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On 24 September, the People’s Bank of China (PBoC) announced China’s biggest monetary stimulus package since the COVID-19 pandemic. The aim is to tackle the prolonged slowdown of the Chinese economy through a combination of monetary easing and the lifting of macro-prudential constraints that sought to cool the housing market. PBoC governor, Pan Gongsheng, also announced the setting up of two funds (so far with a total of 800 billion renminbi) to support the stock market, either by financing stock purchases or through buy-backs.

This triggered a strong but fleeting stock market rally. But then investors started asking questions, such as about the size of the fiscal package accompanying the monetary stimulus. The National Development and Reform Commission was expected to offer further details on the fiscal package in early October but this didn’t materialise, leading to a rapid correction of the stock market rally. A second chance to clarify was given to the finance ministry, with a press conference on 12 October, but this still did not offer any estimate of the stimulus and instead shifted the focus towards what on the face of it looks much more like a rescue package than a stimulus.

The expectation had been that the stimulus would involve support to households, given the lack of recovery in private consumption post-COVID-19. So far, no relevant measures have been announced on that front, except for those related to mortgage refinancing and lower downpayments. The impact of such measures will be limited as Chinese households are generally not credit constrained.

Chinese consumption is weak mostly because of lack of confidence in the future economic outlook, and because of the lack of public or private insurance mechanisms – including unemployment benefits, healthcare and pensions – to smooth out consumption over time. No reforms related to these have been announced.

Instead, the finance ministry introduced three mechanisms to support real estate developers, local governments and banks, given their difficult situation. In other words, the package seems to be much more about risk control than stimulating the economy, as there are too many contingent liabilities that need to be covered. To summarise the three rescue areas:

• Support to real estate developers could amount to 4 trillion renminbi ($561 billion), but it is unclear what the timeframe is and how this will be financed.
• Local governments will be allowed to recognise their hidden debt through debt swaps (with rumours circulating that $855 billion will be needed for this).
• Banks will be recapitalised, but details on the amounts needed have not yet been public. The total amount to clean up is bound to be big.

Money is therefore going to cover losses and not stimulate new activity. The package is thus not comparable to the 2008 stimulus, which amounted to 4 trillion renminbi (and which ended up being much more, approximately 30% of China’s GDP at the time), spent on new housing and infrastructure.

The nature of the measures announced in September also means that the rest of the world should not expect China to grow much faster next year. Most projections (including the International Monetary Fund’s latest revision) expect China’s real GDP growth rate to be lower next year than this year (4.5% versus 4.8%).

This does not mean though that the new measures are not positive. The clean-up is desperately needed to avoid a hard landing stemming from financial instability. There are many potential sources of financial stability, from the ailing real-estate sector to local governments’ poor finances to the increasingly weak banks. Any mismanagement in addressing these three areas could trigger systemic risks, which the Chinese economic authorities are trying to avoid.

Finally, protracted deflationary pressures need to be tackled before they become fully entrenched. They arise from over-competition and the piling up of bad assets in the economy. The current rescue package aims to reduce that burden. In this context, the announced measures can be understood as a prerequisite for any future, more conventional stimulus, oriented towards supporting consumption. This second stage of the stimulus package should involve transitioning toward a more-balanced economic model that prioritises domestic consumption over industrial capacity.

This second stage cannot be achieved fully without structural reforms to address the root causes of China’s macroeconomic imbalances, in particular the lack of consumption and the excess savings. Financial markets now seem to understand that China’s announced stimulus will start with a deep cleaning of its most important sources of systemic risk. The growth implications will not be the same as a stimulus package. Markets must wait longer for a true stimulus, but the clean-up is surely a good start, given the growing fragility of the Chinese economy.

ZhōngHuá Mundus is a newsletter by Bruegel, bringing you monthly analysis of China in the world, as seen from Europe.

This is an output of China Horizons, Bruegel's contribution in the project Dealing with a resurgent China (DWARC). This project has received funding from the European Union’s HORIZON Research and Innovation Actions under grant agreement No. 101061700.