From COVID-19 to economic stimulus: why China is susceptible to sudden policy shifts

After many months of resisting calls for a significant stimulus to boost economic growth, the People’s Bank of China (PBOC) has finally delivered one last week. A significant easing of monetary policy was announced: the central bank’s key policy rate was cut from 1.7 percent to 1.5 percent, while banks’ reserve requirements were reduced by 0.5 percent. The latter would effectively inject RMB 1 trillion ($142 billion) into the banking system.

Even more surprising, the PBOC announced an RMB 800 billion fund for the country’s capital markets, consisting of funds to lend to companies to buy their own shares and to non-bank financial institutions to buy Chinese shares. This is the first time that authorities have provided debt to boost investment in Chinese equities.

The PBOC announcement was followed by a statement from China’s Politburo announcing that it would increase budget spending to support growth. This comes after months in which authorities showed no signs of providing meaningful fiscal support to households, even as many faced declining asset values.

The announcements surprised almost everyone. Until last week, authorities had stubbornly resisted calls for more aggressive monetary easing to ward off the deflationary pressures that have plagued China for two years. Chinese stocks have been down for even longer; before last week, the benchmark CSI 300 index had lost nearly 45 percent from its February 2021 peak.

Not surprisingly, financial markets cheered announcements from last week. The CSI 300 rose more than 24 percent in the week following the PBOC announcement – ​​its best performance since November 2008.

What remains to be seen is what kind of budget support will be deployed to boost household consumption, and whether there will be a more determined effort to stabilize real estate prices, which have been falling for more than two years.

Both are crucial, because household consumption – even more than a recovery in stock markets – is the key to improving the real economy. And with more than 60 percent of Chinese households’ wealth tied up in real estate, household consumption is unlikely to recover until real estate prices stabilize.

Ideology and morality in policy making

The surprising timing and magnitude of these announcements should raise questions about why Chinese authorities appear to have undergone such a conversion in Damascus. Although not as dramatic as China’s abandoning the zero-COVID policy in December 2022, the underlying reasons for the surprising turn in economic policy are much the same.

As with zero COVID, China’s economic problems of the past three years – the asset price collapse, debt deflation dynamics reminiscent of Japan’s lost decades, and sluggish growth since the pandemic – have largely been the result of ideologically driven policy choices. Zero-COVID was driven not by achievable or sustainable public health goals, but by a highly ideological and politicized campaign to demonstrate the superiority of China’s governance system over a supposedly callous and morally bankrupt West. Central and local government officials diligently pursued zero-COVID, often unaware of the costs that strict policy enforcement entailed.

Likewise, China’s economic problems of the past three years have largely resulted from ideologically motivated, morally charged policy campaigns. This included the crackdown on consumer internet companies and private education, the stringent regulatory lines (called the “three red lines”) that prevented lending to highly indebted developers, and the drive for common prosperity that investors and private companies scared the hell out of me.

Like Zero-COVID, these campaigns were not the result of careful assessments of how to address problems in the economy, nor of pragmatic and calibrated ways to regulate the country’s fastest-growing industries. Instead, they were carried out without much regard to the damage they would cause – not only to the intended targets of the crackdown, but also to the broader economy. Consequently, the collateral damage caused by this crackdown likely outweighed the benefits it provided.

For example, even if the crackdown on consumer internet companies like Alibaba and Tencent was justified on the grounds that these companies had monopoly power, it was highly likely that the heavy-handed way in which Chinese authorities went after them undermined investor sentiment and undermined the economy. innovation capacity of China’s emerging technology sector.

In the wake of this crackdown, China’s venture capital industry – so crucial to funding innovative startups – has all but disappeared. Chinese leaders even asked a few months ago, seemingly without any irony, why there seem to be fewer Chinese unicorns these days.

Volatility and vulnerability

Second, as with zero-COVID, authorities stubbornly stuck to policies that were clearly unsustainable – until a tipping point was reached. At that point, the policy pendulum swung abruptly in the opposite direction, revealing how volatile and fragile policy in China can be.

In the case of zero-COVID, the Chinese state mobilized vast amounts of resources for almost two years in an ultimately futile attempt to suppress COVID-19, even after COVID vaccines became widely available, and even after it was clear that every other country on the planet was already living with the virus. It was only when the highly contagious Omicron variant caused outbreaks across China in late 2022 that authorities, rather belatedly, abandoned the archaic zero-COVID policy.

Even worse, the way the zero-COVID policy was suddenly replaced by a de facto COVID-for-all policy led to a much more traumatizing to emerge from the pandemic than if the authorities had planned the transition, prepared the population for it and communicated their intentions well in advance.

While last week’s announcements were not as dramatic or sudden as the end of the zero-COVID crisis, they still provided evidence of how policies can change unpredictably and suddenly. The risk of such sudden policy changes – even if they are welcome – is that there is often little preparation for what comes next. Actions taken hastily when decision makers suddenly change their minds can also create new problems and unintended consequences.

Take, for example, the PBOC’s unprecedented move to provide companies with debt so they can buy stock. Remember, Chinese authorities have long wanted to reduce the debt burden in the financial system and promote common prosperity. Using debt to fuel the purchase of Chinese stocks achieves neither goal. Not only does it increase corporate debt, but it also does not benefit the average citizen, who does not own shares.

A much more effective and equitable way to stimulate growth would be through budget transfers to households. But this requires more lead time. Other measures that would permanently increase domestic consumption, such as stronger social safety nets and economic reforms hurrah system, would take even longer to develop and implement.

The fallacy of Chinese exceptionalism

The third parallel between last week’s surprise announcements and the sudden end of zero-COVID is that before both policy shifts, there was a cottage industry of self-appointed defenders of Chinese exceptionalism. These figures saw their role as stiffening the backbone of the Chinese people in the face of policies that were clearly unworkable and defending those policies against the rest of the world.

With the pandemic, Chinese leaders had proclaimed that “persistence with zero-COVID is a victory.” Defenders of zero-COVID pointed to the millions of deaths caused by Western governments that had chosen to live with COVID. They argued that, unlike the decadent West, Chinese society and tradition valued lives and respected elders. When zero-COVID was suddenly abolished, leading to the dystopia that state media had mocked other countries for, the silence from these zero-COVID advocates was deafening. Like rats on a sinking ship, they abandoned their defense of a policy that Chinese authorities now claimed did not exist.

Similarly, prior to last week’s announcements, these defenders of Chinese exceptionalism had argued that authorities had little to learn from the United States’ experience during the global financial crisis. They pointed to the high debt burden and high inflation that quantitative easing and fiscal stimulus would have caused. They pontificated how, unlike the fiscally reckless US or economically depressed Europe, China has always maintained a careful balancing act between growth and economic growth. sustainability.

Even more blatantly, some even said that China was undergoing a “magnificent deleveraging” as part of its transformation into a high-quality, developed economy. According to these defenders, “a $1 trillion property rescue operation is the last thing the Chinese economy needs,” and the falling stock market was a necessary and even healthy adjustment as China turned away from real estate investment and financial speculation toward “new high-quality productive forces” (party speaks for advanced manufacturing).

In light of last week’s announcements, intellectual integrity demands that these defenders of Chinese exceptionalism criticize the PBOC for using debt and monetary stimulus to raise asset prices and revive the economy. But like zero-COVID defenders, these monetary and fiscal hawks are more likely to slink away.

Alternatively, they may attempt to characterize the stimulus as a gentle, carefully calibrated, and well-designed response that does not detract from the path of high-quality development. Clearly, these defenders of Chinese exceptionalism are not letting the facts get in the way of their good story.