China: Navigating a real estate rescue and renewed trade tensions

What we think

The latest housing policy measures are a step in the right direction, but the scale remains insufficient and the implementation is challenging. If additional policies are rolled out the growth outlook would improve modestly next year. On tariffs, the impact will likely be differentiated by sector and we do not expect significant retaliation from China, though an escalation with Europe could materialize and would be impactful.

Investment implications

We expect slightly higher multiples on more positive market sentiment but continue to prefer onshore equities and fade offshore exposure. Valuations no longer look distressed and the risk-reward is looking increasingly unfavorable. We see better value in the onshore market for long-term investors.

China recently faced two conflicting developments – on the positive side, new policies were announced to support the ailing property sector; on the negative side, the U.S. administration announced a new set of tariffs on Chinese imports. On net, the market focused on the positives. Chinese stocks continued their rally, led by a surge in property-related stocks. MSCI China is now up around 30% since its January trough, led entirely by improved sentiment that has driven valuations higher, while fundamental earnings expectations have actually trended lower. 

We’ll unpack both of these developments and assess their likely impact on the economy and markets. These two policy developments, though seemingly unrelated, are in many ways interconnected. Domestically, China is attempting to steer the economy towards new sectors and away from real estate, but as the country moves heavily towards sectors like electric vehicles, it risks creating substantial excess capacity (and it might already be there). The tariffs are an attempt to preempt a flood of exports in strategic sectors and give the U.S. industries time to diversify their suppliers. 

This is likely just the beginning on both fronts. More announcements are expected from Beijing to support the economy, and the trade landscape is likely to continue shifting as major Western economies reassess their trade relations with China. 

Why property stimulus now? How bad is the situation?

Recent policy announcements may signal the beginning of the end for China’s historic housing bust. To put some context around the property sector and impact of its fallout – at its peak in 2020-21 the sector contributed 25% of GDP and 38% of government revenue. Despite falling prices, property may still account for more than 65% of Chinese household wealth. After hitting a historical high in 2021, the sector experienced a downturn, with new home sales in April 2024 down 60% from 2021. The dire situation has significantly curbed developers’ willingness and ability to acquire land, which has impacted local government finances, many of which depend on land sales revenues. With reduced land purchases by developers, new home starts in April 2024 slumped 69% from historical highs in 2019.

Only the central government appears to have the capacity and authority to stem the real estate slump, given the scale of challenges being faced: 

• There is a significant amount of pre-sold but unfinished homes.
• Developers have a large inventory of finished but unsold properties.
• Since land sales and property-related taxes make up 38% of local governments’ total revenue, the contraction in land sales has severely worsened local fiscal conditions.
• Housing prices have begun to dip, with no sign of stabilization. Falling housing prices reduce a household’s willingness to purchase property, which could lead to even lower prices.

What is the new plan and is it enough to rescue the property market?

The policies announced on May 17th have two key elements.

1. Lowering downpayment and mortgage rates. The minimum downpayment rate for first and second-time homebuyers has been cut from 20% to 15% and 30% to 25% respectively. The minimum mortgage rate requirement has been removed, and the provident fund mortgage rate has been cut by 25bps.
2. RMB300bn special facility. This facility is provided by the People’s Bank of China (PBoC) through commercial banks, and enables local governments to purchase completed but unsold properties for conversion into affordable housing, based on demand. This scheme can be leveraged up to RMB500bn. The facility has an interest rate of 1.75% for one year and is extendable for four years. There are other minor measures – such as continuing the ‘white list’ to support projects under construction, and buying back idle land.

We think the first element is relatively straightforward. There has been a steady stream of measures enacted by local governments over the last six months aimed at lowering mortgage rates, downpayment ratios and relaxing home purchase restrictions. The problem is lack of demand, not high rates or downpayment requirements. Generally prices need to adjust further to encourage buyers back into the market. We therefore think it’s unlikely to result in an immediate sales recovery. That said, the cumulative effect of lower interest rates coupled with ongoing improvements in affordability (lower rates and potentially lower prices) will likely translate into a stabilization of potential demand over time. 

As for the PBoC’s special facility, this scheme represents a shift in the policy approach to the housing crisis. We think focusing on de-stocking and using the PBoC balance sheet could be an effective strategy, but the scale is too small to turn around the housing market. We estimate the scheme could help reduce the supply of finished but unsold housing by about 20%. However, when we use a broader concept of inventory that includes floor space under construction, the program can only purchase at most 5% of this much broader stock of supply. On its own, the scale is unlikely to have a meaningful impact on inventory levels. In addition, implementation is complex given the need to balance the economics of rental housing, local government debt dynamics, as well as supply and demand mismatches. These are some of the reasons why the actual result may be realized more slowly or on a smaller scale than our calculations would suggest. 

However, the overall implication is positive. Recognizing and addressing the problem is a good first step in the right direction. Even if the scale is small, policies are on the right track. The shift to focus on de-stocking and continued efforts to stabilize demand put China on a path towards tackling the big issues in the housing sector. Concurrently, it’s not a reversal to the old housing model meant to reinflate the bubble, but rather a pragmatic solution aligned with other development goals. If the current scheme goes as planned, there will likely be more follow-up actions or similar policies in the coming months.

Can this turn the economy around? What is the expected broader economic impact?

None of these measures are likely to turn the housing market around immediately, and as such we don’t see any major upside risks to GDP growth in 2024. That said, if we see more policies in this style introduced in the coming months, we can see a modestly positive impact on growth for 2025 and beyond. 

There are two main transmission mechanisms. First is restoring a functioning credit and financial cycle. Local governments and financial institutions have been under pressure from housing deleveraging, evidenced by falling credit growth and declining fiscal revenues and spending. This is one of the negative housing spillovers that undermines the rest of the economy, particularly in new and growing sectors. Monetizing unsold housing inventory can help alleviate this problem; giving financial institutions and local governments more space to support other sectors and growth drivers.

Secondly, the three-year-long housing decline has dented business and household confidence. If policymakers are able to support housing while helping other growth drivers, it can bring about a stabilization in confidence.

Washington announced a new round of tariffs on China. What does this mean for our outlook and what can we expect going forward? 

The U.S. announced new tariffs on US$18bn of Chinese goods, including EVs, batteries, semiconductors, steel & aluminum, critical minerals, solar cells, cranes, and medical products – while retaining Trump-era tariffs on more than US$300bn of goods. The tariffed goods represent only 4% of total Chinese exports to the U.S., and 0.5% of China’s total exports. Given their limited size, the new tariffs are unlikely to have a broad economic impact, but there will likely be sector-specific implications.  

In sectors that have a range of global suppliers and higher price sensitivity – like mature semiconductors, medical supplies and steel & aluminum products – trade with the U.S. would simply fall as those consumers source these products elsewhere. In sectors where there is a high level of China-dependency – such as batteries, battery parts and critical minerals – the U.S. could face higher prices until new supplies are developed. For sectors where bilateral trade is almost nonexistent – like EVs and solar cells – the tariffs are purely symbolic.

Looking closely at the more impacted sectors

The new tariffs could reshape the U.S.-China battery trade and will likely raise costs for U.S. EV makers before they find reliable alternative sources. U.S. reliance on Chinese-produced batteries is a key reason why these particular tariffs will not phase in until 2026. Other countries with advanced battery industries such as Korea and Japan may gradually fill the gap in the U.S. market.

The U.S. is highly dependent on Chinese battery parts and critical minerals, with 24% and 59% imported from China respectively. China produces more than 65% of the world’s graphite, and increasingly sees exports of similar minerals from a strategic perspective. U.S. awareness of its reliance on China for critical minerals is evidenced by what is and isn’t tariffed. While new tariffs will be levied on more than two dozen raw materials, the U.S. was careful to avoid the critical minerals where China controls much global supply.

China’s response and risk of retaliation

Retaliation, including tariffs on U.S. products, could soon follow, with reports that cars could be targeted. China’s room for policy responses on trade and investment is rather limited – after all, China exported more than US$500bn to the U.S. while importing only US$164bn; running a surplus of US$336bn in 2023. China’s trade with the U.S. is the most unbalanced across all of its trading partners.

It’s unlikely we’ll see further escalation from the United States, at least until the election. Unlike in the past, the U.S. is not seeking to negotiate market access or use tariffs as a bargaining chip to encourage China to import more U.S. products. The measures are instead designed to protect specific industries, and thus the U.S. is unlikely to increase tariffs further unless they advance this objective. 

The risk of European escalation

The key question is whether this U.S.-China trade war turns global. The EU has launched an anti-subsidy investigation into Chinese imports of wind turbines, solar panels, and EVs. There are reports that China is aiming to retaliate with tariffs on European auto exports. Unlike the U.S., Europe is a significant source of bilateral trade with China, leaving ample room for escalation and negative economic effects. The economics of the relationship point to a reasonable risk of escalation. As China attempts to generate future growth through investment in high-value manufacturing, Europe’s core logic for trade with China – importing attractive low-value-added goods and exporting high-value-added premium products – looks increasingly fraught, with European companies rapidly losing their edge to Chinese competitors, especially in autos. To prevent a “China shock” – widely viewed as a reason for the hollowing out of the U.S. industrial base – from impacting Europe, certain nations will likely join Washington in erecting new protectionist barriers.

On balance, are we more positive on the Chinese market? 

In order to turn more positive on Chinese equities we have emphasized that we need to see a comprehensive property rescue plan and sustainably stronger domestic demand. The housing plan marks a significant step in the right direction and likely signals a change in policy direction. As a result, we expect market sentiment to improve somewhat, leading to a likely valuation re-rating. We slightly raise our index outlook to factor in some multiple expansion (end-2024/mid-2025 index outlooks are MSCI China at 67/69 and CSI 300 at 4,100/4,300), but keep our earnings estimates unchanged.

However, we still do not advise chasing this rally. The broader MSCI China has surged more than 30% from January lows, and we continue to recommend fading the bounce in offshore China as valuations no longer look distressed and the risk-reward is looking increasingly unfavorable. We see better value in the onshore market for long-term investors, alongside dividend names and structures for tactical investors.

On the currency, risks of increasing trade frictions is a key reason why we maintain a bearish bias on the outlook for the RMB. Uncertainty on the export outlook creates risks to the balance of payments and overall growth outlook, both of which weigh on the fair value for the currency. While determined intervention efforts has kept USDCNH relatively stable over the past year, lessons from the 2018-19 trade war suggest that authorities could turn more tolerant of currency depreciation so that the tariff impact is partially offset. While a sharp depreciation is not our base case, risk of further weakness from current levels over the next 6-12 months is high. 

All market and economic data as of May 23, 2024 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

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Index definitions

The MSCI China Index is a free-float weighted equity index. It was developed with a base value of 100 as of December 31, 1992. This index is priced in HKD. Please refer to M3CN Index for USD.

The CSI 300 Index is a free-float weighted index that consists of 300 A-share stocks listed on the Shanghai or Shenzhen Stock Exchanges. Index has a base level of 1000 on 12/31/2004. * Due to our agreement with CSI, shares in the index is restricted, please visit SSIS<go> for more information and access. This ticker holds prices fed from Shenzhen Stock Exchange.