The Chinese equity market failed to sustain the strong rally on October 19 that was induced by Beijing’s announcement of expanded policy measures to fight the downswing in the economy and financial markets.
Last week’s global market sell-off was obviously a big headwind for Chinese equities. But we also think that the lack of details on Beijing’s tax concessions was also a reason for the weak market rebound.
Since trade tension with the US started to escalate in the summer, Beijing has implemented waves of small policy measures to cushion the economy.
They include monetary easing and fiscal measures largely containing small tax cuts and tweaks. In addition, the earlier proposal to expand market access for foreign firms was reaffirmed recently with more details – covering sectors from financial, industrial and agricultural.
The table attached summarises the major policy support measures implemented so far. They are aimed at cushioning exporters in face of higher tariffs and, more importantly, targeting local consumption and investment to boost domestic demand as trade pressure builds.
President Trump’s trade tariff as of today (25% tariff on $50bn Chinese exports plus 10% on another $200bn) will only trim China’s GDP growth marginally by about 30-40bps.
If the 10% tariff on $200bn is raised to 25% in January 2019 as promised by Trump, then China will need to protect the growth slowdown from current 6.6% y/y to around 6%. A bigger potential fall will, therefore, demand a larger dose of policy responses.
So far, we have seen Beijing starting with monetary easing (reserve requirement ratio cuts, liquidity injection, targeted lending plus CNY depreciation) before branching out to more fiscal measures. For the former, we still deem it ‘measured’ easing – essentially encouraging banks to lend to targeted sectors such as private firms and infrastructure projects but balancing by controlling shadow credit growth (although only corporate bond issuances have relaxed noticeably).
Overall, total credits in circulation have improved but not excessively in terms of new flows. Understandably, the spectre of re-leveraging and credit bubble risk is still in the mind of policymakers even though financial de-leveraging has moved to the back seat of Beijing’s policy agenda this year.
Fiscal policy becomes more counter-cyclical
On the fiscal front, China wants prudence – like in its monetary policy. But it looks increasingly difficult to limit flexibility as China’s already high leverage constrains the extent of monetary easing. That said, the tax cuts and incentives provided so far were small tweaks, such as raising taxable income threshold and tax deductions on children’s education and elderly care expenses.
The good news is that China has under-achieved its budgetary plan in the first two quarters quite significantly and have started to spend more handsomely in August-September.
We suspect that the original budget deficit target set for 2018, at 2.6% of GDP, will be raised on expanded fiscal measures. If the actual outcome will be like 2017’s level of around 3.7% of GDP, China can afford to dip into a quarterly fiscal deficit of some 6.4% of GDP in 4Q/18 without worrying too much of major fiscal slippage.
In other words, Beijing can afford more fiscal support measures, and some key policy advisers are alluding that tax cuts amounting 1% of GDP in the coming year will not be too demanding.
Anthony Chan
Chief Asia Investment Strategist