Macroscope | Never mind stimulus, rebalancing is China’s real economic challenge

Few would dispute that Chinese stimulus has the capacity to move financial markets. The Hang Seng China Enterprises Index, which tracks Chinese stocks listed in Hong Kong, has been one of the world’s best-performing equity gauges this year, up 25 per cent compared with a 24 per cent rise for the benchmark S&P 500 index.

Other Chinese equity indices, notably the MSCI China Index of shares listed on the mainland and in Hong Kong, have outperformed emerging market stocks. This includes Indian shares, which have benefited from China’s economic woes.

The unexpected launch in late September of a package of more forceful and coordinated stimulus measures triggered a fierce rally in Chinese and Hong Kong stocks. Between September 23 and October 8, the CSI 300 index of Shanghai and Shenzhen-listed shares surged 32.5 per cent.

Yet it is what happened since that is more revealing. Chinese equities have been volatile during the past two months, even though Beijing announced bolder measures to stabilise the property market and boost domestic demand. The annual central economic work conference earlier this month made lifting consumption the top priority, a major policy shift that Morgan Stanley described as the “most aggressive stimulus tone in a decade”.

That sentiment towards China has cooled despite a reorientation of policy support towards consumption – a shift markets have long demanded – suggests the size, and even the composition, of the stimulus package are less consequential than previously assumed. Bank of America says that while Chinese stocks have outperformed this year, it is “a bull market that doesn’t feel like one”.

A more reliable gauge of sentiment, and a far more accurate indicator of economic conditions, is the yield on China’s 10-year government bonds. Having fallen below the symbolically important 2 per cent level on December 2, the yield has since dropped to a new low of 1.7 per cent, signalling that economic conditions are unlikely to improve and that more aggressive monetary easing is needed to overcome deflation.