China Stimulus Update: Debt Swap Program Underwhelms Investors

Last week, the National People’s Congress meeting concluded on Friday with a press conference discussing the latest measures/announcements. Generally, the announcement was underwhelming on the size and scope of measures.

To recap, China’s economy faces three key headwinds:

• Local governments are heavily indebted, which is a challenge as they have been responsible for delivering stimulus measures in the past
• The property market remains a drag, with construction still weak and developers struggling
• The consumer is reluctant to spend, given the uncertainty around the property market and the economy more broadly

These challenges have been reflected in the declining 10-year government bond yield, which has fallen from 3% at the start of 2023 down to 2.1% as of Nov. 11.

What’s in China’s debt package?

Friday’s announcement only dealt with the first of these three. The Chinese government announced it will allow local governments to issue 6 trillion yuan of bonds to conduct debt-for-debt swaps over the next three years, to reduce the interest expense. We think this is underwhelming because the size of the package comes in at the lower end of market expectations and will be spread over a longer time (market participants had expected it over two years). Additionally, it would have been encouraging and welcome if the central government had used their balance sheet to conduct these debt-for-debt swaps, given that the central government has a healthy balance sheet.

We had expected that there would be some extra detail on the property inventory purchase program that had been announced in August, as well as the potential for some measures to try and boost household consumption—but there was no discussion about either of these.

This doesn’t mean that China has given up on trying to stimulate the economy. We have seen some incremental improvement in the economic data over the last month, and so this may be giving the Chinese government a bit of room to adjust. Given stimulus measures have been reactive to softer data, a bout of softer data would likely lead to more measures. Looking ahead, the market will now turn its attention to the Central Economic Work Conference in December, where we will get a sense of what the growth target will be for 2025.

What are the potential market impacts?

So what does this mean for emerging market (EM) equities and Chinese equities? While we think the Chinese economy does need more stimulus, it’s important to note that equity markets are already pricing in a lot of the softness. For instance, EM equities are trading at a 30% discount to global equities, and Chinese equities are trading at a 15% discount to EM (as the chart below shows).

Additionally, an increasing number of Chinese companies have been engaging in stock buybacks. We believe this is a positive sign that corporates are increasing their attention on shareholder returns, like developments in Japan and more recently South Korea. The chart below shows return on equity for China, EM and global equities. Notably, Chinese return on equity has been improving and closing the gap with broader EM.

The bottom line

The Chinese economy continues to face some headwinds, with stimulus announcements thus far generally underwhelming. We believe that equity markets are pricing in a lot of this news, with Chinese equities cheap relative to broader emerging markets. Ultimately, despite the softer economic backdrop, Chinese corporate fundamentals have been improving, which is an encouraging development for investors.

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