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China’s slowing economy is showing signs that interest rate cuts alone may not be enough to revive growth, according to several leading analysts. The People’s Bank of China (PBOC) surprised markets on Tuesday by announcing multiple rate cuts, including a reduction for existing mortgages. While this news sent Chinese stocks surging, experts believe more extensive measures, such as fiscal stimulus, are required to see a real economic turnaround.
Larry Hu, chief China economist at Macquarie, noted, “This move could signal the beginning of the end of China’s longest deflationary streak since 1999.” However, he emphasized that the rate cuts need to be backed by significant fiscal spending, particularly on housing, to create lasting growth. Analysts agree that weak domestic demand continues to weigh heavily on the economy.
Despite positive reactions in the stock market, the bond market remained cautious. Chinese 10-year government bond yields initially dropped to a record low of 2% following the rate cuts but stabilized at 2.07%. By comparison, the U.S. 10-year Treasury yield stands at 3.74%, a significant gap reflecting differing economic outlooks between the two nations.
Edmund Goh, head of China fixed income at abrdn, stated that without strong fiscal policy support, it’s unlikely Chinese government bond yields will rise. He anticipates more aggressive fiscal stimulus from Beijing due to ongoing weak growth, even though the Chinese government has been reluctant to take this step.
For years, China’s bond yields traded higher than U.S. counterparts, making it an attractive investment. However, since April 2022, U.S. yields have outpaced China’s, largely due to aggressive rate hikes by the U.S. Federal Reserve. Despite the Fed shifting to a more relaxed monetary policy, the yield gap between the U.S. and China continues to widen.
China’s economy grew 5% in the first half of 2024, but there are concerns that full-year growth could fall short of the government’s target without additional fiscal stimulus. Industrial activity has slowed, and retail sales have barely grown by 2% year-on-year in recent months.
While there has been some fiscal spending, analysts say it hasn’t been enough. The Ministry of Finance has remained conservative, with a 3% deficit target for 2024. According to a report by the China Finance 40 Forum (CF40), a prominent Chinese think tank, there’s a 1 trillion yuan shortfall that needs to be addressed if Beijing is to meet its spending goals for the year.
Louis Kuijs, APAC Chief Economist at S&P Global Ratings, noted that although the U.S. rate cut last week provides some relief for China’s currency and exports, the country’s economic growth will still depend on more aggressive fiscal stimulus. “Bond issuance has been slow, and there are no signs of substantial fiscal stimulus plans,” Kuijs said.
The PBOC Governor Pan Gongsheng acknowledged the issue, indicating that the central bank is coordinating with the Ministry of Finance on bond issuance, and stressing that more comprehensive fiscal support is needed to achieve meaningful economic growth.
In the short term, experts predict that Chinese bond yields will remain stable around 2%. Haizhong Chang, executive director of Fitch (China) Bohua Credit Ratings, explained that fiscal stimulus, combined with monetary easing, is essential for transmitting credit to the real economy.
