is still to push companies and households to leverage again, esp. by policy loosening on property and stock market, so as to boost private sector’s confidence and risk appetite, drive their investment and consumption up, and at the same time, help government’s fiscal revenue.
  • The fiscal deficit of Chinese government in the first 7m this year dropped by 950b RMB, largely due to the sunset of the VAT subsidy at the end of last year, this made ytd VAT revenue grew by 1.8t RMB compared to last year. That said, due to continuous slumping land sales, local government’s fiscal situation is still worsening. The current fiscal policy focus is to control the growth of total government debt, and meanwhile replace the current high interest rate and hidden local government debt with low interest rate debt through central government endorsed formal debt issuance channels. This is totally different from the situation in 2015~2017 and 2020~2021 when total fiscal deficits and government debt shoot up sharply.
  • In the absence of large-scale fiscal stimulus, although a variety of easing policies have been introduced, it will still take time to restore market confidence. This is because domestic household income growth slowed down quite significantly since Covid, which made them harder to leverage again, and the property loosening can mostly help 1st tier and part of large 2nd tier cities in the near term, but it can hardly turn around the overall market trend as these cities only composed a very small portion of total home sales and property development investment in China.
  • In August, the US fiscal deficit remained over US$220 billion again, as a result, the pressure on the issuance of US Treasury debt remains unabated. But the market was supported by the liquidity boost from Fed’s OMO as ONRRP continued to drop. This may not be enough to help US stocks to make new highs, so we think US stock market may still be in range bound trading.
  • We believe that A-shares are likely to rebound from September to October. Although the current policies are intensive, we believe it is still difficult to quickly reverse market confidence. Against this background, it is not ruled out that further policies to relax and promote economic recovery will be introduced in the future. We are not pessimistic about A-shares at the current level. The room for the market to fall will be very limited, but the scale of rebound will depend on the introduction and implementation of further favorable policies in the future.
  • We continue to be bullish on oil, though investors should pay attention to the FY24 fiscal deficit drama that may happen at US congress again at the end of September and it may affect oil price movement in the short term as well.

Hou Zhenhai
Straits Financial (China) Chief Strategist

Previous Views:

We do not expect the Chinese government to push forward fiscal stimulus policies in the future. we believe that the primary goal of the current government is to reduce the overall interest rate level of government debt through debt replacement, so as to release future fiscal room. Policymakers believe that the current lack of confidence in the market is the main problem. Therefore, we think that the main focus of future policies will be on restoring market confidence and risk appetite. Our suggestion for US stocks is to sell near the previous high, and the suggestion for A shares is to buy near the previous low. For commodities, we are relatively more optimistic about crude oil.

Views in September:

 I. Recent domestic policy analysis.

Recently, various domestic policies have been introduced to stabilize economic growth. These mainly include the following four aspects: First, interest rate cuts, including PBoC’s reduction of 1-year MLF interest rate by 15bps on August 15, the 10bps reduction of the 7-day reverse repo rate, and 7bps cut of overnight, 7-day and 1-month SLF rates. Then the 1-year LPR was lowered by 10bps on the 21st. On the 31st, PBoC issued a document requiring banks to lower existing mortgage rates. The second is the relaxation of real estate regulations, including the relaxation of the reserve payment ratio to 13% on August 3, the extension of support for residential purchase housing by exemption of partial personal income tax on the 25th, and the announcement at the end of August to “recognize first time home buyer status only by house but not mortgage records” and reduce minimum downpayment ratio requirement. The third is to encourage investment in the capital market, including announcing on August 27 the reduction of stamp taxes on securities transactions, relaxing the financing margin ratio, tightening the speed of IPO issuance, regulating the selling of non-tradeable shares after unlock, and on September 1 require the strengthening of quantitative trading regulation. The fourth is to boost the private company’s confidence, including announcing on August 28 the extension of personal income tax concessions for one-time bonuses and increasing special deductions, and announcing the establishment of the Private Economic Development Bureau on September 4.

The above-mentioned major policies have been introduced intensively in the past month, which shows that the current overall situation of China’s economy is indeed experiencing greater downward pressure. Therefore, the urgency of high-level policymakers to boost economic growth is increasing. However, from the perspective of the various policies mentioned above, the most important policy focus is to promote residents and the corporate sector to increase their own leverage, especially through the relaxation of policies on the property market and stock market, and encourage the private sector to improve themselves risk appetite to drive investment and consumption growth. Therefore, we should also clearly realize that this is different from the government’s financial efforts from 2015 to 2017, specifically through increased financial investment in large-scale old city and town renovation programs, etc., directly gave money to residents and other private sectors by transferring payments, thereby significantly increasing the income and investment and consumption capacity of households (especially residents in third- and fourth-tier cities where town renovation programs were intensive).

In our monthly report in August last month, we proposed that the market needs to lower its expectations for large-scale fiscal stimulus. The many policies we have seen in the past month have not actually changed our judgment. The core of domestic policy at the current stage is to continue to lower the interest rate on the government’s existing debt and control the increasing scales of general government debt. This actually requires the government (including local governments) to no longer continue to increase debt and the size of fiscal spending and deficits as they did in the past. In fact, we have seen that since the beginning of this year, China’s public finance deficit has dropped significantly compared with the same period last year: from January to July this year, China’s public finance deficit was 1.2289 trillion RMB, while it was 2.177 trillion RMB from January to July last year, the deficit yoy has decreased by 950 billion RMB (Figure 1). The main reason for this difference is that the value-added tax reduction policy implemented last year due to Covid lockdown ended at the beginning of this year. Therefore, this year’s VAT revenue increased by 1.8 trillion RMB compared with the first 7 months last year. In other words, if the policy really wants to provide large-scale fiscal stimulus, perhaps the easiest way is to fully extend last year’s VAT reduction policy, but the fact is that it does not.

Source：Bloomberg，CEIC，Wind

Of course, we know that as the main source of tax revenue for China’s finance, the reduction and exemption of VAT cannot be implemented for a long time. But looking further, although the public fiscal deficit has decreased this year, the financial situation of governments at all levels has actually worsened. The main factor causing this situation is the further decline in local government revenue from land sales. In the first 7 months of this year, the statistical revenue from land sales totaled 2.28 trillion RMB, while the land sales revenue in the first seven months of 2021 and 2022 were 4.14 trillion and 2.83 trillion RMB respectively. The current level of income from land sales has dropped to the lowest level since 2016, and the cumulative decline from the high point in 2021 has been nearly near half (Figure 2). Therefore, if the decline in government revenue from land sales is also taken into account, the government’s financial capacity has actually continued to deteriorate this year. This is fundamentally different from the past fiscal stimulus expansion cycle we saw in Figure 1, in which the government deficit continued to expand significantly from only 1 trillion in 2015 to 6 trillion in 2020.

Source：Bloomberg，CEIC，Wind

Therefore, it is not difficult for us to understand why, under the current circumstances, the government’s first choice is not to once again expand the scale of fiscal stimulus to boost the economy, but to lower interest rates, encourage confidence, and lower the threshold for private sector to invest and leverage up, so as to boost the economy and improve the government’s fiscal revenue. At the same time, we can also see this in the speed and structural changes of government debt issuance (Figure 3). First: Since the second half of last year, the scale of government bond issuance has actually decreased, and it has not accelerated again so far. This is very different from the two rounds of large-scale expansion cycles of Chinese government finance in 2015~2017 and 2020~2021. Second: Judging from the structural changes in government bond issuance, the government has made great efforts to reduce the issuance scale of urban investment bonds and other hidden government debts not listed in Figure 3, such as Trusts and local government-sponsored funding vehicle’s debt instruments. The interest on these debts as a whole are much higher than those debts listed in Figure 3 as they are issued through formal channels endorsed by the central government. This shows that while the government is reducing the growth rate of total government debt, it is also working hard to replace some high-interest-rate local government debt from private channels with low-interest debt issued through formal public channels. We believe that until the replacement of such existing local government debt is roughly completed, it will be difficult for us to see the introduction of a new round of large-scale fiscal stimulus policies.

However, before new fiscal stimulus space is available, how to resolve the downward pressure on the economy is a major problem facing the Chinese government. Judging from the various policies currently introduced, it shows that the government still hopes that the confidence of the business and residential sectors will be restored and they will increase leverage again.

 

II. Though many policies have been introduced recently, market confidence’s recovery will still be a slow process.

 

In the absence of large-scale fiscal stimulus, although a variety of easing policies have been introduced, it will still take time to restore market confidence. This is because: First of all, it will take a certain amount of time to reverse the current decline in Chinese households’ income growth and expectations. Since the beginning of this year, although the direct impact of Covid has disappeared, the improvement in overall household’s income growth is still very slow. As shown in Figure 4, the median income of domestic household in the first half of this year increased by 4.4% year-on-year, which was only a slight improvement from the 3.7% at the end of 2022, and was significantly lower than the growth level of about 8% in 2021 and years before Covid. The slowdown in income growth makes it difficult for overall consumer spending to maintain a relatively strong growth momentum. Similarly, due to the slowdown in income, it is difficult for households to effectively restore their debt and leverage capabilities. Although the slight decline in mortgage rates, policy that disregard previous loan record to get first time buyer status, and the reduction of down payments will help improve household’s debt capabilities, the income growth slowdown is still the key driving factor. It determines that the overall households’ ability to increase leverage and purchase houses will be difficult to quickly return to pre-Covid levels.

Source：Bloomberg，CEIC，Wind

The relaxation of mortgage policies and purchase restriction policies will have a short-term boost to the property market in first-tier and some strong second-tier cities. That said, first of all, without further policy stimulus, this short-term boost may be difficult to sustain. Secondly, first-tier cities and a few strong second-tier cities account for a very low proportion of China’s overall property sales area and investment. As shown in Figure 5, the current proportion of first-tier cities in China’s property investment and sales area is only 11.6% and 2.9% respectively. Comparatively, third-tier and below cities accounted for 51.2% and 69.2% respectively. What is more closely related to economic activities and the demand of the upstream and downstream property-related industry chains are changes in the growth rate of overall property sales area and investment. Therefore, even if relaxing purchase restrictions can boost sales in first-tier and some second-tier cities in the short term, it will not be effective for the entire country’s economy to revive. The boosting effect is still relatively limited.

Figure 5. Chinese property investment and home sales composition by different tier cities

Source：Bloomberg，CEIC，Wind

III. Fed’s ONRRP liquidity boost vs Treasury debt’s supply pressure

In August, the US fiscal deficit remained high, exceeding US$220 billion again. Although the high fiscal deficit still ensured that the US economy continued to perform well, especially household consumption and corporate investment, which still maintained rapid growth, on the other hand, it also made the pressure on the issuance of US Treasury debt remain unabated. Therefore, we see that the long-term interest rates of US Treasury rose again and were close to the previous highest level, reflecting the pressure on market liquidity caused by the continued high supply of US Treasury debt. As shown in Figure 6, net issuance of US debt in August reached USD$326.6 billion, exceeding July’s level of US$255.3 billion.

In August, the US fiscal deficit remained high, exceeding US$220 billion again. Although the high fiscal deficit still ensured that the US economy continued to perform well, especially household consumption and corporate investment, which still maintained rapid growth, on the other hand, it also made the pressure on the issuance of US Treasury debt remain unabated. Therefore, we see that the long-term interest rates of US Treasury rose again and were close to the previous highest level, reflecting the pressure on market liquidity caused by the continued high supply of US Treasury debt. As shown in Figure 6, net issuance of US debt in August reached USD$326.6 billion, exceeding July’s level of US$255.3 billion.

Source：Bloomberg，CEIC，Wind

As we pointed out in August’s monthly report, since the Federal Reserve is currently unable to cut interest rates and end its QT soon, the continued high supply pressure on US treasury debt will continue to be transmitted to the capital market, thus affecting the price of major financial assets, both stocks and bonds included.

However, we have also noticed that in order to offset the pressure from the continued increase in the supply of U.S. debt, although the Federal Reserve cannot cut interest rates and end its QT, it can still provide short-term liquidity support to the market through the reduction of overnight reverse repurchases (ONRRP) in open market operations. Therefore, we see that changes in short-term liquidity conditions in the US financial market are not only affected by the increase in the supply of US treasury, but the reduction in the volume of ONRRP in the Federal Reserve’s open market operations also plays a significant hedging role. In that sense, since June, the Fed has provided more than US$700 billion in liquidity to the market through the reduction of ONRRP. As can be seen from Figure 7, this liquidity boost through ONRRP mainly occurred in two periods from early June to mid-July, and from mid-August to early September. And if we look back at the trend of US stocks’ performances in the past two months, we actually saw that US stocks were relatively strong during these two time periods, while declined during other periods.

Source：Bloomberg，CEIC，Wind

Therefore, we believe that in the foreseeable future, the pressure on US treasury debt issuance will remain large against the backdrop that the high US fiscal deficit continues. The pace and intensity of liquidity released by ONRRP reduction will still have an impact on US stocks as one of the main factors.

IV. Market strategy

We continue to hold a neutral outlook on near term US stock performances. US treasury debt issuance will continue to cause market pressure. However, the Fed can also hedge through liquidity boost by open market operations, but the latter force is difficult to push US stocks to new highs. Therefore, we believe that US stocks are still able to maintain a range-bound trading status.

We believe that A-shares are likely to rebound from September to October. Although the current policies are intensive, we believe it is still difficult to quickly reverse market confidence. Against this background, it is not ruled out that further policies to relax and promote economic recovery will be introduced in the future. Especially in the absence of large-scale fiscal stimulus, policies will still hope to improve overall investors’ confidence by promoting the capital market performances. Therefore, we are not pessimistic about A-shares at the current level. The room for the market to continue to fall will be very limited, but the scale of rebound will still depend on the introduction and implementation of further favorable policies in the future.

In the previous monthly reports, we recommended to long crude oil. We believe that this bull run of crude oil prices driven by reduced supply is not over yet. However, due to the large short-term rally, there may be a certain pressure for consolidation for oil prices in the short term. However, we believe that the two driving factors behind the rally are: 1. US fiscal spending that continues to be at an elevated level, and 2. Saudi Arabia’s production cuts that exceed expectations. As long as these two leading factors do not change significantly, oil bull market may still be maintained. Investors should pay attention to the FY24 fiscal deficit drama that may happen at US congress again at the end of September and it may affect oil price movement in the short term as well.