The People's Republic of China announced that it will inject money into the markets with a variety of different tools, along with the decisions it announced on September 24. The required reserve ratio has been reduced by half a basis point, and with this move, an amount close to $140 billion will be converted into credit. Policies that will support the real estate market and credits will be created to be used for the repurchase of shares on the stock exchange. First, let's start by explaining China's situation before the decisions.
Real Estate Industry
Stagnant Sector and Construction Companies
One of the biggest problems China has experienced is its stagnant real estate sector. The reason the sector is at great risk is due to previous policies. The maximum value of home loans in the world is generally five times a person's annual income, but in China this ratio is between 25 and 30.
Construction companies are also constantly making new investments due to the constant demand, but this system works on the assumption that people who have previously taken out loans can pay their debts. If these people cannot pay their debts, this will disrupt future projects and cause trouble for people who have taken out loans for newly built homes, creating a domino effect. For these reasons, it is very important for China to meet its growth targets and support the real estate sector. If people become unemployed in a possible economic crisis, the real estate sector will also be hit, which could lead to a disaster or be the first sector to start the crisis.
Down Payment Discount for Second Home
In its new economic decisions, China has reduced the down payment required for second-home buyers from 25 percent of the home’s value to 15 percent. It has lowered the interest rate on existing home loans to make payments easier. But these moves could cause a real estate bubble like the one in the past. All China can do to avoid this problem is grow faster than the bubble, and if the bubble is allowed to burst, it could take years to reverse the consequences.
Unsafe Household
Another problem is convincing people to buy a house. Citizens who have learned their lesson from the past do not trust construction companies enough. China's largest provinces have also either relaxed the conditions for buying a house too much or completely removed them in line with central decisions. Despite all these policies, if people are not sufficiently encouraged to buy a house, China will face major difficulties. The failure of the real estate sector to accelerate sufficiently could put China's economic growth targets in trouble.
Credit Leg
In the scenario where the Chinese turn to loans, economic stability becomes very important again. During periods when such large loan packages are offered to people, it is expected that borrowing will increase rapidly. Also, considering that it is expected that China will announce more policies in a similar direction because it is desired to spread this to the general public, we can expect that there will be no selective treatment in loans. In order for these loans to be paid regularly, China needs to maintain its stability for many years and also be relatively successful in terms of growth targets.
Since the majority of banks in China are state-owned, the state may have to bail out banks if loans cannot be paid, and may have to facilitate loans to citizens in case of problems in the real estate sector.
Capital Investments
Trust in Chinese Companies
For years, due to geopolitical and political risks, Chinese companies have been priced at much lower multiples than their Western counterparts. For example, Amazon has a P/E ratio of around 45, while Alibaba, despite its recent huge rise, still has a P/E ratio of around 28.5. Similarly, search engine Baidu has a P/E ratio of 14, while Google (Alphabet) has a P/E ratio of close to 24.
The price/earnings ratio shows us how much market value the company has for every dollar it earns, so a high ratio, although not the only indicator, shows that investors have more confidence in the company. Famous investors like Ray Dalio often talked about how cheap Chinese stocks are.
China has created large low-interest credit opportunities for companies and large investors to invest in the stock market in its new decisions. Companies will be able to buy back their own shares. Thanks to all these decisions, the stock market has experienced a very strong increase.
From Saving to Investment
Another effect of these decisions could be an increase in real investment. The rise in the stock market greatly increases the financial power of companies. In addition, China's largest companies were holding a very large amount of cash. Considering that money was injected into the market with the new decisions, the coming years may be good times for companies to spend their cash and invest with new sources of financing. This is a very positive situation for China because both the current sectors not being in trouble and the spread of economic growth to sectors may be important for future growth.
Such investments also have a significant impact on commodity prices. China is one of the places where the most production takes place. China's subsidy announcement or companies' investments also create strong demand pressure on commodities such as oil and coal. Although the exact size and impact of subsidies are not certain at the moment, it can be considered certain that they will greatly affect commodity prices.
Foreign Factors
Federal Reserve (FED)
Despite these, the reasons for the low investment in the past have not yet been completely eliminated. Although the management has given positive news this time, the decisions were announced in a way that can be considered "unexpected".
If you have followed the FED interest rate decisions in the past days, you can clearly see the difference. Before the FED announced its interest rate decisions, many high-level officials made statements that there would be an interest rate cut, and the interest rate decision was made known to the market in advance by using various journalists. By measuring the market's reaction in this way, the FED made the interest rate decision as predictable as possible and established good communication with the markets.
This is one of the areas where the Chinese government has failed the most. In the past, it has announced major decisions that would affect the largest companies, such as Tencent, in unexpected ways. Therefore, there is still an atmosphere of uncertainty.
For more reading on the FED, you can check out our article " Is the FED's Soft Landing Dream Possible? "
American Elections
In the upcoming elections in America, the promises of the candidates may also affect China's situation. In the past few days, America has passed a series of regulations on Chinese and Russian products. Cars using Chinese software will face serious regulations in the country. Former President Trump states that if he is elected, he will impose large customs duties on countries exporting to America. TikTok's ban threat also supports America's stance. In such an atmosphere, the direction of American-Chinese relations is uncertain and may have negative effects.
Protectionist Policies
If you examine China's budget distribution in previous years, you can see that spending on technology investments has been on a growth trend. If China's expansion into foreign markets is prevented in various ways, this could be bad for both companies and the state, because the reason why Chinese companies are ahead in competition right now is because of huge state support. These supports cannot be provided forever, and it is becoming increasingly important that their returns are short-term.
Likewise, they have a chance of losing to their rival companies. Some of the sectors that the government gives the highest subsidies to are technology companies that produce things like phones, tablets, laptops. These companies already have very strong competitors. If Tesla reaches full autonomous driving before them in terms of electric cars, they could be hit very hard.
The European Union can use its regulatory power on green energy. The most disturbing issue for the European Union countries seems to be electric cars. The reason is the very cheap prices offered thanks to state support. Since the automotive sector is of great importance especially for Germany, regulations may become stricter. At this point, considering the reasons I have explained so far and how important continuous economic growth is for China, I do not think China will be able to give strong responses.
Summary
In summary, the general reaction to these new decisions has been good, but there are some things that should not happen so that the money transferred to the market does not turn into a bubble. In the end, China has given a sigh of relief to the stock market by allocating resources here, but there are still areas in their economy that can be considered fragile. When we consider the place of the banking and real estate sectors, the problems in these sectors can open the door to bigger problems.
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