Can China's stimulus drive fix its flagging economy?

Pan Gongsheng, the governor of China's central bank, announced on September 24 a series of measures aimed at reviving the country's flagging economy. The move, coming a week before the 75th anniversary of Communist Party rule, was made in response to concerns that China could miss its own annual growth target of 5%.

The stimulus package included a 0.5 percentage point reduction in the amount of cash reserves that commercial banks are required to hold on deposit with the central bank. This should free approximately 1 trillion yuan (108 billion) for new loans. Pan said this ratio could be reduced by another 0.25 to 0.5 percentage points later in 2024.

The central bank also reduced the rate at which it lends money to commercial banks by 0.2 percentage points. Pan signaled that this could be followed by a 2,025 basis point reduction in the rate charged to borrowers with the best credit scores.

In an attempt to stem the downward spiral that saw property prices in August falling at their fastest rate in nine years, the central bank also reduced the deposit amount required for people wishing to buy a second home from 25% to 15%.

Credit expansion, at least in the short term, is expected to have a positive effect on financial markets and commodity prices, with investors expecting increased demand for goods and services. And this is exactly what we saw after the series of new measures.

The main Chinese stock index jumped by more than 4% a few hours after the central banks' announcement, thus experiencing its best recovery in a single day in 16 years. And this was followed by a increase of more than 1% in the reference price of oil. Sentiment has remained positive since then, with Chinese stocks rising. about 20% within five days of announcement.

However, expansionary policies also carry risks. China's real estate market has been in crisis since 2021, when the government introduced restrictions on the amount developers could borrow, leading many people to borrow. default on their debts. Dramatically reducing borrowing costs could reignite a boom in sales and value, creating a new housing bubble.

But it may be some time before China's real estate market starts to overheat. China's property prices are falling rapidly and there is plenty of spare inventory. Goldman Sachs estimated in April, the government may need to spend more than 15 trillion yuan to resolve the problems plaguing the sector, far more than the recent stimulus package can provide alone.

It is difficult to predict the long-term results of the central banks' new economic program. It will probably be a year or two before we start to notice any real effects. But, at least in theory, the expansion of domestic credit that will be triggered by lower interest rates from central banks, as well as associated banking stimulus measures, should extend to the economy as a whole.

This is expected to revive construction activities, improve consumer spending and increase demand for capital goods. This could eventually help China move towards growth driven more by domestic demand than by a reliance on exports.

China's economic miracle has traditionally been based on expanding exports, which peaked in 2017. 36% of GDP in 2006. This ratio has decreased considerably since then, falling to 19.7% in 2023, but it remains high compared to comparable economies. In 2022, the exports/GDP ratio in the United States, for example, it was 11.6%.

This has made China particularly exposed to demand volatility in overseas markets and geopolitical shocks, such as the United States' decision in May to introduce new tariffs on imports of electric vehicles, solar equipment and Chinese batteries.

Tariffs have dampened demand for Chinese exports in the U.S. market, but they did not modify China's dominance in global supply chains. It is true that demand in the United States, particularly for Chinese electric vehicles, was already quite low.

The outlook is not so gloomy

The Chinese economy is going through turbulence. But China has always outperformed the rest of the world on GDP growth since 1990, and its economic outlook remains relatively positive.

In fact, China's 5% annual growth target remains significantly higher than before. most other countries. In all G7 countries other than the United States, growth is expected stay below an annual rate of 2%.

These countries account for a significant share of Chinese exports, so the weak economic outlook will continue to weigh on the Chinese economy for now. However, China will increasingly benefit from infrastructure projects carried out by the Eurasian Development Bank and the Belt and Road Initiative in the years to come.

These infrastructure projects connect China to resource-rich Central Asian countries through roads, railways, gas pipelines and power grids. China has signed a lucrative gas supply contract with Kazakhstan in 2023. And China now represents the majority of Mongolia's mineral exportswhich increased by about 3% between 2023 and 2024.

China will also benefit from trade with Russia, India, Saudi Arabia and other members of the BRICS group of large emerging economies. In recent years, China has developed closer trade relations with these countries and led efforts to admit six new members Iran, Saudi Arabia, Egypt, Argentina, United Arab Emirates and Ethiopia in early 2025.

We are waiting to see what impact the new central bank measures will have. But a strong economic outlook for China would be a positive force in boosting consumer confidence and the economic outlook for the rest of the world.