2 unconventional ideas for how to revive China’s flagging economy

Instead of being unduly cautious about stimulus, Beijing should learn to avoid allocating it to unproductive sectors
China’s policymakers could also consider relying on the equity market, instead of property, to unleash household wealth

Aidan Yao

Published: 12:30am, 14 Jun 2023

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With the property market in renewed distress, exports succumbing to soft external demand and households reluctant to spend, the Chinese economy is in desperate need of help. Yet, Beijing has so far not come to the economy’s rescue in a substantial fashion, although the seven-day reverse repo rate cut on June 13 could be the start of a more active response.

Unlike in many developed economies, where inflation is substantially above central bank targets, inflation isn’t what is holding Beijing back. On the contrary, China has seen falling factory gate prices and may be on the verge of economy-wide deflation. The price dynamics are therefore aligned with the soft activity in the calls for more policy support.

The real concern is leverage, which increased every time stimulus has been undertaken since the global financial crisis. Beijing’s cautious attitude towards unbridled policy easing is consistent with its desire to keep systemic financial risks at bay.

However, a careful investigation reveals a more complex relationship between stimulus and debt than simple causality.

Changes in leverage – calculated as debt over gross domestic product – are, in fact, more a function of how stimulus is rolled out. If done properly, a productive allocation of resources could in fact bolster output more than debt, leading to what hedge fund founder Ray Dalio calls a “beautiful deleveraging”.

The debt problem in China is, therefore, really a result of stimulus misallocated to unproductive sectors, like property, and should not be seen as a hurdle to policy easing when the economy clearly needs it.

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The real question, therefore, is how to implement a stimulus package that maximises the benefits while minimising the costs. To avoid the side effects caused by the old playbook, Beijing needs to think outside the box and break some stereotypes. The goal here is to both bolster near-term growth and rebalance the economy, so that a self-sustained recovery can be fostered.

Here are two rather unconventional recommendations. First, when there is limited conventional policy room for manoeuvre, conditions might be ripe for a quantitative easing-like operation. This would require the monetary and fiscal authorities to join forces to support consumption via transfers, coupons and subsidies, much like what Western governments did during the pandemic. This would, for sure, sound controversial to many in China’s policy circle where prudence is considered a virtue and quantitative easing a taboo.

However, China is not unfamiliar with helicopter money. De facto quantitative easing was implemented most recently in shantytown redevelopment projects, which involved the central bank creating base money, quasi-fiscal institutions (such as policy banks) serving as intermediaries, and local governments providing credit allocation. The operation was effective in extending a lifeline to the ailing property market at the time. Now, Beijing needs to repeat that exercise, but with a focus on households this time to boost their spending.

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Second, with the property market in distress, the economy has lost its most effective credit multiplier. This means that despite accommodative monetary policy, money has not found its way into the real economy, but is stuck in bank deposits.

Reviving the property market could be a solution, but Beijing may not wish to kick the real estate can down the road. Rather, it is more appealing to replace property as the key policy transmitter, and the equity market may be well suited to playing this role.

A clear signal of support, together with the necessary reforms, could help to re-rate equity markets from their historically cheap valuations. This will help restore investor confidence, drain deposits from banks and boost consumption via wealth creation. A sustained equity rally can help redirect household wealth from real estate to financial assets that contribute to more balanced household portfolios over time.

Further, relying on the equity market, instead of property, for credit intermediation can better ensure resources are channelled into more productive parts of the economy, supporting innovation and consumption, instead of propping up ailing industries that end up exacerbating overcapacity and leverage.

Finally, better performing Chinese markets could lure back foreign investors, who are eager to diversify away from developed markets amid high valuations and uncertainties. Even Japanese markets are getting noticed after decades of negligence by global asset allocators. China should seize this opportunity to further open its markets and win back global investors in an effort to promote yuan internationalisation.

In short, the Chinese economy is in a precarious place. With the private sector in danger of falling into a balance sheet recession – as Japan did after the burst of the bubble in the 1990s – Beijing needs to expand its own balance sheet to avert an “ugly deleveraging”, with output on a downward spiral. Time is of the essence, and the authorities need to move fast and decisively to prevent a repeat in China of what has plagued Japan for decades.

Aidan Yao is a macroeconomist with more than 15 years’ experience in both public- and private-sector organisations