By Seth Carpenter, chief economist at Morgan Stanley
For a while, market focus on China waned because of the debt-deflation cycle (see our work on the 3D Journey), but China’s recent policy pivot has taken local markets by storm. Possibly in reaction to downside surprises in nominal growth data that further eroded confidence, coupled with shortfalls in fiscal revenues, Beijing launched what appears to be a substantial shift in its policy approach. Clients are asking how much upside this shift could provide to Chinese growth and whether we are entering a new cycle. I have quipped that we are hopeful but not yet confident.
Our take is that the policy pivot demonstrates an awareness among policymakers that seemed absent a month ago. However, our China team has long noted that undoing the debt-deflation cycle requires a particular policy response. Fiscal policy has already attempted to boost investment spending, but that push created even more excess capacity, reinforcing deflationary pressures. The new policy response largely came from the People’s Bank of China (PBOC), the central bank. But monetary policy has not been an obstacle for reflation, so it will likely not be the solution. Even the support to the property sector was small compared to the inventory in question. For investors looking to be bullish on Chinese reflation, an end to the debt-deflation cycle in China might come if the recent moves signal only the beginning of a shift in policy, with more to follow.
