After many months of resisting calls for a sizable stimulus to boost economic growth, the People’s Bank of China (PBOC) finally delivered one last week. It announced a significant easing of monetary policy: the central bank’s main policy rate was reduced from 1.7 percent to 1.5 percent, while the reserve requirement ratio of banks was reduced by 0.5 percent. The latter would effectively inject 1 trillion RMB ($142 billion) into the banking system.
Even more surprisingly, the PBOC announced an 800 billion RMB fund for the country’s capital markets, comprising funds to lend to companies to buy their own shares and to non-bank financial institutions to buy Chinese equities. This is the first time that the authorities are providing debt to spur investment in Chinese stocks.
The PBOC’s announcement was followed by a statement from China’s Politburo, which announced that it would step up fiscal spending to support growth. This comes after months in which the authorities showed no signs that they would provide meaningful fiscal support for households, even as many endured falling asset values.
The announcements caught almost everyone by surprise. Until last week, the authorities had stubbornly resisted calls for more aggressive monetary easing to ward off the deflationary pressures that have afflicted China for two years. Chinese stocks have fallen for an even longer period; before last week, the benchmark CSI 300 index had lost nearly 45 percent from its peak in February 2021.
Not surprisingly, financial markets have cheered last week’s announcements. The CSI 300 rose by more than 24 percent in the week after the PBOC’s announcement – its best performance since November 2008.
What remains to be seen is what kind of fiscal support would be put in place to bolster household consumption, and whether there would be a more determined effort to stabilize property prices that have been falling for more than two years.
Both are critical, as household consumption – more so than a stock market rebound – holds the key to the real economy improving. And since more than 60 percent of Chinese household wealth is tied up in property, household consumption is unlikely to recover until property prices stabilize.
Ideology and Morality in Policymaking
The surprise timing and scale of these announcements should prompt questions about why the Chinese authorities seem to have had such a Damascene conversion. While not as dramatic as China’s sudden abandonment of the zero-COVID policy in December 2022, the underlying reasons for the surprising turn in economic policy are quite similar.
As with zero-COVID, China’s economic problems of the last three years – the collapse in asset prices, the debt deflation dynamic that is reminiscent of Japan’s lost decades, and sluggish growth since the pandemic – are largely the result of ideologically driven policy choices. Zero-COVID was driven not by achievable or sustainable public health objectives, but by a highly ideological and politicized campaign to demonstrate the superiority of China’s system of governance over a supposedly callous and morally bankrupt West. Central and local government officials pursued zero-COVID zealously, often oblivious to the costs that strict enforcement of the policy entailed.
Similarly, China’s economic problems of the last three years are largely the consequence of ideologically motivated, morally charged policy campaigns. This included the crackdowns on consumer internet companies and private education, the regulatory strictures (termed the “three redlines”) that turned off the supply of credit to highly indebted property developers, and the drive for common prosperity that spooked investors and private firms.
Like zero-COVID, these campaigns were not the result of careful assessments of how problems in the economy should be dealt with, nor of pragmatic and calibrated ways to regulate the country’s fastest growing industries. Rather, they were implemented without much consideration of the damage they would cause – not just for the intended targets of the crackdowns, but also for the wider economy. Consequently, the collateral damage caused by these crackdowns probably exceeded whatever benefits they achieved.
For instance, even if the crackdown on consumer internet companies like Alibaba and Tencent was justified on grounds that these companies wielded monopoly power, it was quite likely that the heavy-handed ways in which the Chinese authorities went after them depressed investor sentiment and undermined the innovation capacity of China’s nascent technology sector.
In the aftermath of this crackdown, the Chinese venture capital industry – so critical in financing innovative start-ups – has virtually disappeared. The Chinese leadership even asked a few months ago, apparently without any hint of irony, why there seems to be fewer Chinese unicorns today.
Volatility and Fragility
Second, as with zero-COVID, the authorities stubbornly persisted with 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 policies in China can be.
In the case of zero-COVID, for nearly two years the Chinese state mobilized vast amounts of resources in an ultimately futile effort to suppress COVID-19, even after COVID vaccines had become widely available, and even after it was clear that every other country on the planet was already living with the virus. Only when the highly contagious Omicron variant caused outbreaks all over China in late 2022 did the authorities abandon, rather belatedly, the archaic zero-COVID policy.
Worse, the way in which the zero-COVID policy was suddenly replaced by a de facto COVID-for-everyone policy led to a far more traumatizing exit from the pandemic than if the authorities had planned for the transition, prepared the population for it, and communicated its intentions well in advance.
While last week’s announcements were not as dramatic or sudden as the end of zero-COVID, they still provided evidence of how policies can change unpredictably and suddenly. The risk with such sudden policy shifts – even if they are welcome – is that there is often little preparation for what comes next. Measures that are hastily put together when decision-makers suddenly change their minds may also create new problems and unintended consequences.
Take for instance the unprecedented measure by the PBOC to provide debt for companies to buy equities. Recall that the Chinese authorities had long wanted to reduce leverage in the financial system and to promote common prosperity. Using debt to promote purchases of Chinese equities 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 boost growth would be through fiscal transfers to households. But this requires more lead time. Other measures that would increase domestic consumption permanently, such as stronger social safety nets and reforms to the hukou system, would take even longer to develop and implement.
The Fallacy of Chinese Exceptionalism
The third parallel between last week’s surprising announcements and the sudden end of zero-COVID is that before both policy U-turns, there was a cottage industry of self-appointed defenders of Chinese exceptionalism. These figures saw their roles as stiffening the spine of the Chinese people in the face of policies that were clearly unworkable and defending these policies to the rest of the world.
With the pandemic, Chinese leaders had proclaimed that “perseverance with zero-COVID is victory.” Defenders of zero-COVID pointed to the millions of deaths caused by Western governments that had chosen to live with COVID. They claimed that unlike the decadent West, Chinese society and tradition valued lives and respected elders. When zero-COVID was suddenly abandoned, leading to the very dystopia that state media had mocked other countries for, the silence of these zero-COVID defenders was deafening. Like rats on a sinking ship, they abandoned their defense of a policy that the Chinese authorities now pretended had not existed.
Similarly, prior to last week’s announcements, these defenders of Chinese exceptionalism had argued that the authorities had little to learn from the experience of the United States during the Global Financial Crisis. They pointed to the high levels of indebtedness and the high inflation that quantitative easing and fiscal stimuli were supposed to have caused. They pontificated about how unlike the fiscally reckless U.S. or economically depressed Europe, China has always maintained a careful balancing act between growth and sustainability.
More egregiously, some even said that China was undergoing a “beautiful deleveraging” as part of its transformation into a high-quality, developed economy. According to these defenders, “a US$1 trillion property bailout is the last thing China’s economy needs,” and the falling stock market was a necessary and even healthy adjustment as China pivoted away from property investments and financial speculation to “new quality productive forces” (party speak for advanced manufacturing).
In light of last week’s announcements, intellectual integrity requires these defenders of Chinese exceptionalism to criticize the PBOC for using debt and monetary stimulus to boost asset prices and reflate the economy. But as with the defenders of zero-COVID, these monetary and fiscal hawks are more likely to slink away.
Alternatively, they may try to characterize the stimulus as being a prudent, carefully calibrated, and well-designed response that does not detract from the path of high-quality development. Clearly, these defenders of Chinese exceptionalism do not let facts get in the way of their good story.