Monetary and fiscal environment in China continues to loosen says abrdn

The abrdn Global Marco Research team has released research on the China economy showing that policy had already succeeded in loosening financial conditions modestly over the past three months, even prior to the latest package of policy measures announced on Tuesday 24 September.

The abrdn Chinese Financial Conditions Index and the abrdn China Activity Indicator has helped inform abrdn’s thinking on China since 2019.

While headline economic data continued to be challenging in August, abrdn’s China Activity Indicator points to a nascent stabilisation. Financial conditions remain accommodative; Policy gained further traction in August.

The monetary and fiscal environment in China continues to loosen. abrdn Chinese Financial Conditions Index (CFCI) has eased for the third consecutive month to 0.74 from 0.43 in May this year, moving into a marginally more accommodative stance. Money & Credit remains a drag to the financial environment largely due to weakness in money growth, especially M1.

While a negative credit impulse is not helping, July may have marked the low point and it now appears to be turning back up. Robust government debt issuance of RMB 1.6 trillion in August helped underpin credit expansion on the month[1]. Issuance should remain strong for the remainder of the year, which could further ease the financial environment.

Speculation had been rife that banks were about to be pushed to lower interest rates on existing mortgages, and the People’s Bank of China (PBOC) delivered, announcing a 50bp reduction. This will provide a welcome boost to disposable income and may help consumer sentiment to recover over time.

Robert Gilhooly, senior emerging markets economist, abrdn, said: “The 2024 growth target of ‘around 5%’ remains on a knife edge, but the latest package of policy stimulus - combined with signs that past policy easing was already gaining traction - will shore up growth and reduce the risk of deflation becoming engrained.”

Economic activity in the country continues to defy the pessimists, even if it is progressing at a sluggish pace.

China’s August data releases generally reinforced the lacklustre economic picture that emerged over the summer. Several headline activity measures slowed, while most housing metrics continue to slide. That said, year-over-year growth rates are often slow to pick up changing economic momentum.

abrdn China Activity Indicator (CAI) has firmed slightly month-on-month over the past two months, rising from -0.97 in June to -0.56 in August, helped by an improving export sector (Figure 2). China’s exports rose by 8.7% year-on-year in US dollar terms in August, higher than the forecast for growth of 6.5% year-on-year[2].

There is only modest good news in nominal dynamics. Headline CPI inflation was positive for the seventh month in a row in August, but it is still advancing at a tepid pace of only 0.6%[3]. Moreover, recent dynamics in producer prices imply that consumer goods inflation in the CPI basket is likely to be short-lived.

Robert Gilhooly said: “Overall, the supply-side biased policy mix, which favours investment in strategic industries over consumption, implies ‘low-flation’ will be hard to shake. As such, we now expect annual CPI growth of just 1% next year, below consensus expectations of 1.5%.”

Volatility is likely to persist, making it hard to judge trend growth. Traditionally, the manufacturing sector played the role of the more volatile component in China's economy, while the services sector maintained relative stability prior to 2019.

However, the onset of the pandemic significantly disrupted the services sector, a situation that has persisted even after China emerged from its lockdown phase. As authorities have placed a greater focus on manufacturing, the pre-pandemic trend which led to a steady rise in the share of services in the economy has broken down. These two key changes which are highlighted by abrdn’s CAI suggest that this era of volatility will continue.

Policymakers appear to be keeping some powder dry in case Trump launches another trade war, and may have eased more aggressively than expected, but they could still do more.

The spectre of another trade war under a potential second Donald Trump presidency is likely a key factor keeping some policy levers – such as fiscal easing – held in reserve. If a trade war was to emerge – for example one that pushes up tariffs substantially – the Chinese authorities would be able to deploy a more targeted response once they know its exact format. All of this may be enough to unlock a much more forceful stimulus package which could offset much of the hit to near-term economic growth.

Commenting on the investment market, Nicholas Yeo, head of China equities, abrdn, said: “We are at a pivotal moment for the Chinese economy and its equities market, buoyed by recent policy shifts in the US. The US Federal Reserve's decision to cut interest rates in September is set to serve as a significant tailwind. It is expected to ease the devaluation pressure on the Chinese Yuan, enhancing the Chinese authorities' ability to stimulate economic growth and improve sentiment. Additionally, a stronger currency is likely to attract more capital inflows, especially at a time when positioning in China is at a low, potentially marking a turning point for our capital markets. Moreover, global easing conditions are poised to bolster consumption, which is a boon for China, the world's largest exporter.”

Nicholas Yeo added: “There is substantial disconnect between valuations and fundamentals. Currently, valuations are at undemanding levels despite companies showing resilient earnings growth. With market expectations leaning towards double-digit earnings growth both onshore and offshore in 2024, we believe this opens up an opportunity for investors to accumulate high-quality Chinese assets. Many leading companies are trading at attractive discounts, and our focus is on those high-quality companies that are gaining market share, both domestically and internationally, offering good earnings visibility, and increasingly growing shareholder yields through buybacks and dividends. In essence, the current landscape presents a compelling case for investing in Chinese equities, and we remain optimistic about the opportunities that lie ahead.”

The abrdn Chinese Financial Conditions Index (CFCI) and the abrdn China Activity Indicator (CAI) are bespoke indices, meticulously crafted by abrdn's in-house Global Macro Research team. Established in 2019 and updated internally on a monthly basis, these indices offer comprehensive insights into China's financial and economic landscape. The CFCI provides a detailed analysis of macroeconomic indicators, including monetary policy instruments and duration assets, growth in money and credit, the risk premia of asset prices, and market volatility. Meanwhile, the CAI offers a nuanced view of the dynamics of economic activities, encompassing industrial production, the housing market, trade, and household consumption. Together, these indices serve as invaluable tools for understanding the intricate workings of China's economy. The findings and analysis derived from these indices are expected to publish externally every quarter.