In the second quarter of 2024, China's economic growth slowed down, increasing the difficulty of achieving the annual growth target of 5%. As the GDP growth rate in the second quarter fell below the target value of 5%, the market entered a critical policy observation period. Whether the upcoming stable growth policies can take effective measures against the current sources of economic pressure will significantly affect the market's expectations and confidence in the economic trend for the second half of this year and even for a longer term.

To stabilize economic growth, the focus should be on boosting spending behavior in the real economy. In terms of stimulating spending in the real economy, monetary policy has only an indirect effect. When the financing demand of the real economy is no longer sensitive to interest rates, the ability of monetary policy to stabilize growth is effective. Faced with the decline in demand from the real economy, fiscal policy is an available means. However, the expansion of fiscal policy also faces constraints.

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There is another more effective option for stable growth, which is to address the main contradiction in the real estate industry by establishing a "Real Estate Relief Fund" with one or two trillion yuan of fiscal funds. Public funds can be used to universally rescue real estate companies, break the market failure within the real estate industry, restore the normal market cycle, and thus allow the return of real estate sales to the normal state to break the trend of shrinking demand.

In the second quarter of 2024, China's economic growth slowed down, and the difficulty of achieving the annual growth target of 5% increased. In the second quarter, China's GDP grew by 4.7% year-on-year, slowing down by 0.6 percentage points compared to the first quarter, lower than the market's previous expectations. According to the estimates of the National Bureau of Statistics, the seasonally adjusted GDP growth rate (annual rate) in the second quarter has also significantly declined to 2.8%, which is already quite lower than the annual growth target. If the quarter-on-quarter momentum of economic growth cannot be significantly improved in the second half of this year, it will be quite difficult to achieve the growth target.

The downward pressure on economic growth still mainly comes from real estate investment. In the first half of 2024, China's economy was "warm outside and cold inside". On the one hand, China's exports performed well, driving the prosperity of related industries (especially high-tech manufacturing) to a high level. On the other hand, the risks in the domestic real estate industry have not been effectively curbed, and the growth of real estate investment further declined in the second quarter of this year. Affected by the real estate industry, the performance of domestic investment-related industries was not good. Against the background of weakened income growth expectations, domestic consumption also showed fatigue.

Looking at the data from June 2024, there are signs of increasing downward risks in real estate. In recent years, the trend of declining sources of real estate investment funds has reflected the pressure on the real estate industry. The real estate investment fund source indicator covers the total amount of funds obtained by real estate companies from various channels such as deposits and prepayments, development loans, mortgage loans, and self-raised funds. The decline of this indicator means that the capital chain of real estate companies is tight, which naturally leads to a decline in real estate investment. After stabilizing at a low level for nearly a year, the scale of real estate investment fund sources has significantly declined again in June this year. From the latest data, the effects of the ongoing real estate rescue policies such as "ensuring delivery of buildings", "project whitelist", and relaxation of purchase restrictions are not obvious, and the downward pressure on real estate has not been controlled.

As the GDP growth rate in the second quarter fell below the target value of 5%, the market entered a critical policy observation period. After the "two sessions" in March this year set the annual GDP growth target of "about 5%", senior leaders have repeatedly expressed their determination to achieve this target. On June 25, 2024, Premier Li Qiang said at the Summer Davos Forum that China has the confidence and ability to achieve an annual economic growth target of about 5%. At the just concluded Third Plenary Session of the 20th Central Committee, the Party Central Committee also emphasized the need to "unswervingly achieve the annual economic and social development goals". Therefore, the market previously had a strong expectation that after the GDP growth rate fell below 5%, the stable growth policy would further intensify. After the GDP growth rate of 4.7% in the second quarter of this year was released, the market is observing the direction of macro policies to determine whether the previous policy expectations can be realized. The upcoming Political Bureau meeting at the end of July will be a key observation point for the market's policy. Whether the upcoming stable growth policies can take effective measures against the current sources of economic pressure will significantly affect the market's expectations and confidence in the economic trend for the second half of this year and even for a longer term.

The current downward pressure on China's economy mainly comes from the internal cycle, from the weak spending willingness of the domestic market, and the随之而来的 contraction of domestic demand and weakening expectations. To stabilize economic growth, the focus should be on boosting spending behavior in the real economy. During the economic downturn, market-oriented economic entities will generally have weakened income expectations and reduced spending willingness. And the macroeconomy is an internally interconnected organism, and the expenditure of one economic entity is the income of other economic entities. If all economic entities reduce their expenditures, everyone's income will decrease, further reducing the spending willingness of each household, thus forming a vicious cycle. To break this cycle, it is necessary to have economic entities increase their expenditures against the trend, thereby driving the income growth of other economic entities and breaking the trend of weakening income expectations.

In terms of stimulating spending in the real economy, monetary policy has only an indirect effect. Whether it is the central bank or other financial institutions, they are not the main buyers in the real economy. Their role is more reflected in providing financing for various entities in the real economy and helping them expand expenditures. In simple terms, financial institutions lend money to economic entities in the real economy, allowing them to have stronger spending power. But the problem here is that even if financial institutions are willing to lend funds, real economy entities may not necessarily be willing to borrow.

Monetary easing can reduce the cost of funds in the financial system. Under normal circumstances, facing lower funding costs, the willingness of real economy entities to borrow will correspondingly increase. However, if the entities in the real economy lack stable expectations for the future (whether it is income expectations, wealth expectations, or investment return expectations), the decline in funding costs is also difficult to drive the willingness of economic entities to borrow and spend.This is precisely the issue that current monetary easing encounters—amidst the contraction of demand and weakening expectations in China's real economy, the transmission of monetary easing to the expansion of real economy expenditure has been significantly obstructed. At present, the interest rate levels in China's financial markets have reached a new low in recent years. However, during the same period, the scale of social financing provided by the financial system to the real economy has increased at a notably lower rate. More concerning is that the sensitivity of real economy financing rates to interest rates has significantly decreased. Over the past decade, there has been a significant negative correlation between the growth of social financing and the level of financial market interest rates, with low interest rates often accompanying high growth in social financing scale. Yet this year, despite interest rates being significantly lower than the bottom levels of previous cycles, social financing growth has not accelerated accordingly, instead forming a rare divergence from the interest rate trend. When the expansion of real economy financing becomes insensitive to interest rates, the ability of monetary policy to stabilize growth is limited.

In the face of declining demand in the real economy, fiscal policy is an available tool. After all, fiscal policy can spend directly in the real economy, thereby creating income for other economic entities. The fiscal deficit is a commonly used indicator to measure the extent of fiscal policy expansion. The larger the fiscal deficit, the more proactive the fiscal policy, and the more significant its role in driving real economy demand. In the past three months, China's central fiscal deficit has indeed expanded compared to the same period last year. However, during the same period, the local fiscal deficit has remained unchanged from last year, and the deficit in government fund revenues and expenditures (mainly related to local government land finance) has significantly decreased. As a result, when adding up these three parts of fiscal revenues and expenditures, the deficit has actually decreased compared to the same period last year. There is a further need for expansion in the broad fiscal policy to stimulate real economy demand.

However, the expansion of fiscal policy also faces constraints. In the current economic downturn, China's fiscal revenue reduction pressure is relatively large. In the first five months of 2024, China's government tax revenue decreased by 5% year-on-year, and the revenue from the transfer of state-owned land use rights decreased by 14% year-on-year. In theory, during an economic downturn, fiscal policy should act counter-cyclically, offsetting the downward economic pressure through the expansion of fiscal deficits. However, the National People's Congress in March this year has already set the fiscal deficit and the scale of government bond issuance for the whole year. Before requesting an increase in the deficit scale at the National People's Congress, the intensity of fiscal expansion is constrained by fiscal revenue, deficit, and bond issuance scale. Of course, if more proactive fiscal policies are introduced, it would have a positive significance in alleviating the pressure of insufficient economic demand and enhancing the confidence of all parties. Considering that China's GDP scale has reached 126 trillion yuan in 2023, even if fiscal expenditure further expands at the current planned level, if the increase cannot reach a scale of several trillion yuan, its impact on the economy may not be too significant.

In fact, there is another more effective option for stabilizing growth, which is to address the main contradiction in the real estate industry by establishing a "Real Estate Relief Fund" with one to two trillion yuan of fiscal funds. Public funds can provide universal assistance to real estate companies, breaking the market failure within the real estate industry, restoring the normal market cycle, and thus allowing the return of real estate sales to the norm to break the trend of demand contraction in the economy.

The downturn in the real estate industry is the main reason for the current weakness of domestic demand in China. The weakness of the real estate industry is not inevitable, nor is it, as some people say, beyond an irreversible turning point. One fact can illustrate this. Since 2021, the sales area of commercial housing under construction (houses not yet completed) in China has decreased by more than half, while the sales area of commercial housing ready for use (houses already completed) has not decreased, but has significantly increased this year. In other words, in recent years, people are not afraid to buy houses, but are just not very willing to buy houses under construction. If real estate sales really declined due to income expectations or population aging, what should be seen is a simultaneous decline in the sales area of commercial housing under construction and ready for use. From the contrast in the sales trends of commercial housing under construction and ready for use, the anxiety about the "unfinished" risk of houses under construction, and its reflection of the worry about the credit risk of real estate companies, is the main reason for suppressing overall real estate sales and hindering the normal cycle of the real estate market.

At the beginning of this year, policies increased the intensity of "ensuring delivery of buildings" and introduced a "white list" system for real estate projects, attempting to provide more abundant financing support for real estate projects that enter the white list. The original intention of these policies is, of course, good. However, in the current market environment, "ensuring delivery of buildings" and resolving the credit risk of real estate companies cannot be separated. Attempting to bypass real estate companies and directly provide financing for real estate projects cannot resolve the risks in the real estate industry. This is because if the credit risk of real estate companies continues to be high, people's "cautious purchase" sentiment will be difficult to suppress—when assessing the risk of "unfinished" houses under construction, people are more concerned about the possibility of the corresponding real estate company "exploding" rather than whether a certain project has been included in the "white list". And if the "cautious purchase" sentiment cannot be suppressed, real estate sales will be difficult to stimulate, and the "ensuring delivery of buildings" policy will also be difficult to enter a virtuous cycle. The significant decline in the sources of real estate investment funds in June this year has already shown that the effect of the "white list" policy is limited.

At present, the key blockage hindering the market cycle of the real estate industry is the high credit risk of real estate companies. It not only breeds the "cautious purchase" sentiment of homebuyers but also brings the "cautious lending" sentiment of financial institutions. The decline in the interest rate sensitivity of real economy financing demand also mainly comes from this—when homebuyers are worried about the risk of unfinished houses, the reduction of mortgage interest rates naturally finds it difficult to significantly boost real estate sales. On the other hand, the current real estate financing market is in a state of market coordination failure. At present, financial institutions are not short of money, and the government has repeatedly called for equal satisfaction of the reasonable financing needs of real estate companies of different ownerships. In fact, as long as all financial institutions massively provide financing to real estate companies, the current market dilemma can be resolved. However, from the perspective of each financial institution itself, there will be a strong "cautious lending" sentiment due to the consideration of bad debt risks. In other words, all financial institutions are in a "prisoner's dilemma," and it is difficult to break this coordinated failure market stalemate without external forces.

When the market fails, the external force needed to unblock the market cycle can only come from the government. At this time, the government can use one to two trillion yuan of fiscal funds to establish a "Real Estate Relief Fund" and universally purchase the shares and bonds of various real estate companies. The amount of money the government spends is not that important (so a fund scale of one trillion yuan should also be possible), what is important is the action of the government spending money to universally rescue real estate developers. This action can break the "prisoner's dilemma" in the real estate financing market—after government funds are injected into real estate companies, the bad debt worries of financial institutions will significantly recede, and the liquidity of the financial market will flow massively to real estate companies, thereby resolving the credit risk of real estate companies, dispelling the "cautious purchase" sentiment of homebuyers, and allowing the real estate market to return to normal. The process of real estate sales returning to the norm will break the trend of domestic demand contraction, thereby strongly stabilizing China's economic growth. In this way, by accurately identifying the main contradiction and对症下药, the economic situation can be significantly improved immediately.

In summary, the current downward pressure on China's economy comes from the internal cycle rather than the external cycle. The key blockage of the internal cycle, and also the main contradiction in China's economy at present, is the weakness of real estate sales caused by the high credit risk of real estate companies. At this time, the ability of monetary policy to drive real economy demand is limited. To stabilize economic growth, the effective options are nothing more than more proactive fiscal policies and universal assistance to real estate companies. After the GDP growth rate falls to 5%, and the market enters a key policy observation window, if positive actions can be seen in these two areas, market sentiment and economic performance can be significantly improved. If there are no effective measures in both aspects, market confidence is likely to further weaken, increasing the difficulty of achieving this year's economic growth target.