Statement on Monetary Policy – November 2024Box B: Economic Policy Developments in China

In late September, Chinese authorities announced a comprehensive package of economic stimulus measures. This was a notable change from the incremental and targeted measures implemented in recent years. This Box discusses the measures and possible implications for China and Australia.

Weaker-than-expected economic activity prompted Chinese authorities to act.

Chinese economic activity and core inflation have weakened significantly in recent quarters, in contrast to the modest improvement expected by authorities earlier in the year (Graph B.1). Domestic demand growth has weakened, local government revenues have declined and expenditure growth has slowed. Furthermore, the property market continues to contract, credit demand is declining, and household income growth and consumer sentiment remain weak. Recent announcements suggest that authorities are not willing to accept a sharp decline in economic activity, especially as this would hinder their ability to meet other objectives such as deleveraging in the local government sector.

Graph B.1
A two-panel graph showing the six-month annualised growth in China’s GDP and Core CPI. The left panel shows that China’s GDP growth has declined significantly in the past two quarters. The right panel shows that six-month annualised core CPI inflation has fallen over the past two quarters and has recently turned negative.

The package includes fiscal, monetary and property market measures.

Fiscal policies

Authorities announced an increase in fiscal expenditure in response to weaker-than-expected economic activity, which has been driven partly by pressure on local government finances. Local governments will be allowed to issue an extra CNY400 billion in local government debt this year (using unused bond quotas from previous years) and authorities have indicated that additional fiscal stimulus will be forthcoming. Authorities are reportedly considering issuing an additional CNY2 trillion of central government special-purpose bonds, with around half expected to be used to support consumption and business investment and the rest to address local government fiscal pressures. While this is a material increase in fiscal expenditure, government expenditure as a proportion of GDP is still projected to be 2.6 per cent lower than budgeted this year (Graph B.2).

Graph B.2
Graph B.2: A two-panel graph showing Chinese government spending relative to the March budget, and the issuance of extrabudgetary government bonds. The graph shows government spending has been lower than budgeted in each of the past five years, and is expected to be 3.3 per cent of GDP below budgeted spending in 2024. Issuance of extrabudgetary government bonds has been high over the same period, and is expected to grow to its highest level yet in 2024 due to forthcoming fiscal stimulus. However, the additional issuance expected is small relative to the shortfall of government spending.

Monetary policies

Since late September, the People’s Bank of China (PBC) has reduced its key policy rates by up to 30 basis points and lowered the reserve requirement ratio by 50 basis points (Graph B.3).[1] These rate reductions and the forward guidance that further policy rate reductions may be required, contrasts with the earlier more gradual approach of the PBC. Although nominal interest rates have declined to historical lows, real interest rates remain well above their historical averages due to low inflation, which is one factor that has contributed to ongoing weakness in credit demand.

The PBC has also announced further liquidity support for the stock market – in the form of a CNY500 billion swap facility and a CNY300 billion relending facility, which appear to be aimed at supporting market sentiment. Authorities are also reportedly planning to inject capital into the largest state banks to support their capacity to increase lending to households and businesses in the face of an impending increase in non-performing loans and declining profitability. Funding for the capital injection is likely to come from the issuance of special sovereign bonds.

Graph B.3
A two-panel line graph showing China’s reserve requirement ratios in the left panel, and key lending rates in the right panel. It shows reserve requirement ratios and key lending rates are lower than at the start of 2024.

Property sector and mortgage support

Also in September, authorities committed to ‘stop the decline’ in property sector activity and have announced plans to expand and increase the effectiveness of existing property support, such as directing banks to lend to ‘whitelisted’ projects. The PBC’s measures to support the property sector include expanding measures that support lending to state-owned enterprises to purchase housing from developers and directing banks to lower existing mortgage rates. It is estimated that the latter will save households CNY150 billion (0.3 per cent of household consumption in 2023) annually, thereby supporting household consumption. It is unclear how effective the new measures will be in supporting sales and investment because they largely extend existing support measures, which have not yet stabilised the property market.

Markets have responded positively to these announcements and the economic outlook has improved.

The policy package should boost sentiment and be more effective in supporting Chinese domestic growth than previous, incremental monetary policy and property sector measures – particularly if the fiscal support is substantial. Indeed, the initial financial market reaction to the announcements was positive and significant, and iron ore prices rebounded sharply from recent lows (see Chapter 1: Financial Conditions; Chapter 2: Economic Conditions). However, the measures have so far had only a modest impact on housing sales.

Overall, these measures are expected to boost growth from next year and have led us to upgrade our forecast for China in 2025 and 2026 modestly (see Chapter 3: Outlook). While CNY2 trillion of additional spending is large (at around 1.6 per cent of GDP), the revision to our forecast for Chinese growth in 2025 relative to the August Statement is much smaller. This is because some expectations for further stimulus had already been factored in, and the stimulus is partly offset by the weakening activity and local government positions to which the authorities are responding.

Stimulus in China will affect Australia primarily through commodities.

China is Australia’s largest trading partner and developments there have a direct effect on demand for our exports. However, developments in China also affect demand for our exports indirectly, through their effect on growth in Australia’s other major trading partners, such as Japan and South Korea. Resource exports comprise more than 60 per cent of Australia’s exports, and changes in the growth outlook for our trading partners would support export revenues – most importantly, boosting prices of iron ore and coal, which are two key inputs in steel production.

The overall impact of the fiscal stimulus package on Australia will be affected by both its size and its composition. If the authorities’ stimulus is more focused on consumption than investment, then the impact on steel demand in China – and demand for Australia’s commodity exports – would be smaller than in the previous episodes of fiscal support.

The impact of changes in demand for key resource exports is expected to be mostly through export prices and Australia’s terms of trade rather than large changes in export volumes. Mining investment and output in Australia has become much less price sensitive since the previous investment boom, with mining firms focusing on long-run price fundamentals and maintaining export volumes. Australian export volumes are resilient to price declines because Australian production costs are among the lowest in the world.

A higher terms of trade boosts national income, with the most direct effects on mining sector and government revenues. The current forecast for the terms of trade is higher than it would have been absent stimulus announcements in China, and there remains some upside risk if the stimulus is ultimately larger or more resource intensive than forecast (Graph B.4). The Australian dollar exchange rate continues to act as a shock absorber for the Australian economy in response to movements in the terms of trade and developments in China (see Chapter 1: Financial Conditions).

Overall, the positive effects of stimulus could be amplified by an improvement in sentiment in China, Australia and globally, with flow-on effects to consumption and activity.

Graph B.4
A line graph showing the terms of trade from 2022 to the current level, along with the RBA’s terms of trade forecasts under different China stimulus scenarios. It shows the central forecast, a pre-stimulus announcement forecast, and an upside scenario forecast. The central forecast is for the terms of trade to gradually decline over the forecast period, but to decline at a slower pace and to remain at a higher level than the pre-stimulus forecast. The upside scenario shows the terms of trade increasing until mid-2025 before declining back to the same end point as the central forecast by early 2026.

Endnotes

For an explanation of policy instruments used by the PBC, including the reserve requirement ratio, see Maher W (2024), ‘China’s Monetary Policy Framework and Financial Market Transmission’, RBA Bulletin, April. [1]