At a press conference in Beijing, People’s Bank of China (PBOC) governor Pan Gongsheng introduced a series of monetary reforms designed to boost investment and consumption.

Reserve requirement ratio (RRR) reduction

The PBOC will reduce the RRR – the amount of money banks must keep aside and cannot lend out – by 50 basis points, which will release approximately CNY 1 trillion (£107 billion) for new lending. This reduction may be followed by a further cut of 0.25 to 0.5 percentage points later in the year, depending on market liquidity​.

Interest rate cuts

The seven-day reverse repo rate – the interest rate at which the PBOC lends money to commercial banks for short periods, using government bonds as collateral – will be lowered from 1.7% to 1.5%. Other key rates will also be cut to encourage borrowing​.

Mortgage and property market support

Average interest rates for existing mortgages will be reduced by 50 basis points. Furthermore, the minimum down payment requirement for second homes will be cut from 25% to 15%.

A CNY 300 billion (£31.9 billion) fund, introduced in May and initially 60% funded by the central bank, will now be fully funded by the central bank to encourage local governments to purchase unsold homes and convert them into subsidised housing​.

Capital market tools

A CNY 500 billion (£53.3 billion) swap programme will be introduced, allowing companies (funds, insurers, and brokers) to provide assets like shares or bonds as collateral to the central bank in exchange for credit or cash, enabling them to access liquidity more easily for stock purchases​.

A separate CNY 300 billion facility will offer cheap PBOC loans to commercial banks to finance share purchases and buybacks​.

Response

Global equities reacted positively to the news, reaching record highs, with Asian, European, luxury, car, and mining stocks benefiting the most.

According to analyses of the stimulus measures published by outlets including SCMP and Reuters, economists have largely welcomed the measures, although some have argued that they are insufficient to fully revive the economy.

Experts suggest that fiscal, rather than monetary, stimulus has historically been more effective and may still be necessary to meet the 5% growth target for 2024.

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On Saturday, 3 August, the State Council, China’s highest administrative governing body, issued a wide range of suggested consumption-boosting steps to all levels of government. The steps (available in Chinese here) aim to address China’s ongoing struggle with poor consumer demand, which is proving to be a drag on GDP growth.

Some of the key consumption-boosting measures included:

Catering: The government aims to boost the catering sector through food culture (e.g., food festivals, unearthing and developing local foods, tying tourist locations such as villages to signature dishes) and encouraging international catering brands to establish operations in China.

Accommodation: The tourism sector has been doing well in recent months, and the government hopes to build on this success by better integrating accommodation with tourist sites, improving the foreign-related services provided by hotels (a key complaint for some foreign visitors to China, as we wrote earlier this year) and revitalising idle rural houses to be used as rural hotels and homestay inns.

Tourism & Entertainment:

• Encouraging the development of new leisure tourism areas including cruise ships, yachting, and outdoor sports.
• Strengthening regional culture and increasing the supply of cultural performances and films.
• Improving the quality of online literature, online performances, online games, radio and television, and online audiovisual content.
• Accelerating the development of ultra-high-definition television and encouraging the development of new formats such as immersive experiences, role-playing games, digital art, and online performances.

New Types of Consumption: Companies will be encouraged to cultivate unmanned retail stores and self-pickup lockers. The government will also offer support for the development of esports and livestreaming e-commerce (the latter is already worth trillions of RMB).

One of the ways the above goals will be achieved is by enhancing financing support for eligible small and micro enterprises in the service industry. The government has also proposed implementing additional personal income tax deductions to offset the cost of caring for infants and children under three, as well as expenses related to education and support for the elderly to boost the so-called ‘silver economy’.

These proposed measures came just days after the government announced a $42 billion stimulus package aimed at renewing large-scale equipment and replacing outdated consumer goods with new ones.

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This years’ annual plenary meetings of the National People’s Congress (NPC) and the Chinese People’s Political Consultative Conference (CPPCC) – also called the Two Sessions (or Lianghui in Chinese) – stood in sharp contrast to the general political atmosphere both in China and worldwide. While the country faces the worst Covid outbreak since the start of the pandemic and the world watches in horror at Russia’s invasion of Ukraine, China’s government is focusing – almost stoically – on its policy of fiscal consolidation and limited monetary support. 

Jobs and innovation remain Beijing’s answer to nearly all policy problems, and while this is good news for businesses, the focus on ‘stability’ also harbours new risks. A lack of consensus over the direction of Xi Jinping’s policy of ‘Common Prosperity’ and the uncertainty over Li Keqiang’s successor will make ‘reactive’ policy adjustments more likely, thus increasing uncertainty for both foreign and domestic businesses in China. 

Background 

First things first. China’s government wants its economy to grow by at least 5.5% this year. This is slightly lower than last year’s target of 6%. The figure itself came as scant surprise as Chinese provinces – which published their own targets ahead of the Two Sessions – had already zeroed in on the same objective. 

Yet as Chinese Premier Li Keqiang pointed out in his traditional press conference at the end of the Two Sessions, China’s ever-increasing GDP – which reached £13.8 trillion last year – makes it more difficult to reach the stellar growth numbers seen a decade ago. In fact, even a 5.5% increase would add around £760 billion to the Chinese economy – more than the whole economy of the Netherlands. 

Yet achieving this goal won’t be easy. Several analysts, including CBBC, therefore expected a significant monetary stimulus in the first quarter of the year. Yet the Chinese government has largely stuck to its supply-side oriented fiscal measures. As Li Keqiang explained at the press conference on 11th March, tax refunds and fee reductions are considered the fastest and most direct way to help businesses.

Nonetheless, China will transfer around RMB9.8 trillion to local governments and increase subsidies to cash-strapped localities by around 18% compared to last year. In total, government spending will rise by 12.8%.

Nominal GDP value change and official GDP growth (in %) (Source: National Bureau of Statistics, Xinhua)

But Li has also made clear that the extra money will focus on two things. First, social services, such as education, healthcare and better access of social services for migrant workers. Public spending on education should remain at around 4% of GDP, with a greater emphasis on reducing tuition fees for poorer kids. The government also wants to extend its basic healthcare coverage and raise coverage of treatment for the most common diseases to at least 70%. Finally, digitalisation of social services should make it easier for migrant workers to access social benefits. 

Second, local governments are expected to do more to help Micro- and Small Enterprises (MSEs). Those companies – which account for over two-thirds of Chinese private businesses – were particularly hit by the pandemic, especially in the hospitality and tourism sector. A survey conducted by researchers at Peking University in collaboration with the Ant Group Research Institute found that only 30.6% of MSEs have returned to pre-pandemic turnover levels. 

At the same time, MSEs have become the preferred solution to deal with unemployment. Rather than providing unemployment benefits – for which many local governments don’t have funds anyway – Chinese authorities have promoted self-employment as a way to keep people off the streets. Supporting these businesses via loans and tax cuts will therefore become an increasingly important task for Chinese policymakers.

Common Prosperity and jobs 

Indeed, job creation – rather than welfare benefits – remains the principal concern for the Chinese government. According to Li Keqiang, China needs at least 11 million new jobs every year for its college graduates alone. This year 10.76 million young Chinese are expected to graduate from an institution for tertiary education, including vocational schools. However, this excludes around 45% of the cohort who are entering the labour market directly upon – or even without – gaining their high school degree. On top of that, 300 million migrant workers as well 200 million gig workers will need stable employment, too. 

How does this tie in with China’s new policy of ‘Common Prosperity’ – the concept which emerged last year as a ‘guiding principle’ for the much-touted ‘New Era’. Concrete proposals for how this can be achieved were conspicuously absent from the week-long gathering. What’s more, ambitious reforms such as the planned ‘property tax’ have – once again – been shelved until further notice.

As noted in an earlier update on Common Prosperity, the Chinese government seems – at least for now – to be unwilling to significantly ramp up government benefits which could help create a modern ‘welfare state’ – as some Chinese economists have suggested. Instead, jobs, not benefits, remain the top priority.

New urban jobs added annually (Source: National Bureau of Statistics)

Regulatory risks 

While lower taxes and fees are good news, Chinese regulatory risks will continue to occupy board room discussions in both China and the West. Ironically, Beijing’s focus on stability heightens this risk. Keeping a ship steady in stormy waters – i.e. Covid, real estate woes, and geopolitical tensions – is more difficult if there is no clear long-term development plan. 

Even though more spending on R&D and ‘high-tech infrastructure’ is certainly helping some industries, Li’s remarks on job security underline the risk from weak consumer spending and a struggling real estate sector. Additionally, more ‘existential’ concerns, such as China’s collapsing birth rates – which drove last year’s bombshell decision to ban private tutoring businesses – add further uncertainty to China’s regulatory environment. As result, ad-hoc reversals and awkward policy implementation might well become more frequent. 

The CBBC View 

Despite its usual grandiosity, this year’s Two Sessions appeared to be more like a ‘farewell event’ for the current government under Premier Li Keqiang than a ‘rally’ for an ambitious reform push. Li himself admitted that this was his last Two Sessions as Premier and the unwillingness to leave unfinished business for his successor might indeed partly explain the stoic focus on financial stability and job security. 

Apart from this observation, there are two main takeaways for foreign businesses. First, the Chinese government’s focus on innovation and entrepreneurship as an answer to slowing growth is a positive sign for businesses. In particular, high-tech industries will benefit from China’s continued upgrading of manufacturing capacity, supply chains and digital communication technologies. Individual entrepreneurship also provides new opportunities for professional and financial services as small companies or individual founders will require expert support to run their businesses. 

The downside of Beijing’s emphasis on stability is that regulatory changes will become more ‘reactive’ and event-driven. Some of these events are ‘Grey Rhinos’ – to borrow Michele Wucker’s term for challenges which are obvious but neglected. This includes Covid and China’s struggling property sector. 

Other risks are less obvious. For example, Beijing’s worries over the country’s demographic decline and the desperate push to ramp up birth figures are much harder to gauge. Embellished statistics and obscure political rhetoric might be a boon for Western ‘tea leaf readers’, but also make it fiendishly difficult for businesses to adopt to sudden changes. 

While 2022 might therefore offer numerous new opportunities, it could also be less ‘stable’ than many are hoping for.

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The latter move has attracted most attention in the foreign media, owing to its unpredictable impact on the tense situation in Hong Kong and China’s relationship with the US. The former step, though, could have a far bigger impact on the business environment in China.

Civil Code

The Civil Code, which will take effect on 1 January 2021, is China’s first comprehensive legal framework for personal and private property rights, and includes laws regulating contracts and torts. The Chinese government has tried to establish a civil code since the 1950s: the current legislation, which was first introduced in 2014, is its fifth attempt.

During the six-year-long process, the code attracted widespread attention and lawmakers received over 900,000 public comments.

Although it is largely based on existing laws, eg the 1986 General Principles of Civil Law, and does not cover disputes between private parties and state entities, the new code removes inconsistencies and establishes a common legal terminology. It also clarifies contractual obligations and liabilities, especially for non-incorporated businesses, thus enhancing their legal protections.

While there might be few immediate consequences, the passing of the code itself marks a milestone in China’s legal development. It firmly entrenches individual and property rights in the country’s legal system.

Li Keqiang: Economic recovery is top priority

As in previous years, the Two Sessions ended with a press conference given by Chinese Premier Li Keqiang. Li defended the government’s decision not to set a fixed economic growth target for this year, adding that to do so would have been unrealistic given that the global economy is expected to shrink by 3 percent in 2019. Nonetheless, he was optimistic that China would achieve positive growth by the end of 2020.

Li announced that the government would inject a total of RMB 6 trillion (£680 billion) into the economy. One-third of that would be in the form of special bonds, whereas the rest would be achieved via tax cuts and other cost reductions. In total, these cuts should free up around 10 percent of Chinese aggregate annual income of RMB 40 trillion (£4.55 trillion).

The Premier repeated that this stimulus effort would be more targeted than the indiscriminate post-GFC stimulus effort which China launched in 2008, and which led to massive infrastructure spending, as well as multiple asset bubbles. Instead, most of the money will be used to safeguard jobs, and to broaden China’s social security net, he said.

Li made special mention of the 8.57 million graduates who are expected to enter China’s job market this year, as well as the country’s 200 million migrant workers. He also expects that the number of people relying on basic social transfer payments – currently estimated at around 60 million – will probably increase. Local governments should therefore use the additional funds to protect these vulnerable groups, he said.

Boost private businesses

The premier also stressed the importance of China’s private sector and the role of Chinese SMEs. According to Li, these firms provide 90 percent of total employment in China and should receive 70 percent of the government’s additional funding.

Pointing again to the difference with previous stimuli, Li said the extra money injected by the government would be aimed primarily at keeping these 120 million businesses afloat and at creating a fertile ground for new business ventures. The ultimate objective, Li said, is to create 20,000 newly registered companies per day this year.

On foreign trade and investment

Finally, Li highlighted the importance of foreign trade and investment. He stressed that the Chinese government remains committed to further opening up its economy and to collaborating with neighbours – South Korea and Japan in particular – to deepen economic integration. He indicated that China remains committed to its goal of concluding the Regional Comprehensive Economic Partnership this year, which would establish a free trade agreement between 15 regional countries, including Australia and New Zealand.

Li’s reassurance to foreign business follows an article published on Monday by the economic editor-in-chief of the People’s Daily, Lu Yanan, who emphasised the importance of FDI for the Chinese economy. Lu noted that big-ticket investments, such as energy projects and advanced manufacturing, are a significant part of China’s recovery strategy.

CBBC View

The outcome of this year’s Two Sessions highlights, above all, the seriousness of the economic impact of COVID-19. The government’s main concern clearly lies with protecting local businesses and shielding the Chinese economy and vulnerable economic groups from the looming global recession.

While there is disappointment among some China watchers about the lack of market-based reforms, the government’s cautious attitude is probably warranted, given the high degree of uncertainty. Chinese leaders want to play safe before committing themselves to new growth targets.

Li’s restraint with regard to a large monetary stimulus also reflects both the split attitude within the Chinese leadership (CBBC has written about this before) as well as the painful lessons learnt from previous rounds of economic stimulus, which have led to major misallocations of capital and numerous asset bubbles.

Nonetheless, Li’s particular emphasis on the private sector and China’s social welfare safety net are positive signs because they address two major structural problems: the persistent bias of local governments and banks towards favouring state-owned enterprises, and China’s insufficient social protections, which suppresses consumption. If the short-term measures announced during the ‘Lianghui’ are followed-up by a general and long-term policy shift, the government’s prudent approach could indeed succeed in setting China’s economy on much more sustainable path.

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