China’s massive stimulus plan holds lessons for Labour

There’s nothing like a good surprise to wake up markets, especially when that surprise comes in the form of unexpected monetary and fiscal stimulus for the world’s second-largest economy.
For investors, the announcement on Tuesday from the People’s Bank of China of a salvo of rate cuts and a $114 billion war chest to boost equities and animal spirits, followed by the government’s pledge this Thursday to also intensify fiscal support, was a bit like receiving a perfectly presentable swimming costume on your birthday before being told two days later that you also get an all-expenses paid tropical island holiday to go with it.
Chinese stocks are up more than 10 per cent this week, erasing their losses for the year. The yuan hit its highest level against the dollar for almost 18 months. While questions remain over the scale of the fiscal stimulus, it has the potential to be pivotal because the measures are not just a re-run of remedial efforts that investors have watched China try before.
In the recent past, China has concentrated on monetary over fiscal support in the hope that delivering interest rate cuts and mortgage rate reductions to make borrowing easier would jolt the flatlining real economy back to life. If at first, or second, or third, this did not succeed, the solution was to try and try again — going bigger each time.
This was always destined to be ineffectual. It’s the central banking equivalent of a football fan trying to encourage their team by repeatedly yelling, increasingly loudly, at the TV. China’s problem has been less a debt crisis and more a crisis of confidence. To say that the country fared particularly badly during Covid is an understatement akin to Nigel Farage’s refrain that the UK might experience “bumps in the road” after Brexit.
The Zero Covid policy and hokey-cokey of lockdowns torpedoed the economy and decimated consumer sentiment. Before the stimulus packages were announced this week, the consumer confidence index score from the National Bureau of Statistics of China stood at 86, versus a long term average of about 110, close to all-time lows.
Economic confidence has simply been too shaky to entice consumers or businesses to spend. This issue is especially acute in the property sector, where demand for building and land has collapsed. It’s hard to exaggerate the importance of property and associated building industries to the Chinese economy. Real estate, construction and materials make up about 30 per cent of GDP in China, roughly double the proportion in the US. Property accounts for about 60 per cent of household wealth, again about twice the level of households in America. This year, the value of new home sales has plummeted nearly 20 per cent. That’s why this week’s promise of fiscal support, and particularly its focus on supporting local government investment, is so tantalising.
What’s also interesting is how jitters over a prolonged economic slowdown seem to have catalysed China into toning down its infatuation with reducing the fiscal deficit. The decision to unleash government spending — with strong hints of more to come — signals a recognition among officials that, without sustained fiscal support, hitting this year’s growth target is a pipedream.
Despite being vastly different economies, China’s predicament is a cautionary tale for the UK. Despite all the fist pumping around going for growth during the Labour Party conference, plenty of discussion still focuses on debt reduction.
Back in May, the International Monetary Fund, an institution that usually demonstrates all the carefree largesse of Ebenezer Scrooge, recently advocated for new “comprehensive policy approach” in China. In an uncanny parallel, this week the normally equally austere OECD urged Rachel Reeves to prioritise investment over fiscal fiddling.
In both cases the warning is clear: fiscal discipline is all very well, but if it isn’t balanced with maintaining growth, a government starts to look, at best, intransigent and, at worst, blinkered.
If China’s economy is property-dependent, the UK’s is almost as reliant on financial services, accounting for about 12 per cent of GDP. Some kind of tax on the banks is widely expected at the autumn budget, alongside hikes on capital gains tax, which will hit businesses more broadly. If the UK is sucked into the same deficit-obsessed vortex as China, the path ahead is likely to ultimately lead to the same forced U-turn which the politburo has just made.
Fixating on its budget deficit led China to a place where it crushed consumer confidence, spooked international investors and sapped energy from the economy. Investors gazing into the crystal ball will hope the UK government sees China as an economic warning rather than a prediction of things to come.
Seema Shah is chief global strategist at Principal Asset Management