Valerio Baselli: Hello and welcome to Morningstar. Volatility is back in China. Chinese stocks jumped by over 10% as trading restarted after the Golden Week holiday, but fell back right after. Investors now hope to get more information and above all wonder if the government plans to support economic growth will be enough to revive the Chinese market. To talk about that today, I’m joined by Erik Lueth, Global Emerging Market Economist at Legal and General Investment Management.
Eric, first of all, can you explain very briefly what has been going on in China over the last few days?
Erik Lueth: Yeah, basically, good morning, first of all. First of all, late September, the authorities came out with a big stimulus package. I think it’s fair to say that it was bigger than what was expected. It comprised several areas, several interest rate cuts and cuts to the reserve requirement ratio. There was some bank recapitalization there of the six largest banks. The central bank was providing liquidity for people to buy stocks and to boost the stock market. And that was not an official announcement, but on the same day, there was a leak from Reuters that there would also be a fiscal package coming. And the number floated was about RMB2 trillion, which is about 1.6% of GDP. So that’s kind of – that was the announcement.
VB: Perfect. And do you believe that this monetary stimulus package will be enough to support Chinese economy and Chinese companies?
EL: No, we don’t think that at the stage where we are, monetary policy will do the trick. We are in a typical liquidity trap. That means people are sitting on houses that are worth much less than they thought they were worth. Unemployment is quite high. So people are not really going out and spending, they want to pay down debt. And so in this situation, monetary policy is not very effective. Another way to look at it is that prices are falling, the deflator in China, the GDP deflator is falling, so we are in a deflationary environment. And so if you look at the real policy rate, that still, despite the cuts in the nominal policy rate, the real policy rate is still very close to all-time highs because prices are falling. And so in this situation, we don’t think monetary policy is really effective and we need fiscal policy, fiscal stimulus.
VB: All right. And what are in your view the main flaws of this government plan? I mean, what would you expect from the Chinese government?
EL: First of all, we haven’t really heard from official side whether there will be a fiscal stimulus. But let’s assume there will be a fiscal stimulus and let’s assume it will be the two trillion renminbi that have been floated. We think that is just a very small stimulus, because we have to see the context. Fiscal policy has been underperforming very, very strongly this year. That’s because government revenues rely very heavily on land sales and land sales are down. So government revenues are down very significantly this year. And it was also very difficult to identify investment projects. So given all that, fiscal spending has been lagging the budget targets very significantly. And so a lot of the fiscal stimulus that is being talked about is really just a catch-up with the budget rather than additional stimulus. So, the fiscal stimulus would have to be bigger. Second, we would also want to see something particularly on the property sector. And there has been nothing really of essence on the property sector.
VB: And in the light of this, what do you think investors should do at this point concerning Chinese stocks? At this stage, do you see more opportunities or more risks?
EL: We firmly see more risks. I mean, stocks have rallied a lot. You are right that they fell back yesterday and today, depending on whether you’re looking at offshore or onshore, so they have retreated somewhat, but they’re still up a lot. And the price earnings ratio is still above the historical average. And so we think that stocks are not that cheap. And given that we are not that convinced as it is with the stimulus, we think that there are more risks than opportunities at the moment.
VB: Very interesting and very clear. Thanks for your time, Eric. For Morningstar, I’m Valerio Baselli. Thanks for watching.
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