- 2018 has been the most volatile year for Chinese stocks since the market crash of 2015.
- However, JP Morgan says the buildup of debt over that time means policy makers will need to use different tools to maintain economic growth.
- Instead of cutting interest rates, authorities will focus on tax cuts and infrastructure spending, with other policy tweaks to help free up liquidity.
The volatility in Chinese markets this year has brought back memories of 2015, when sharp falls in Chinese stocks sent shock-waves through global markets.
However, there’s now a lot more debt in the economy than there was three years ago, JP Morgan says.
And as a result, policymakers will have to adopt a different strategy to maintain growth.
“In contrast to 2015, the high leverage within the household sector and listed companies might make monetary easing less effective in supporting growth,” strategists Marcella Chow and Chaoping Zhu said.
Three years ago, China’s household debt amounted to 35.7% of GDP. Since then, it’s climbed to 49.3% — mainly as a result of China’s booming property market, which continued to run hot as recently as July.
And there’s a second key difference. China’s 2015 market meltdown was largely driven by leveraged investors, who were forced to sell their positions when prices began to fall.
Now, the buildup of debt has been caused by the listed companies themselves.
“Given the difficulties in getting ordinary bank loans, listed companies have increasingly financed by using stocks as collaterial — i.e. share-pledge trading”, JP Morgan said.
Back in 2013, only around 90 billion yuan (around $US13 billion) of Chinese stocks were used as collateral.
That number has now risen to 4 trillion yuan, and it’s created a $US600 billion problem which could further exacerbate price falls.
Prior to today’s session, stocks in Shanghai ripped higher for two straight days following a coordinated show of support from top-level Chinese officials.
Among the positive rhetoric, the head of China’s finance regulator said insurance companies would be free to offer products that help boost liquidity for companies that use share-pledge trading.
But more broadly, JP Morgan says that because of the build up of debt in China over the last three years, the details of the next policy response will have to change.
For one thing, China’s central bank is unlikely to cut rates this time around — a tactic used often in 2015 when the official cash rate fell from 6% to 4.35% (where it still remains).
Instead, “monetary policy will mainly focus on target support to the small- and medium-size enterprises (SMEs), JP Morgan said.
The analysts noted that policymakers have already cut China’s reserve requirement ratio (RRR) by 2.5% this year, and they expect it to fall further.
A lower RRR frees up liquidity by reducing the minimum amount of capital banks have to hold to issue debt.
On the fiscal side, the analysts said more tax cuts are likely, both for personal income tax and the value added tax (VAT is a version of Australia’s GST).
Previous research by Nomura showed VAT cuts could reduce the collective tax burden on Chinese companies by around $US160 billion.
Looking ahead, the JP Morgan analysts said they “expect market sentiment to pick up once investors see more clarity in the policy outlook”.
Over the next few months, more infrastructure spending and moves to increase credit growth are likely. And longer-term, they expect China’s economy to continue its transition to growth driven by domestic consumption and the services sector.
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