The Sept 26 Politburo meeting marked a clear change in China’s policy priorities. Since 2021, financial deleveraging and austerity have been the primary agenda. However, faced with weakening demand and a slowing economy, there’s now a clear urgency to support growth. We think a policy turning point is evidenced by the Politburo’s strong rhetoric about the economy, calls to reverse the property decline and subsequent expansionary policies.
A decisive policy pivot
The first set of announcements from the People’s Bank of China (PBOC) and other financial regulators focused on monetary easing, including interest rate cuts, reduced reserve requirements for banks, lower costs for existing mortgages and targeted equity market support. The Ministry of Finance followed with fiscal support announcements, prioritising local government debt, property destocking and increased spending on the safety net for low-income groups.
While the market is currently laser-focused on the specific size of the fiscal budget, we believe the directional change is more crucial. With a strong commitment to support growth, a “policy put” may now be in place. More support is likely if initial measures prove insufficient. Moreover, Beijing’s clear message will shift local governments’ mentality, creating a more favourable policy environment at local and execution levels.
Current financial deleverage cycle enters late innings
China’s post-Covid economic recovery has disappointed, largely due to the deleveraging cycle since 2021. The agenda addressed overinvestment and overpricing in the property sector. From the 2020 peak, secondary home prices fell by 30%, primary sales volume dropped by over 50%, and new housing starts plunged by more than 70%. While the impact on China’s economy was notable, the worst may be behind us. With property investment normalising to 9%–10% of total investment, the industry is now on a more sustainable footing.
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The property slump exacerbated local government debt issues. Land finance, previously close to 40% of local government revenues, has declined by over 40%. This reduced local government investment willingness and created an austerity mentality and a less business-friendly environment.
Compared to the 2011-2015 deleveraging cycle, which primarily affected infrastructure and upstream industries, the current cycle since 2021 has significantly impacted the property sector’s supply chain and household wealth. The symptoms are weak consumption and deflationary pressure rather than the weak producer price index of the previous cycle.
Recent policy announcements directly target weak links in China’s economy: property, local government debt and consumption. We expect these initiatives to stop the negative feedback loop and stabilise the economy in the coming quarters.
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China’s long-term economic transition remains intact
While near-term policies address immediate challenges, China needs new drivers to sustain high-quality growth over the mid- to long-term. We expect a gradual shift away from traditional fixed asset investment-driven growth.
Historically, each of China’s four economic downturns in the past three decades has been followed by the emergence of a new growth driver. We expect consumption and industrial upgrading to drive China’s next growth phase.
Currently, China’s private consumption is below 40% of its GDP, significantly lower than other major economies. However, this could change as the government’s agenda shifts from “hard infrastructure” to “soft infrastructure”, including new urbanisation, a social safety net, education, healthcare and childcare. These trends should support increased consumption in the coming years.
Technology and industrial upgrades are another key driver, both domestically and globally. China already accounts for over 30% of global manufacturing output. The future focus is increasing value-added rather than pure volume, as reflected in China’s evolving export mix. China’s processing trade has declined over the past decade while ordinary trade, which carries much higher value-added, has more than doubled during this period.
Compelling opportunities in China’s deep equity market
Following PBOC’s announcement on Sept 24, the MSCI China index rallied over 30% before a 10% pullback after the market reopened on Oct 8 following China’s weeklong National Holiday. We believe the market is currently trading primarily on sentiment and policy expectations, with economic improvement and corporate earnings inflection likely still two to three quarters away. Despite near-term volatility, we see a potentially improving outlook and attractive valuations and remain constructive on Chinese equities over the next two to three years.
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Despite the recent recovery, MSCI China’s P/E ratio remains at a 20% discount to Emerging Markets-ex China markets. We expect corporate fundamentals to be key performance drivers in the future.
From a bottom-up perspective, we seek to find compelling investment opportunities in China’s deep, liquid stock market.
After three and a half years of market downturn and growth stock underperformance, selective high-quality growth stocks in China are trading at an attractive price. We continued to favour online recruiting, shopping malls, and hotel chains. We believe these scalable businesses likely have high earnings growth visibility over the next few years and stand to benefit from an improving macro outlook.
Industrial businesses with strong competitiveness and favourable industry cycles, such as rail equipment, power grid upgrades, shipbuilding and construction machinery, also present opportunities. We expect these businesses to see potential accelerating earnings growth and improving returns in the coming quarters.
Additionally, as businesses in selective industries mature and enter the “harvest stage”, they become highly cash-generative, presenting increasing opportunities for rising shareholder returns. We seek Chinese companies that combine rising cash flow, disciplined capital allocation, and a shareholder-friendly mindset. We have identified this combination in telecom tower, outdoor media and delivery companies.
China’s economic policy has turned from deleveraging to growth support. Increased policy support could stabilise the economy by effectively addressing property and local debt issues. We believe the transition to consumption and industrial upgrading will drive China’s subsequent economic growth phase. Despite near-term volatility, we seek to find compelling opportunities in Chinese equities and aim to build a balanced portfolio that will benefit from China’s economic transition in the coming years.
Wenli Zheng is a portfolio manager for China evolution equity strategy at T Rowe Price
