Analysts Warn That China Needs More Than Rate Cuts for Economic Recovery

China’s slowing economy requires more than just interest rate cuts to spur growth, analysts caution. Despite a recent surprise rate reduction by the People’s Bank of China, which included cuts to existing mortgage rates, experts argue that substantial fiscal policy support is necessary.

According to Edmund Goh, head of China fixed income at abrdn, achieving higher government bond yields hinges on major fiscal intervention. CF40, a prominent Chinese think tank, has highlighted a projected shortfall of 1 trillion yuan in spending for the year, indicating that Beijing will need to ramp up fiscal efforts to meet its targets.

Larry Hu, chief economist at Macquarie, believes that fiscal spending, particularly in housing, is essential for re-inflating the economy. While mainland Chinese stocks responded positively to the rate cuts, the bond market reacted with caution, as the 10-year government yield fell to a record low of 2% before slightly rebounding.

Market dynamics show a widening gap between U.S. and Chinese bond yields, primarily driven by diverging growth expectations. The U.S. Federal Reserve’s aggressive rate hikes have led to a scenario where U.S. yields are now higher than China’s for the first time in over a decade.

Despite recent cuts, analysts like Yifei Ding from Invesco maintain a neutral outlook on Chinese government bonds, expecting yields to remain low. China’s economy grew by 5% in the first half of the year, but without additional stimulus, concerns linger that the country may fall short of its annual growth target.

Fiscal stimulus hopes are tempered by the Ministry of Finance’s conservative approach, which has kept the fiscal deficit target at 3% despite an increase to 3.8% in October. CF40 suggests that if budget revenue does not recover significantly, Beijing may need to increase the deficit and issue more treasury bonds.

PBOC Governor Pan Gongsheng noted that the decline in government bond yields is partly due to slower bond issuance, and analysts anticipate that the Chinese 10-year bond yield will remain above 2% in the near future.

Haizhong Chang from Fitch Ratings emphasized the importance of fiscal stimulus alongside monetary easing to effectively transmit credit to the real economy, given the high leverage faced by Chinese corporates and households.

With U.S. interest rates dropping, there may be some relief for China’s financial markets. Louis Kuijs from S&P Global Ratings pointed out that lower U.S. rates could ease external pressures, but he still calls for more aggressive fiscal measures to support economic growth.