China’s March NPC meeting recap and investment implications amid transition from “old China” to “new China”

China’s 2024 March NPC (National People’s Congress) concluded, and policy makers made it clear that China will continue to shift away from its old growth model—largely linked to RE (Real Estate) dynamic—while pushing forward the transition to the new growth model—where manufacturing upgrades and renewables gain prominence. We highlight the takeaways and related investment implications in this blog.

(1) March NPC Government Work Report (GWR)

Premier Li Qiang delivered the Government Work Report (GWR) during China’s National People’s Congress session. Major economic development targets are set as below:

Same GDP growth target, more efforts needed. “Around 5%” is fully in line with our view and market consensus. Unlike last year when “around 5%” was sort of guaranteed (on favorable base effect), we think the same growth setting this year will require more government efforts than in 2023. The setting this year reflects policy makers’ intention on (1) supporting college graduate employment, (2) boosting up market confidence – that is depressed by RE stress, (3) accommodating 2035 target on doubling GDP per capita compared to 2021 and (4) balancing quality growth and financial stability.

Expansionary fiscal policy focusing on Fixed Asset Investment (FAI). Nominal fiscal deficit target remained at 3%, while there will be another CNY1trn central government special ultralong bond arrangement (in addition to the CNY1trn issued in Q4 last year). Moreover, GWR said the central government special ultralong bond will be issued each year for the next few years. The central government fiscal setting is equivalent to nominal fiscal deficit of GDP at ~3.8%. The CNY1trn special China Government Bonds (CGB) will be supporting important and strategic investment projects, especially related to economic structural transition and national security. The quota for new Local Government (LG) special bonds for 2024 is set at CNY3.9trn. Based on our estimate, augmented fiscal deficit (including nominal fiscal deficit, special CGB, LG special bond, tax cut/rebate, quasi-fiscal such as PSL) increases by 1.3pp to 12.5% in 2024.

Monetary policy remains accommodative with more easing on the way. Monetary policy (MP) in GWR shared similar verbiage to the past few months. In general, MP will be flexible, targeted and effective. Money supply will be compatible with economic growth and the inflation target, implying boosting up inflation is an important target for the People’s Bank of China this year. Policy makers will continue to improve MP transmission and further guide down overall financing costs, while keeping CNY stable at a reasonable level. We think more Reserve Ratio Requirement (RRR) cuts and one/two policy rate cuts are on the way in 2024. But, given the exchange rate constraints (police makers clearly favor stable CNY) and considering the government bond issuance pattern, we think RRR cuts are more likely in the first half of the year and policy rate cuts will be delayed to late 2nd Quarter or even the 2nd half of the year to avoid front-running the Federal Reserve.

Continued efforts on new growth model. GWR reiterated quality growth as the general guidance in framing various policy setting, which requires manufacturing upgrades, cultivating new sectors (i.e., new energy, new materials, new medicine and etc.), promoting digital economy developments (such as AI) and accelerating key technology developments (such as semiconductor). Having said that, along with infrastructure investment, a larger portion of funds will be allocated to these manufacturing projects. And we expect that manufacturing FAI will be as important as infrastructure FAI to sustain a decent growth target.

Stability is assigned with top priority. GWR ranked stability high in the context and called for all policy setting to target stabilizing expectations, growth and employment. We think there are two layers of guidance here. (1) Trying to avoid policy mistakes. Regulators are required to be cautious in announcing any contractionary guidance and enhance coordination across different areas (such as fiscal, monetary, employment, industrial, technology, environment protection and etc). (2) Proper handling of exposed risks. Local government debt  and housing remained the key risks that need to be carefully handled. GWR said policy makers will continue to apply debt swap for local government this year and strictly curb new debt increase. We estimate that there might be another CNY1.5trn available for debt swap in 2024. Meanwhile, the GWR said all developer’s financing demand should be treated equally and called for increasing social housing supply to accommodate for low income housing demand. We expect housing market adjustments will continue in 2024, while policy makers will use three major projects (social housing, urban renovation, facilities for regular and urgent usage) to partially offset housing FAI drag on GDP. Also we may see a decoupling between home sales and housing FAI, which fits in a stabilization scenario in our view.

(2) Investment landscape change in onshore market amid transition from “old China” to “new China”

We have seen a visible decoupling between resilient economic data and a meaningful rally in CGBs since December last year and noted increasing talks about asset scarcity in the onshore fixed income market. We think economic transition and corresponding tightening on the real estate sector is the main reason behind the so-called asset scarcity in China recently. This is reflected by abundant funds chasing limited investable assets and a large credit spread squeeze.

High yielding assets derived from real estate sector gradually fade. In previous cycles, the rapidly growing real estate sector was supporting the majority of the high yielding assets in China. However, in policy makers’ new mindset of reducing dependence on real estate sector, the traditional high yielding assets are fading. (1) Most real estate bonds are gradually phased out. As home sales remain sluggish, concerns on developer defaults linger and any bond investment regarding the real estate sector will be guided with high cautiousness. (2) LGFV (Local Government Financing Vehicle) bonds are engineered to be low yielding assets. Even though weak land sales heavily weigh on LGFV’s balance sheet, the central government guided debt swap program helped investors to price out any near-term LGFV default. Moreover, the general guidance on replacing maturing and high funding cost debt with long tenor and lower funding cost bank loans has meaningfully compressed credit spreads of LGFV. (3) Shadow banking has been squeezed. We note that shadow banking used to be an important financing channel for both developers and LGFV, charging much higher funding costs than bank loans and bonds. Along with the new asset management rule transition period concluding in 2022, the size of shadow banking has decreased by ~CNY12trn to 50.3trn by the end of 2022, compared to its peak of CNY62.2trn in 2017, according to Moody’s.

Asset searching amid economic transition. The housing sector’s total contribution to GDP has been decreasing over the past few years, dropping from 25% at the peak to ~16% in 2023, and we expect the housing adjustment will continue at least in 2024. On the other hand, the renewable sector’s contribution to GDP has been growing and is supported by significant investment. For example, 2023 investments in renewables account for more than 77% of total energy investment. And as of 2023, renewables power supply exceeds 1/3 of total power demand in China, with wind and photovoltaic power generation fully covering household demand. Therefore, substitutes for old asset classes (with housing sector as underlying assets) are more likely to appear in renewable, new materials and other manufacturing upgrading sectors. 

Financial repression. 5y LPR (key reference for bank loans) has dropped by 90bps since LPR reform in 2019, which is mainly accommodated by the banks’ net interest margin before April 2022. Meanwhile, we note banks also play an important role in local government debt swaps and boosting household consumption (such as reducing existing mortgage rate by 70-80bp in 2023). To alleviate pressure on banks, the central government began to guide down the deposit rate, and we note that the 5y deposit rate has been reduced by ~65bps on average since April 2022. Against such backdrop, we note household outstanding deposit growth has been slowing visibly, along with a drop in the savings rate over the past three quarters. Given China’s capital account remains largely closed and the public has limited channel to invest overseas, the most relevant substitute to deposits would be fixed income assets.

Investment implication. We expect the economic transition is less likely to conclude soon. At least for 2024, continued housing adjustment and more monetary policy easing (to support economic transition) will sustain a low yielding environment, which should be friendly for long CGB. Having said that, we think the bond issuance pattern and economic data momentum may create technical trading windows.