The stimulus from Beijing will not be enough to revive the Chinese…

Valerio Baselli: Hello and welcome to Morningstar. Volatility is back in China. Chinese shares rose more than 10 percent as trading resumed after the Golden Week holiday, but fell soon after. Investors are now hoping for more information and, above all, wondering whether the government’s 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 Markets Economist at Legal and General Investment Management.

Eric, first of all, can you briefly explain what happened in China in the last few days?

Erik Lueth: Yes basically, good morning first of all. First, at the end of September, the authorities came out with a big stimulus package. I think it’s fair to say it was bigger than expected. It covered several areas, several interest rate cuts and reductions in the reserve requirement ratio. There has been some bank recapitalization of the six largest banks. The central bank provided liquidity for people to buy stocks and stimulate the stock market. And this was not an official announcement, but on the same day, there was a leak from Reuters that a tax package would also be coming. And the number was about RMB 2 trillion, which is about 1.6% of GDP. So that’s kind of – that was the announcement.

WB: Perfect. And do you think this monetary stimulus package will be enough to support the Chinese economy and Chinese companies?

HE: No, we don’t think that at the stage we are in, monetary policy will do the trick. We are in a typical liquidity trap. That means people are sitting on homes that are worth far less than they thought they were worth. Unemployment is quite high. So people don’t really go out and spend, they want to pay off the debt. And so, in this situation, monetary policy is not very effective. Another way to look at it is that prices are going down, China’s deflator, the GDP deflator is going down, so we’re in a deflationary environment. And so if you look at the real policy rate, that still, despite the reductions in the nominal policy rate, the real policy rate is still very close to historic highs because prices are falling. And so, in this situation, we don’t think that monetary policy is really effective and we need fiscal policy, fiscal stimulus.

BB: All right. And what, in your opinion, are the main shortcomings of this government plan? I mean, what would you expect from the Chinese government?

HE: First of all, we haven’t really heard from the official side if there will be a tax incentive. 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 it’s only a very small incentive, because we have to see the context. Fiscal policy has performed very, very strongly this year. That’s because government revenue depends heavily on land sales, and land sales are declining. So government revenue has dropped very significantly this year. And it was also very difficult to identify investment projects. So, with all this in mind, fiscal spending has lagged the budget targets very significantly. And so a lot of the tax stimulus that’s being talked about is really just catching up with the budget, rather than additional stimulus. So the fiscal stimulus should be higher. Secondly, we would also like to see something specifically in the real estate sector. And there was nothing really essential in the real estate sector.

WB: And in light of that, what do you think investors should do about Chinese stocks right now? At this stage, do you see more opportunities or more risks?

HE: We strongly see more risks. I mean, the stock went up a lot. You’re right they pulled back yesterday and today depending on whether you’re looking offshore or onshore, so they’ve pulled back somewhat, but they’re still up a lot. And the price earnings ratio is still above the historical average. And so we think stocks are not that cheap. And given that we’re not so convinced about the stimulus, we think there are more risks than opportunities right now.

WB: Very interesting and very clear. Thanks for your time, Eric. For Morningstar, I’m Valerio Baselli. Thanks for watching.