Recently, the Chinese government announced a wave of new policies such as tax cuts, support to private companies, and relaxing some rules for wealth management products. We think these policies will smooth the downward macroeconomics trajectory, but is unlikely to turnaround the trajectory itself [1] – i.e. this is a Band-Aid, not the bazooka. Specific measures taken recently include the following:

Private companies:

• What happened: Many highly ranked government officials, including the central bank, reiterated government’s commitment to support private companies and urged financial institutions to provide liquidity to support private companies. The government is also planning to inject RMB10bn into the China Bond Insurance Co. to provide credit guarantees for domestic bonds issued by private companies[2].
• Near term effects: We have seen some banks are more willing to grant credit to selective private Small and Medium Enterprises (SME) in sectors that the government supports, such as technology and environmental protection industries. However, we also notice these credits are mostly provided to companies that already have access to banks’ credit facilities and these are mostly working capital loans rather than longer term funding for capex.
• Our view: Corporate governance problems, such as alleged fraud and poor audit quality which are causing some of the recent defaults, underpins banks’ cautious attitude towards private companies in China. So far, the policy focuses on pushing for more credit to private companies, rather than resolving the reasons behind the banks’ cautiousness. The risk sharing through credit guarantee might help in terms of signaling institutions to provide liquidity to the private companies for the time being, although the details of the credit guarantee are yet to be clarified and the amount of government injection is a little small in the context of the size of China bond market.

Tax cuts:

• What happened: Ministry of Finance and State Administration of Taxation circulated a draft on 20 Oct, effective on 1 Jan 2019, which detailed guidance on deduction items such as education, healthcare, housing and elderly care on personal income tax for public consultation[3].
• Near term effects: We also notice other government departments are following the trend and cutting taxes. Consumers should see a boost of confidence to spend, at least temporarily.
• Our view: The key is how much and when the government is willing to run a larger fiscal deficit, either through a larger fiscal stimulus or lower taxes. We will focus on the benefit as well as potential costs, rather than the gross impact of the tax cut on a standalone basis. We also note that the personal tax cuts are done through changing the tax brackets and deductibles. It’s almost impossible to quantify a ballpark impact especially in a country with massive population like China and its poor tax collection.

Shadow banking:

• What happened: China Banking and Insurance Regulatory Commission (CBIRC) issued a consultation paper on banks’ wealth management subsidiaries (WMS) for banks to shift its wealth management operation from the parent bank to the independently managed WMS, and non-standard credit assets (NSCA) are capped at 35% of the AUM of wealth management products but no longer limited to 4% of parent bank’s assets [4].
• Near term effects: This policy should relieve some of the funding pressure for the smaller banks in China, which have been relying on wealth management products.
• Our view: It could take 1-2 quarters to see the early signs of the potential impact. Our primary focus is on the overall banking system leverage as indicated by total social financing (TSF) growth and the structure of the TSF. The execution of the WMS and roll-over of NSCA is likely to drive the leverage trend in the next 12 months. We’ll also pay close attention to the capital raising activities of the Chinese financial institution.

The key challenge for China at this juncture is to balance gaining self-sufficiency on strategic initiatives such as technology, maintaining economic stability and managing the ongoing US-China tension. This challenge is further complicated by a fragile global market sentiment and recent weakness in the Chinese market; China stock market gains made last week were almost wiped out and the Renminbi against the US Dollar is approaching 7.0 once again. Although China’s market performance is already better than some countries elsewhere on a relative basis, it’s also true that China is swimming against the tide.

Stronger “bazooka-like” policy tools remain a possibility should the economy continue to deteriorate. A few possibilities include, running a larger fiscal deficit, much looser monetary policy, further currency depreciation, and policy-driven SME guarantee schemes. The question remains:  Is the Chinese economy healthy enough to stabilize on “band-aid” policies, is further policy intervention needed, or is the government already too late in deploying their “bazookas”. We believe it’s the former case for now. The macro indicators are suggesting moderate economic growth in China, and although we continue to see more default cases; we have not reached the pace of deceleration experienced in 2008. Our conclusion is the “China put” theory: We will probably see stronger policies when the economy deteriorates further from here. The investment implication for investors with exposure to China is to stay nimble and to look for downside protection. Remember, liquidity is king in volatile markets, and in such an environment its best to stay up in quality and diversified.

[1] Orlik and Chang (23 Oct 2018), “CHINA REACT: Stimulus – Cross-Cutting? Yes. Big? Unclear”, Bloomberg

[2] Bloomberg News (23 Oct 2018), “PBOC Is Said to Plan 10 Billion Yuan to Help Private Bond Sales”, Bloomberg

[3] Chang (22 Oct 2018), “CHINA REACT: Tax Cut Plan Broadens Multi-Pronged Growth Aid”, Bloomberg

[4] Bloomberg News (19 Oct 2018), “China Issues Draft Rules on Banks’ Wealth Management Units”, Bloomberg