It’s been a long time coming, but Beijing is finally ramping up economic support to counter the fallout from tariffs.
In this week’s podcast, Trivium Co-founder Andrew Polk and Dinny McMahon, Head of Markets Research, discuss the wave of monetary policy measures rolled out by financial regulators on Wednesday.
The gents get into the nitty gritty of China’s financial system – with forays into PBoC relending facilities, provident fund mortgages, and insurance companies’ capital requirements – to explain just what officials hope to achieve.
They then round things off with a chat about the latest developments in the US-China trade war, and touch on China’s plan to double down on exports in the years ahead.
Enjoy!
Full transcript follows:
00:00:10
Andrew Polk
Hi, everybody, and welcome to the latest Trivium China Podcast. A proud member of the Sinica Podcast Network. I’m your host, Trivium co-founder Andrew Polk, and I’m joined today by our head of markets research, Dinny McMahon. Dinny, it’s been a while since you’ve been on the pod, man. How are you doing?
00:00:25
Dinny McMahon
I’m doing great, mate. All the better for seeing you.
00:00:28
Andrew
Yeah. Glad to have you. I mean, it’s been a while, and it’s good timing today because there are a lot of things to discuss as far as China’s economy goes. And in fact, we are recording this episode at 2 p.m. Eastern time on Wednesday, May 7th. So, we always like to timestamp these. And just overnight on Wednesday in China, Chinese financial and monetary regulators have this big meeting where they announced sort of the first round of policy support moves for the economy since the trade war kicked into high gear in April.
00:00:55
So, exciting times to sort of see the domestic response as the challenges, the trade war pain starts to bite. So, today, we’re going to discuss the latest policy moves, including interest rate cuts, reserve requirement ratio cuts in relending facilities, and mortgage rate cuts. We’ll also touch on the official confirmation over the past 24 hours that the U.S. and China trade negotiators will meet for the first time this weekend in Switzerland. And, finally, just briefly at the end, we’ll touch on Dinny’s latest research that you’ve been working on for a while, kind of give readers a preview of that. We’ll be going through some of the key findings of that in upcoming pods. But this is partly why Dinny hasn’t been on the podcast as much lately, because he’s been finalizing this big research project. So, we’ll introduce that. But before we get into all of it, we have to start with our customary vibe check. Dinny, after a few months away from the pod, how’s your vibe, man?
00:01:47
Dinny
I think the whole world kind of has the same vibe at the moment. That is, no one really knows what’s going on, and everyone’s a little bit wary about what comes next and whether we should be sporting toilet paper. I think that’s where things are at the moment.
00:01:57
Andrew
I always hoard toilet paper (laughs).
00:01:59
Dinny
On an international level, on a personal level, I think the general vibe is great uncertainty, and that’s certainly seeping through into the Chinese economy as well.
00:02:08
Andrew
Yeah. I mean, this has been a consistent theme in terms of the vibes for our past few podcasts. I will say that, for me, the vibe today is hungry because I haven’t eaten all day, and I was just going to eat lunch right before I came on the pod, only to find the power is out in our kitchen, so my vibe is hungry. So, we’re going to be snacking on some delicious macroeconomic analysis, Dinny, for lunch — I know, I can see your face.
00:02:32
Dinny
That was awful. Awful. That’s what happens when you podcast on an empty stomach.
00:02:40
Andrew
That’s what listeners come for. I’m sorry. I’m sorry. All right, before we get into the meat of the discussion, I have to do the usual quick housekeeping to go through. First, a quick reminder, we’re not just a podcast here. Trivium China is a strategic advisory firm that helps businesses and investors navigate the China policy landscape. That, of course, includes policy towards China out of D.C., London, Brussels, and other Western capitals. So, if you need any help on that front, please reach out to us at hq@triviumchina.com. That’s hq@triviumchina.com. We’d love to have a conversation about how we can help support your business or your fund. Otherwise, if you’re interested in receiving more Trivium content, check out our website, triviumchina.com where we have a bunch of different subscription products, both free and paid.
00:03:23
You can check those out. You can definitely find something that will get you up to speed on China in whatever capacity you need. And finally, please, as always, tell your friends and colleagues about Trivium generally and about the podcast in particular. And while you’re at it, like and subscribe to the pod, leave us a rating. The more pod subscriptions and comments we get and ratings, the wider the reach is and the more free content we can put out into the world, and the more our business grows. So, helps out with that if you can. All right. Let’s get into it, Dinny. We’re going to start with the latest announcement on economic policy support that took place on Wednesday in China. As I said, there are sort of a spate of announcements. So, a bunch of the big financial regulators got together. They previewed this meeting in advance. So, it was pretty clear something was coming.
00:04:05
But the big announcements included the following. The first was at the PBoC, China’s Central Bank, cut the interest rate on seven-day reverse repos, that’s the main policy rate, by ten basis points to 1.4%. It also reduced the reserve requirement ratio for banks by 0.5 percentage points, freeing up about a trillion renminbi worth of bank liquidity, making it easier for those banks to lend. Meanwhile, the reserve requirement for auto finance companies and financial leasing companies was cut from 5% to zero. In addition, the PBoC cut the interest rate on loans borrowed from the government-run Housing Provident Fund by 25 basis points. So, this is to support the housing market or housing demand that the Housing Provident Fund is an employer-employee focused social insurance program designed to help citizens save for home purchases, often at below-market mortgage rates.
00:04:55
Under these cuts, which will take effect on Thursday, the Housing Provident Fund rate on mortgages with a duration of more than five years will follow the 2.6% and 2.85% previously for first homes. So, 2.6%. That’s pretty good. That’s kind of 2019 rates here in the States when people were paying 3% for a home mortgage. Rates are obviously much higher now. We’ll see if that does anything to support housing demand. But finally, the PBoC announced a slew of new relending facilities as well, including 300 billion renminbi for agricultural and small businesses, between 300 and 800 billion renminbi for innovation and technological upgrading, and RMB 500 billion to support service consumption and elderly care. That last 500 billion will specifically be for businesses in the elderly care, hotel, catering, entertainment, culture, sports, and education sectors.
00:05:48
All right. So, those are the big things really that came yesterday, Dinny. So, first things first, what do you make of all these moves sort of at the overarching level? Is Chinese authorities beginning to panic in the face of the trade war, or is this just a prudent policy support program or something in between? What do you make of it?
00:06:05
Dinny
Well, particularly when it comes to the interest rate cuts and the cuts to the bank’s reserve requirement ratios, the real question is why hasn’t this happened well before now? I mean, regulators, the government has been signaling that, yeah, cuts are coming for almost six months. So, back in December, the Central Economic Work Conference, which is the big get-together at the end of each year of policymakers to talk about the economy, in their big readout, they said that they would cut interest rates and cut the reserve requirement ratio in a timely manner. And we’ve heard this thing — in a timely manner — a number of times since then, which kind of seemed to be a signal that, yeah, interest rate cuts are coming. Finally, we had the Politburo at the end of April, kind of used similar phrasing.
00:06:48
Yeah, we’re going to cut these things when appropriate. That really is just slightly more of the same. I’d almost given up on cuts at all. So, the big question is really why it’s taken so long. The last time we had interest rate cuts, at least at the benchmark rate, which is what they cut today, the seven-day reverse repo, that was cut in September. So, what? Nine months ago? So, given the state of the economy, now, sure, headline growth is being fine, but everyone knows the economy’s weak. The whole internal dialogue in China is that domestic demand is weak, they’re relying too much on exports. It’s all about trying to get people, get household spending and getting firms investing. Given that narrative or that conversation in China, you would have thought that interest rates would have been cut well before now.
00:07:31
And I think they haven’t for a bunch of reasons that we’ve talked about before. One is because they’re worried about bank profits, and the other one is, I think, PBoC kind of made comments to this effect, I think, in the first half of last year is that in some ways it’s dealing with a two-state economy at the moment. It’s dealing with a bunch of firms that have been really dealing with deflationary pressures. Those are the ones in overcapacity issues. They’re dealing with overcapacity issues, particularly those into the sunset industries, those that did incredibly well under a vibrant housing construction market. But now that the housing market has slumped, there’s just too much demand. We’re talking steel and aluminum.
00:08:09
We’re talking white goods, cement. The whole thing. And so there’s a big chunk of the economy which is suffering deflation for those reasons. And the PBoC doesn’t really want to cut interest rates for them. They kind of like the idea of being able to deal with overcapacity, at least partially, through market mechanism. At least that’s what they said in the past. And then you’ve got another part of the economy, such as electric vehicles and batteries and wind turbines, also have a bunch of stuff in the service sector. I think the PBoC was pretty happy with restaurants and cinemas and whatnot where they don’t really need interest rate cuts because business is doing pretty well. So, I think that’s kind of the back story for why we haven’t seen cuts before.
00:08:49
On one hand, the PBoC has been reluctant to do it because of the banks. On the other side, it’s kind of been wary of like, do we really need it?? For the good of the economy, do we really need it? But I think the timing is clearly in response to the tariffs. And I think all those comments by the Politburo and various levels of government over the last few months, saying that it would happen in a timely manner, was kind of signaling to say it’s going to happen when we need it.
00:09:16
And because we haven’t really seen those cuts over the last six, nine months, now that it’s finally happening, it’s the government saying, “Okay, we haven’t needed it up to now, but now that economic conditions are starting to change, right now is the time.” So, going back to your original question, this isn’t panic. I think this has kind of been built into the system since the end of last year, and they’ve laid the groundwork, they’ve told everyone it’s coming. Now that they feel like they need to loosen monetary conditions and free up extra funding for the economy, it’s finally happening now.
00:09:46
Andrew
Yeah. And I would throw on top of that, I actually wonder if, in a timely manner, actually, in an oblique way, sort of referred to the trade war, meaning I wonder if they, rather than getting out in front of the trade war, they sort of knew tariffs were happening, obviously early, as early as… I mean, they generally expected them, but then initial tariffs were placed on China by the U.S. in February. And I actually wonder if they just wanted to see how the economic data rolled out. I mean, we’re still not seeing much economic data since the height of the Liberation Day tariffs or the reciprocal tariffs or whatever you want to call them. But I actually wonder if the looming trade war maybe even made them more cautious to put out an economic support package when they didn’t quite know what they were dealing with yet at the time, which kind of cuts against, A, what a lot of people thought they’d do, and, B, maybe logic, I don’t know.
00:10:40
You’d sort of think you want to get in front of it. But this, we’ve been saying, you probably haven’t been listening to the pods, but I’ve been talking to Trey a lot on these pods. And I think the overarching word that I’d use to describe China’s approach to the trade war, generally in kind of this whole geopolitical strife, I don’t know what the right word is, but kerfuffle that doesn’t seem strong enough. Anyway, the approach has been one of patience. They really have patiently hit back against the U.S., not rush to come to the table. At the same time, they’ve had a plan for the domestic economy that they seem to be patiently sort of monitoring the economy and now looking to execute their plan, which, as you say, has been on paper since December.
00:11:19
And now they say, “Okay, now that we’re starting to get an early read on what we think the real impact is from the trade war, now is the time to go ahead with these moves.” So, that’s my general thinking. First, react to that. But then also the other thing to think about, I like that you actually laid out your thinking on why they’re doing this now, fully focused on the domestic economy. Because even though the trade war is taking all the headlines, still the domestic economy is really, by far, the biggest chunk of China’s economy. And that’s what they have to manage. And you don’t fight a trade war with monetary policy anyway, right?
00:11:53
Dinny
Yeah. No, absolutely. I think you’re right. I don’t think they have really taken a wait and see approach with this, which is, on one level, is surprising given the weaknesses of the domestic economy. But I think it’s a case of they didn’t know how bad tariffs would be. They didn’t know what it would be on. It was pretty clear early on that things weren’t shaking out the way that anyone really anticipated them. I think, going into the Trump administration, we all expected tariffs on Chinese goods, but this sort of broad campaign against move to impose tariffs globally came completely out of left field. And I think Beijing was completely surprised by that, as everyone else was. So, I think, yeah, their approach has been let’s see how the economy handles it and then we can calibrate our response.
00:12:37
I think there’s been a lot of sense of like, whoa, the United States imposed 145% tariffs on China. Chinese exports are going to zero. Mean Chinese exports into the U.S. are going to get hit. But it really is a question of how much. I mean, there’s a bunch of stuff that the U.S. will struggle to buy from other places, the way that global supply chains are set up. Will China be able to adapt and sell it elsewhere? I mean, there’s just so many questions about how both the U.S. economy and the Chinese economy adapt to this, like getting out in front of it isn’t necessarily the right idea, because you don’t really know what problem you’re trying to solve.
00:13:11
Andrew
Yeah, that’s 100%. And something I’ve been thinking about today is it seems like everyone has a total lack of imagination as to how Chinese exporters, as individual businesses, are going to respond, right? If you’re a business and something happens in the world that is existential, you don’t just throw up your hands and say, “Well, too bad, I guess we lost our main customer.” No, you do whatever you can to either get that customer back, cut the price, find a new market. And that’s why the FT was reporting today about how the Chinese are sort of reworking how they label goods that are sold to the U.S. so that the exporter pays the tariff instead of the importer. And when the exporter pays the tariff, I’m not familiar with the full details, but they have more control over what they say is in the packages or the shipments.
00:14:01
And so they’re undervaluing the goods that are in the shipments. Right? So, they’re just saying, “Oh no, these are only worth $100, not $1,000.” And so, you know, stuff like that is hard for customs in the U.S. to monitor. So, there going to be tricks like that that’ll be exploited. Obviously, there will be transshipment through third countries. Obviously, these exporters will be trying to sell into new markets. I think people are sort of doing the economists thing of being like, “Oh, well, when your exports go down by X because of x amount, take y amount tariff, that hits GDP growth by Z.”
00:14:34
But, actually, these businesses are going to be much more nimble, I think, and this thing’s going to be pretty messy. And there’s going to be some trade that’s happening. Obviously, trade will be impacted negatively, but companies are going to find some interesting ways around this, I think.
00:14:49
Dinny
Definitely.
00:14:49
Andrew
Okay. That’s a little bit of a dogleg to the interest rate cuts. But you covered the interest rate cuts well. What about the second part of this announcement, which was on the cuts to the rates on the Housing Provident Fund mortgages? It was 25 basis points. So, we’re now down to, what did I say? It was 2.65, I think, on mortgages over five years. Are these big enough cuts? Will they do anything to revive housing demand in a significant way, you think?
00:15:15
Dinny
Firstly, a bit of a primer, what these funds are because they’re not really a common institution outside of China — as an employer in China, particularly if you’re working for a state firm or a large institution, you make monthly payments into Social Security health insurance. But you also make contributions into this provident fund. And what it does is that when it comes time to you to buy a home, or increasingly, even if you’re renting a home, you can tap this fund, and one of the ways that you tap it is by getting low interest rate loans.
00:15:45
So, the interesting thing about this particular fund, or at least a change that they’ve been making to it over the past year, is that you can actually borrow money from this fund and then use it as the down payment for your mortgage. So, originally, it was just one city here, one city there. But if I recall rightly, over the last couple of months, they pretty much made it universal. And so rather than having to save up for your, what? 20% down payment using your own cash, you can actually tap this fund, borrowing at a relatively low interest rate to make the down payment. So, in that sense, it might help move the needle a little bit because it’s not just an additional sort of supplementary form of mortgage.
00:16:23
It’s actually a way to kind of get, particularly first-home buyers, get them over the line in terms of accumulating the amount of savings that they need to put down in the first place. So, the theory here is it potentially opens up a potentially larger pool of potential home buyers than would be the case. So, the idea here is, by allowing the funds to be used for a down payment, plus cutting the interest rate, you will create an incremental expansion in the source of demand for newly constructed homes.
00:16:51
Is this going to have a huge impact on the market? Is this the thing we were all waiting for that’s going to change the direction of demand for housing in China? I don’t think so, largely because this does just feel like a variation on every other incremental measure we’ve seen over the last three years. We cut rates, we make greater liquidity available for the buying of the house. Yeah, we’ve seen this time and time again. Will it potentially help boost demand in the next few months? Yeah, yeah, probably will. Will that be sustained over the next couple of years? It’s impossible to tell. I think, at this point, the only thing that’s really going to help is this kind of decline, this market adjustment, this market fall for it to burn itself out as prices fall far enough, as people feel like they really can’t afford to wait to buy a house anymore.
00:17:39
All those dynamics that kind of bring a housing adjustment to an end. I think we’re kind of getting towards that. Measures like this help at the margin, but it’s certainly not going to be a game changer. Oh, the other thing to keep in mind about this as well is that the State Council flagged that this reduction in the interest rate for the provident fund mortgages was coming. They said some in March. But they made that comment in the context of a consumption support program. This gives you a sense of where the government’s coming from with this particular measure. This isn’t just about the housing market. It is about sort of what they see is trying to sort of support domestic demand. And if I can just get people buying houses again, then, more broadly, it’s a good thing for the economy.
00:18:21
Andrew
Yeah, it is a chicken and egg thing, right? Where people’s households confidence will be down until the housing market stabilizes, but the housing market won’t stabilize until people’s confidence returns. Right? So, it really is a chicken and egg problem. It does seem, we have seen the data at the beginning of the year — it’s kind of conflicting, showing prices dropping less slow or less quickly, some stabilization, maybe even in investment. So, we’ll see if we’re finally nearing the bottom in the property market. But that would be a huge boon because, as we’ve said many times, we need domestic demand to offset the drag from the trade war. And not only would housing stabilization provide direct domestic demand, but then it would have knock on effects of having boosting consumer confidence and therefore overall consumption.
00:19:11
So, that would be a big one. And policymakers can get it right. But as you say, it does sort of feel like just more incremental moves in terms of the Housing Provident Fund. Okay, let’s move on to the next chunk of things that were announced at this press conference. So, this is the lending facilities. First, walk us through, you did a good job of working through the Housing Provident Fund, can you walk us through what the relending facilities are? And then let us know what you think they will do in terms of how effective they’ll be in supporting small businesses and agricultural businesses. And the relending facility focused on boosting service consumption, will that have any material impact, do you think?
00:19:49
Dinny
Yeah. Well, the short version is the relending facility is a way for the PBoC to provide cheap funding to the banks, which they can then use to make relatively low interest rates to key parts of the economy. The actual mechanism is that banks first have to find a firm that it wants to lend to in a particular area that the government has identified as a priority. So, the PBoC has heaps of these relending facilities. It has one quota for supporting clean coal. It has another to support transportation. And so banks have to go out, find someone who wants to borrow money in the clean coal sector, make the loan, then turns around to the PBoC and says, “Hey, we found this borrower. I’m giving them a great interest rate. Can you fund me?”
00:20:33
And so then the PBoC will lend at a relatively low interest rate. At the moment, the interest rate, or up until now, the interest rate was 1.75% for one year. And the PBoC has just cut it to 1.5%. I think that was it. The PBoC loves this facility. Traditionally, it’s been around for 20, 30 years, maybe. For most of that period, it was all about funding the three agricultural… So, agricultural businesses. It was also about supporting micro firms, and then, more broadly, small firms. And year on year, it was kind of a fairly boring facility. The PBoC gradually lent more and more. And it was a way of supporting kind of small parts of the economy. And then when COVID hit, it became far more important. It became this sort of central tool to be able to get credit to those parts of the economy that the central government thought was, okay, we’re going to focus on these areas to ensure that they get the support that they need. And there was some real progress there. Up until, I think, the end of about 2023, the amount of lending under the relending facility just kept going up and up.
00:21:39
And then probably I think it peaked in the third quarter of 2023. And since then, lending under all these facilities have gradually declined. At least the data provided by the PBoC has declined. It hasn’t always been consistent in how much information it provides about this stuff. So, what’s interesting is that the PBoC has doubled down in a big way on relending facilities as part of its program to support the economy in the face of the tariffs because the banks haven’t really got behind the relending quotas over the last 18 months or so.
00:22:11
So, one of the quotas that they just ramped up was funding for science and technological innovation and industrial upgrading. And that quota stands at 500 billion renminbi. PBoC has just added another 300 billion. So, it’s going to be an 800 billion renminbi quota for lending to effectively supporting innovation and industrial upgrading. That’s a lot of money. But the quota used to be 500 billion. And at its peak at the end of 20, or in September 2023, it got up to, I think it was 340 billion. So, never got up to the full 500, a big chunk of change, but it never got up to the full 500. And then at the end of last year it was down to 120.
00:22:51
So, we’ve got this massive quota that hasn’t been used in full. Now the PBoC has just increased it by 300 billion. Now, something very similar is going on with the facility, new facility they introduced to support aged elderly services and services, more broadly speaking, which is a 500 billion quarter. They don’t have anything exactly like that already on the books. But in 2022, they introduced a 40 billion renminbi lending facility to support the construction of aged care facilities. And it had next to no take-up whatsoever. At its peak, which was September last year, only 2.1 billion renminbi had been lent out — 2.1 billion out of a potential 40 billion. So, the upshot of this is that the lending facilities had their day in the year during COVID and have since fallen out of favor.
00:23:41
And I think the real issue here is that the interest rate has been too high. The appeal comes from this being cheap credit for the banks. But at the moment, at least for the last year or so, a little bit longer, the banks have been able to borrow money incredibly cheaply from the interbank market. The one you rate on negotiable certificates of deposit, which is kind of the main tool for funding for banks in the interbank market. The interest rate for the highest-rated banks has been more or less the same as that they could get through the PBoC on the relending facility. Now, of course, if they then borrow short term and kept rolling it over, then they can probably fund themselves more cheaply than what the PBoC was offering. So, given the choice, the banks haven’t actually, and I think also the Re lending facility can be a little bit cumbersome sometimes because the mechanism is first you make the loan and then you get the funding.
00:24:32
Now, that works fine if it’s really worth the discount if the credit being provided is that much cheaper. But when it’s only a difference of maybe a few basis points, it’s not really worth it. So, it’s interesting that not only has the PBoC rolled out new relending facilities this time, but it’s also cut the interest rate on those facilities by 25 basis points. The question is now is that now going to be cheap enough for the banks to go, “Yes, this is a material reduction in my funding costs. I’m going to use what the PBoC is offering and then pass on those savings to the real economy, to firms in innovative areas and upgrading and in services to give them an incentive to be able to go out and borrow and invest.”
00:25:17
It is too early to say because, yes, they’ve cut the interest rate, but they’ve also cut the interest rate on the seven-day reverse repo, which is the benchmark policy lending rate. So, we can expect interest rates across the entire breadth of the financial system to come down. So, will this 25-basis-point reduction on relending loans be enough? I think we’re only going to be able to tell over the next few months.
00:25:38
Andrew
Yeah. And the last part I’d say is, weighing on how much you think this will impact consumption, I mean, so the relending facility makes sense if you’re trying to support small businesses or buy the export thing, if you’re trying to support agricultural businesses, if you’re trying to provide cheap loans for industrial upgrading and adding technology into your manufacturing processes. But for the consumption, the services consumption, classic China, they’re saying, okay, we want people to buy more services. What do we do? We make it cheaper for businesses to provide services so there are more services to provide. So, instead of, you know, people providing services, let’s give them more services. So, it’s a classic demand-side response.
00:26:22
Dinny
Supply side response.
00:26:23
Andrew
Oh sorry. Yes, supply side response when the issue is a demand side issue. Seems like maybe they maybe missed the boat on this one. I don’t know. What do you think?
00:26:33
Dinny
Yeah, it’s this idea that they developed, I think two years ago, maybe a little bit longer, which is we can boost spending, household spending by unlocking latent demand. So, the idea that people want to spend then don’t have access to the things they want to spend on. And so I think this is one of the reasons they’re focusing on elderly care stuff, for example, partly it’s because the population is aging so rapidly, but it’s also people are crying out for retirement villages and support for their parents, just good environments where they can kind of see out their days. And there’s just not enough of them. And so it’s like, hey, this is something that people would be spending money on if only there was adequate supply.
00:27:13
So, that’s the rationale. But they’ve been flogging this horse for over two years now. And variations on that theme, not just building elderly accommodation, but they’ve applied this to a bunch of different parts of the economy, like, let’s build more cruise liners. Clearly, Chinese people want to spend more holidays out in the ocean. If we build them, they will come. And it hasn’t really had any meaningful impact on household consumption. But they’re not giving up because it just fits so well with their economic model. It’s like we invest, and investment will drive demand. And it’s just not quite working the way they want it to.
00:27:46
Andrew
I mean, personally, I know that anytime my wallet’s tight and I’m trying to save money, it’s usually because I can’t find the right retirement home for my parents. So, I think we’re both in agreement that this may not be consumption that much, but we’ll see. And we also will stipulate, we’ll get into this in a minute, like there’s more coming. Like this announcement today is not one and done. They’re going to monitor and adjust as they see further fallout from the trade war, and further, just evolution in the domestic economic momentum and things like that.
00:28:16
Dinny
Well, I mean, that’s a good point. I mean, we talked about the interest rates, but the reserve requirement rate cut in some ways is perhaps more interesting because, as you said, it’s freeing up a trillion renminbi’s worth of liquidity. What they’ve done in the past is when they’ve cut the reserve requirement ratio, it’s because there’s a big increase in issuance in government bonds coming through that they’re worried that there’s not enough liquidity in the system for them to be able to sell the bonds that they want to without impacting interest rates.
00:28:42
And so I think that’s probably what the signing is. Sure, this is the monetary policy response. Maybe it’s not going to have that much of an impact. But I think the cut to the reserve requirement ratio is a big, loud flashing light, if lights could be loud, saying that more government spending, the fiscal side of this support plan is coming down the turnpike.
00:29:01
Andrew
Really struggling today with these mixed metaphors and bad jokes, but that’s okay. That’s okay. I love it. Okay, so wrap up on this. Anything else that we missed in this package of announcements on Wednesday that’s worth mentioning?
00:29:15
Dinny
Few bits and pieces. The PBoC also cut the interest rate on the pledged supplementary lending facility by 25 basis points. This is the window through which the PBoC lends money relatively cheaply to the policy banks. So, I kind of like the relending facility. Lending to the policy banks has kind of been declining over the last year or so, largely because the interest rates have been relatively high. Will the 25 basis points reduction get the policy banks let borrowing again, and what will they use it for? Is this the first step towards pushing the policy banks to ramp up their lending in some direction? It might be, but it’s too early to speculate, and that’s kind of an area we’ll kind of keep one eye on. Also, the head of the National Financial Regulatory Authority, financial regulator, Li Yunze, said that they are cutting the risk factor for insurers solvency ratio by 10%.
00:30:15
Complicated way of saying that they’re going to reduce the amount of capital that insurers have to have relative to the amount of stocks, listed equities that they hold. So, the idea is that, hey, they currently hold a bunch of shares in listed companies, and they have to hold a lot of capital against that. Well, in the future, the insurance companies need to hold as much capital as they currently do. And Li was pretty explicit about this. He said the whole point is that the savings and capital is supposed to get plowed back into the stock market. So, this is something that Beijing has wanted for ages. Talks about it all the time. It wants more what it calls patient capital invested in equities. It wants long-term investors to account for a larger share of the funds that are invested in A-shares.
00:30:59
And it’s been incrementally moving in that direction. It’s freeing up the funds that insurers can invest in A-shares. It’s freed up the amount of funds that the pension fund can invest. So, this has broadly been the direction of travel for quite some time now. And the third thing that it did is that PBoC has made a few changes to a couple of facilities that it introduced a few months back to support A-share valuations. What it did is it introduced a swap facility whereby fund management companies and securities companies could effectively swap some of their assets for cash and then use that cash to invest in A-shares. It also said an unrelenting facility for listed companies to borrow cheaply to then fund buybacks, share buybacks as a way to push up share prices.
00:31:47
So, the PBoC pretty much feels that this has been a relatively successful program. The changes are thus those two programs. The initial quota for the swaps was 300 billion renminbi. Initial quota for the relending facility was 500 billion. Those two programs have now merged. So, there is an overall quota of 800 billion that the PBoC will allocate depending on what demand is. So far, most of the demand has come from listed companies doing buybacks. I think the PBoC said that’s about 500 companies that have already tapped that facility to buy back their shares. The other changes they made is originally that swap facility, only 20 financial institutions had access to it. Now we’re up to 40. And in terms of the relending facility for listed companies doing buybacks, originally, they had to fund the buybacks with at least 30% of their own cash.
00:32:36
Now that’s been reduced to 10% of their own cash. So, the buybacks can be far more leveraged than they could initially. So, again, all this is straight up about supporting the stock market. But in a very specific way, the buybacks in particular are a part of Beijing’s broader campaign to build household wealth through dividends. And buybacks are part of that as well. It’s very specific about putting money, more money back into the middle class’s pockets through the capital markets. And there’s been a recognition that they can only do that so much through rising valuations, because, frankly, they’ve done an awful job in trying to push up the price of A-shares. But what they’ve done incredibly well is push listed companies to up their annual dividend payments, get them to do multiple dividend payments throughout the year.
00:33:21
And now, increasingly, by funding their share buyback programs. So, yeah, shareholders haven’t benefited that much from rising share valuations, which really haven’t happened. But they’re starting to do better from buybacks and dividends.
00:33:34
Andrew
Yeah. Well, that’s all very helpful. And I mean, I think there’s a tendency from the outside to look at, oh, this is just them juicing the stock market. It’s all smoke and mirrors. And the national team’s coming in, and it’s just kind of a vanity project. But actually they are trying to boost household sentiment, which they know they have a problem with. They know they have a problem with household sentiment by making people wealthier through their equity holdings. I mean, whether that be through valuations or dividends, I mean, it really can have a material impact on confidence. And I think we should see it as sort of a serious part of the support package. It’s not just them, again, undertaking a vanity project.
00:34:14
It’s really trying to feed through to boost sentiment. Before we move on to the U.S.-China stuff, just last thing. I mean, we talked about what’s next, or you touched on it, that fiscal support is almost definitely coming. I mean, we need, as I said, like monetary policy is not what you need to address the trade war, monetary policy is really not what you need to address a lot of the domestic challenges which have symptoms, which we’ve talked about and you’ve written about, that are similar to sort of a balance sheet recession. It’s not really about the price capital. It’s just like you’ve got a lack of demand, and companies don’t want to invest. People don’t want to buy. So, what you really need is fiscal policy.
00:34:48
And you just made the case because there are, and it’s likely that fiscal policy is coming. What does that look like? I mean, my guess would be that that’s not a new announcement of more spending. It’s maybe accelerated spending of money that’s already been announced, at least for now. They could supplement the fiscal package later in the year, potentially. But what do you think? Are you talking new money? Are you just talking like, let’s get the money that we promised out the door?
00:35:13
Dinny:
It’s the latter. And the authorities, I mean, the Politburo, has been pretty explicit about this as well in their meeting at the end of April. It’s about accelerating of what they’ve already promised. And you look back at all the budgetary announcements back at the National People’s Congress back in March, I mean, they’ve really ramped up their promise of government spending this year.
00:35:33
I mean, a 4% budget deficit, which is way above the 3%, which has sort of been the norm for years and years. Additional special Treasury bond issuance, an incremental increase in special-purpose bond issuance. I mean, they’ve been pretty explicit upfront that, hey, we are going to spend a lot more this year than we did in the past, and I don’t think we’ve really seen that much evidence of that being shoveled out the door so far. I mean, if we look at economic growth in the first quarter, it was really led by exports. I think exports accounted for about 35% of what generated growth. It wasn’t investment or even consumption. So, I think what we’re going to see from here on in is that everything that’s been promised, now, we’re going to see that sort of material increase in government spending that was promised earlier in the year.
00:36:22
Andrew
Well, we’ll be on the lookout for it. We’ll see how this plays out. But these moves obviously are taking place, at least in part, to counteract the pain from the trade war. And on that front, there was a big development over the past 24 hours. Specifically, we got our first official confirmation that trade talks between the U.S. and China will begin soon. Both the U.S. and China confirmed that Vice Premier He Lifeng will meet Treasury Secretary Scott Bessent and U.S. Trade Representative Jamieson Greer in Geneva, Switzerland, on Saturday. This will be the first confirmed dialog between the two countries since the trade war kicked off in April. Both sides are really looking to keep expectations in check as we kind of go into this meeting. Bessent told the press that talks will focus on, quote, de-escalation rather than a big trade deal, according to Bloomberg.
00:37:11
And then China’s Ministry of Commerce urged the U.S. to “engage in good faith negotiations and correct previous rounds’ doing.” So, neither of them is going in saying like, “Hey, we’re going to get a deal this weekend.” How positive of a development is this, though, in your view, that at least the two sides are coming together?
00:37:32
Dinny
Yeah, I mean, it sounds like everyone’s aggressively lowering expectations, but I think at this point, putting that aside, it’s clear that everyone’s trying to move in the right direction. And I think, at this point, that’s all that can be expected or asked for. I mean, given everything that’s brought us to this point, I think progress was always going to be slow. So, this is encouraging.
00:37:54
Andrew
Yeah, I think that’s right. I mean, we’ve talked a lot on the part about how we think this is going to be a protracted trade war, that we thought it might even take months for them to even begin talking. So, the fact that something, the Chinese were sending signals last week, “Hey, we’re open to this,” the U.S. administration obviously heard those signals and they were able to move something forward. So, I would say that’s positive. Just in terms of kind of the scorecard, in a way, I almost think this is an early win for Xi Jinping in that negotiations are beginning at the cabinet level. The U.S. side has been pushing for the leader-to-leader talks.
00:38:29
They wanted Donald Trump to hash this out directly with Xi, and the Chinese side was having none of that, of course. So, the fact that things are starting out at a level that China is comfortable with, I think, is kind of, in at least one way, starting out on terms that they, again, are comfortable with, unlike and basically the terms that they sort of put forth like we’re not going to talk unless it’s in this level, this seniority level. We’re not going to do leader-to-leader. So, that’s just an interesting observation that China at least is asserting its interests and being able to, I don’t know if I necessarily call them early wins, but they’re getting some concessions, even if they’re small in the U.S.
00:39:06
And, in addition, the fact that this is on a neutral territory, the negotiations between the U.S. and basically all its trading partners have been happening in Washington. Right? Everyone’s coming to the White House, kissing the ring, saying, “What can we do to stop this?” The fact that this is in a third country and neither side looks to be sort of coming to the other, bending the knee, groveling, that’s also positive, I think for China, at least relative to all the other trade negotiations that the U.S. is undertaking.
00:39:37
So, I think, at least optically, it puts China in a pretty good position to start things out. That said, I still think this is going to take a long time. I think the managed expectations are right, that people should have limited expectations. I think my best-case outcome is probably that both sides agree to broaden the carve-out for current tariff exemptions. I would be pretty surprised if we got an actual reduction in tariffs from this meeting, but maybe they both say, “Okay, we’ll exempt this, that, the other thing.” So, that’s one thing that would be really positive. And then the other thing that would be really positive or, again, the best-case scenario is something super positive, that if the U.S. side clearly spelled out its demands for China, like, this is what we really want from you in the negotiations — again, I keep referencing earlier pods. We’ve been talking about is pretty much every week for the past few weeks.
00:40:27
But China doesn’t know what it’s negotiating over. It doesn’t know if Trump won’t sell or trade surplus. It doesn’t know if Trump wants them to take more action on fentanyl. Does the U.S. want more Chinese investment in the U.S.? Less Chinese investment in the U.S., China to play some more proactive role in Russia-Ukraine negotiations? It seems totally unclear. So, if they came out of the meeting with a pretty clear indication of like, “Hey, these are the boxes we want to check to get to a deal,” then at least China can know what it’s negotiating over.
00:40:57
So, I’ll be watching for that and we’ll be looking at these readouts closely when we get them on Saturday. But there’s not really a bunch more to go into detail on that. I do want to wrap up quickly. Speaking of trade, I just want to quickly highlight some of the work you’ve been doing. We won’t go into depth on this, but I want you to introduce the project you’ve been working on. And the reason I say, speaking of trade, is that you’ve been working on this research about China’s evolving economic model. What’s the model? It’s like shooting for in the future. One of the scenarios around China’s growth. And exports are shockingly going to be a huge part of that plan. I think people are assuming, because of the trade war, China is going to try to limit its exports.
00:41:42
We’ll get into that part of it in a minute. But can you just generally introduce the research and what you’ve been working on? Then I want to ask you one other question on that, and then we’ll dive into all of this more in depth for listeners in the weeks ahead.
00:41:54
Dinny
Yeah, of course, I’ve been working on this for the past year. What it is it’s an attempt to kind of put together some scenarios for what the Chinese economy will look like in 2035. Of course, putting together forecasts, particularly 110 years out, is incredibly fraught. But what we’ve been trying to do with this is kind of look at what China is trying to achieve with the economic transformation that is currently going through. And there’s no doubt that China is radically changing its economic model. I mean, property market is no longer driving growth. It’s kind of getting diminishing returns from its investments in infrastructure. It’s pivoting to something radically different, while at the same time, it’s kind of dealing with the legacy or the fallout of those kind of the legacy of the previous economic model.
00:42:36
So, local government debt, excessive housing construction, bad loans in the banking system. And at the same time, it’s also dealing with a rapidly aging and shrinking population. So, you kind of put all that together. And it’s like, what is Beijing trying to achieve? How is it trying to deal with those legacy problems? How is it trying to mitigate the potential risks? And why is it doing things the way that it’s doing? So, yeah, we kind of went in the eyes open that knowing exactly what’s going to happen in 2035 or trying to tell the world what it’s going to look like is a bit of a mug’s game. But what we’re doing is like, look, this is what Beijing, given everything that’s happening at the moment, in a perfect world, this is where they’re arrive at, or this is where they’d like to arrive at in 2035. Ten years to kind of let it all shake out and all these sort of reforms and changes to kind of coalesce.
00:43:23
And then given what Beijing is striving for, how do we handicap that? How feasible is that likely to be given, primarily, the stresses brought about or the challenges posed by debt, by demographic changes and also what we call globalization, but ultimately sort of the rising trade tensions around the world? So, that’s what we’ve been doing. And as you said, I mean, exports have rose out of that as a surprisingly big part of the overall picture.
00:43:53
Andrew
We’ll be putting out that paper here soon. It’ll be a few more weeks, but we’ll definitely be talking about some of the really interesting conclusions that you’ve made through that research on the pod and in other places. But just to wrap it up, one of the more interesting things you found is I think everyone’s kind of looking at what’s happening now with the trade war and saying, you know, Donald Trump might be able to do the one thing that Xi Jinping couldn’t do, which is make the Chinese economy pivot more towards consumption.
00:44:18
They’re going to have to double down on consumption to offset the trade weakness, and not only the trade weakness currently with the U.S., but what will be permanently exacerbated trade tensions. And I started the pod up top talking about how people are not being quite savvy enough, I think, around, or creative enough, around understanding how these individual Chinese firms are going to find ways to adapt to the new reality. But your research basically says that, according to our understanding of what Chinese leaders are saying and thinking in these policy documents, that the plan is still not to really go full bore on consumption, but instead, in a way, double down on exports, a different type of exports. But just can you talk a little bit about the emphasis on exports that will remain central to the economic model if Xi Jinping has his way over the next decade?
00:45:06
Dinny
Yeah, absolutely. The issue with consumption is that they would love consumption to be a driver of the economy, but they see it as being the endpoint of this economic transition, not the starting point. So, so often we have this conversation about the only way that can drive the economy is the only thing left is consumption. The way the Chinese see it is like, yeah, yeah, we want consumption, but we want it to come about organically in a way that people start spending more, not through a government-led redistribution program, which is really, when economists talk about China shifting to a consumption-led model, that’s what they’re talking about. They’re talking about a government-led redistribution program to take money away from the state, money away from corporations, and putting it in the pockets of people. That’s not what China is talking about. I mean, even in the context of common prosperity, they want an economic model that raises corporate profitability so that companies can spend more on wages and salaries and bonuses, and that those companies that are more profitable can then spend more on taxes.
00:46:07:07
And the population that are getting higher salaries will pay out more in personal income tax. And the government, with a broader tax base, will then be able to have the financial resources to be able to spend on an expansion of welfare, which they’d love to do. They talk about it all the time, but they also say we’re not going to spend on welfare until it’s within our means, until the economy is in a position to actually support the expansion of welfare. And that’s effectively what they’re talking about, having a tax base that is big enough to support it. And that’s where exports come in. Because the growth model they envision is one where growth is led by productivity gains, and win by productivity gains, specifically what we’re talking about, is drive into innovation and commercialization of those innovations and it’s about industrial upgrading so that firms can charge more for their products, or that they can cut costs more aggressively on their products.
00:47:00:
And at the end of the day, you have a more profitable corporate sector, which pays more in salaries and pays more in taxes. And once you get to that point, you have an economy or a public that is much more equipped to spend more on consumption. And that’s the vision. The problem is the Chinese public doesn’t have enough money to spend on all those innovative new products and the expansion of manufacturing that Beijing envisions. So, someone has to buy it. And pretty much the only market that can absorb it is the global market. And so that’s kind of the problem that this model of productivity-led gains in manufacturing rely not just on China maintaining exports at current levels, but continuing to increase the value of what it exports year in, year out. And, of course, that’s going to pose challenges for everybody.
00:47:50
Andrew
Yeah. Well, we’ll get into all that in more depth. That was a really great summary and explanation. I’m sure people will be hankering for more, which we will give them, but unfortunately not today because we have to wrap it up. But Dinny, thanks man for joining me. It’s good to see you on here.
00:48:06
Dinny
Yeah, absolutely, mate. It’s been too long.
00:48:08
Andrew
Yeah. Well, thanks everybody for listening. Obviously covered a lot of ground as usual, but we’ll be back next week. And until then, take care. Bye, everybody.
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