1 Central bank rate cuts after Third Plenum bodes ill for regime
PBoC cuts rates
July 22
1. The People’s Bank of China announced that it would cut the seven-day reverse repo rate to 1.7 percent from 1.8 percent. The central bank also announced that it would improve the mechanism of open market operations.
2. The PBoC authorized the National Interbank Funding Center to lower the one-year loan prime rate (LPR) to 3.35 percent from 3.45 percent and the five-year LPR to 3.85 percent from 3.95 percent.
The LPR cut was the first in four months. The last rate cut in February 2024 saw the five-year LPR lowered by 25 basis points. This was also the first simultaneous cut of both the 1-year LPR and 5-year LPR since June 2023.
July 25
The PBoC cut the one-year medium-term lending facility (MLF) to 2.3 percent from 2.5 percent. In a statement, the central bank said it sold 200 billion yuan of one-year loans under its MLF at 2.3 percent.
The PBoC also sold 235.1 billion yuan of the seven-day reverse repo at 1.7 percent and said the cash injection was to “maintain reasonably ample month-end banking system liquidity conditions.”
MLF collateral requirement lowered
July 22
The PBoC announced that institutions participating in medium-term lending facility operations and planning to sell medium to long-term bonds can apply a lower collateral requirement or an exemption for a certain period of time.
China’s fiscal revenue falls in H1
July 22
The PRC Ministry of Finance released China’s fiscal revenue and expenditure data for the first half of 2024.
General public budget revenue
- The national general public budget revenue decreased by 2.8 percent year-on-year in the first six months of 2024 to 11.59 trillion yuan. However, the ministry added that the fiscal revenue in H1 grew by about 1.5 percent year-on-year after accounting for the impact of a higher base due to deferred tax payments for small and medium-sized enterprises in the same period in 2023 and the carryover effects of the tax reduction policy introduced in mid-2023.
- The national tax revenue decreased by 5.6 percent year-on-year to 9.40 trillion yuan.
- The non-tax revenue increased by 11.7 percent year-on-year to 2.18 trillion yuan.
- Main tax revenue sources
- Domestic value-added tax decreased by 5.6 percent year-on-year to 3.54 trillion yuan.
- Domestic consumption tax increased by 6.8 percent year-on-year to 883.4 billion yuan.
- Corporate income tax decreased by 5.5 percent year-on-year to 2.54 trillion yuan.
- Personal income tax decreased by 5.7 percent year-on-year to 735.8 billion yuan.
- Stamp duty on securities transactions decreased by 54 percent year-on-year to 50.9 billion yuan.
- Export tax rebates increased by 21.2 percent year-on-year to 970.9 billion yuan.
General public budget expenditure
- The national general public budget expenditure increased by 2 percent year-on-year in H1 2024 to 13.66 trillion yuan.
- Debt interest expenditure increased by 6.5 percent year-on-year to 630.4 billion yuan.
National government fund budget revenue and expenditure
- Revenue from the transfer of state-owned land use rights decreased by 18.3 percent year-on-year to 1.53 trillion yuan.
- Expenditure related to the transfer of state-owned land use rights decreased by 9.2 percent year-on-year to 2.2 trillion yuan.
Backdrop
1. China’s economic data for the first half of 2024 was unsatisfactory, with real estate, financial, and social financing data all lower than expected.
2. The Shanghai Composite Index fluctuated between 2,900 points and the psychologically important 3,000 points after falling below 3,000 points on June 21. After the conclusion of the Third Plenum, the Shanghai index fell by 1.65 percent on July 23 after experiencing the most severe sell-off in six months. On July 24, the Shanghai index dropped below 2,900 points during intra-day trading.
3. The yield on China’s 30-year government bonds briefly rose above the PBoC’s target level of 2.5 percent after the central bank announced that it would “borrow sovereign bonds from primary traders in the open market in the near future.”
However, the yield on the 30-year sovereign bonds fell below 2.5 percent starting from July 12 and continued to drop after the conclusion of the Third Plenum. On July 24, the yield reached 2.4676 percent.
Our take
1. The PBoC’s rate cuts and lowering of the collateral requirement for medium-term loans after the Third Plenum of the 20th Central Committee appear to be a response to the market’s disappointment in the policies that emerged from the political conclave.
i) The PRC central bank’s move to cut rates ahead of the U.S. Federal Reserves is a sign that China’s economy is under immense downward pressure and that the CCP authorities are wary of financial risks being triggered by the bursting real estate bubble.
China’s real estate woes are placing tremendous strain on the financial sector. During the property boom period (2010 to 2019), over 60 percent of new loans went to the real estate sector. New loans, however, are reverting to the pre-boom era. In the first half of 2024, Chinese developers only took out 1.35 trillion yuan in new loans and are estimated to take out around 2 trillion yuan in new loans by the end of the year, or near the 2009 level of 1.97 trillion yuan. Meanwhile, new residential loans in the first half of 2024 were 1.47 trillion yuan and are estimated to reach 2.6 trillion yuan by the end of the year, or comparable to the 2.53 trillion yuan of new residential loans in 2012.
The steep reduction in land sales revenue for local governments hints at the extent of the downturn in China’s real estate sector. Local government revenue from land sales was just 1.53 trillion yuan in H1 2024, or less than half of the 3.44 trillion yuan in the same period in 2021.
The banking industry is also being burdened by real estate sector troubles. Data on major regulatory indicators for the banking and insurance industries released by the National Financial Regulatory Administration for the first quarter of 2024 show that the net interest margin of commercial banks was 1.54 percent and their non-performing loan ratio was 1.59 percent. The overall gross yield of negative 0.05 percent for commercial banks indicates that many are technically operating at a loss. Given that Chinese banks generally conceal non-performing assets, the non-performing loan ratio in China’s banking industry is likely far higher than stated in official data.
In view of trouble in the financial and real estate sectors, the PBoC likely decided to cut rates without waiting for the Fed to make the move first in the hopes of stimulating the economy and counteracting the post-Third Plenum market negativity.
ii) The central bank’s move to lower the collateral requirement for medium-term bonds will increase the size of tradable bonds in the market. This appears to be a move by the CCP authorities to alleviate the asset shortage (or “asset famine”) pressure on the bond market as a large amount of bonds will be released should financial institutions opt to sell long-term bonds following the adjustment to the collateral requirement.
However, we believe that lowering the collateral requirement will not be sufficient to deter financial institutions from scrambling to snap up medium- and long-term government bonds for arbitrage and to mitigate risks.
2. China’s fiscal revenue situation in H1 2024 is a sign of a sluggish economy and indirectly affirms our assessment that China’s growth was much weaker than the official figure.
The PRC finance ministry’s explanation that the national general public budget revenue increased rather than decreased due to the higher base caused by deferred tax payments for small and medium-sized enterprises, as well as the carryover effects of the tax reduction policy rolled out in mid-2023, are not convincing on closer scrutiny. Publicly available information disclosed by relevant government departments indicates that some micro and small enterprises that were originally scheduled to declare taxes from December 2021 to July 2022 could defer their declarations to January 2023 to May 2023. Meanwhile, the State Taxation Administration announced twelve tax and fee preferential policies In May 2023. This means there was only a “higher base” in 2023 until May, after which the tax revenue went down rather than up. Without the impact of a higher base in June 2023, the fiscal revenue in June 2024 (1.9 trillion yuan) fell by 2.6 percent compared to the same period last year (1.95 trillion yuan), the national tax revenue fell by 8.5 percent, the non-tax revenue increased by 16.4 percent, and corporate income tax fell by 26.8 percent.
The main tax revenue situation also reflects the sluggishness of China’s economy. Aside from the 11.7 percent growth in non-tax revenue and the 6.8 percent increase in consumption tax, other major sources of tax revenue showed declines. Meanwhile, the growth in non-tax revenue reflects the increase in fines and arbitrary charges as local governments struggle to source more revenue, which in turn reflects a squeeze on businesses and the public when the business environment is already fragile.
The significant increase in export tax rebates aligns with recent export growth in China. However, export tax rebates are not revenue but are taxes that the Ministry of Finance needs to refund to export companies.
3. China’s decreasing revenue and increasing expenditures (China’s fiscal deficit in H1 2024 increased by 140.8 percent to reach 2.07 trillion yuan) suggest that the CCP authorities’ effort to turn the economic situation around is not having the expected results but is instead increasing its fiscal burden.
The central government has repeatedly called for local governments to engage in belt-tightening (including laying off staff and reducing salaries) to save costs. However, China’s economic downturn has also forced the CCP authorities to issue large amounts of bonds to maintain the scale of social financing. While Beijing aims to stimulate the economy and private investment through government spending and investments in various projects, it has instead created conditions for financial institutions facing an “asset famine” to snap up government bonds as they look to mitigate risks. This in turn pushes investment risks back to the government while the economy continues to flounder rather than revive.
2 New financial anti-corruption entity made public after Third Plenum
July 22
The Central Commission for Discipline Inspection published an article on its website titled, “Advancing Reform With an Indomitable Spirit of Struggle” (以一往無前的奮鬥姿態把改革推向前進). The article revealed the existence of a Central Financial Discipline Inspection and Supervision Working Commission (中央金融紀檢監察工作委員會). This was the first official acknowledgment of the new Commission.
The article quotes Wang Weidong, the secretary of the Central Financial Discipline Inspection and Supervision Working Commission, as saying, “On the new journey, the Central Financial Discipline Inspection and Supervision Working Commission will resolutely shoulder its political responsibility … to be brave and adept in struggle, and to faithfully fulfill its duties.” Wang added that the Commission will “take a clear-cut stand and strengthen political supervision,” “implement the major decisions and arrangements of Party Central regarding financial work,” and “ensure that the financial system implements various arrangements to comprehensively strengthen supervision, prevent and resolve risks, and promote high-quality financial development.”
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Wang Weidong, 56, spent his formative years at the National Government Offices Administration under the PRC State Council.
From June 2018 to May 2019, Wang served as a deputy ministerial-level inspector of a central inspection team, deputy secretary-general of the CCDI, and director of the National Government Offices Administration.
In May 2019, Wang was transferred to Tibet to serve as provincial anti-corruption chief. He was appointed director of the Tibet Supervisory Commission in January 2020.
In March 2024, the Standing Committee of the Tibet Autonomous Region People’s Congress accepted Wang’s resignation. Wang was likely then transferred to head the Central Financial Discipline Inspection and Supervision Working Commission.
Background
The CCP authorities established the Central Financial Commission and Central Financial Work Commission as part of state and Party institutional reform at the Two Sessions in March 2023.
The Central Financial Commission is a decision-making and coordinating body of Party Central. The Commission works to strengthen the centralized and unified leadership of Party Central over financial work; carry out top-level planning, coordination, overall advancement of financial stability and development, and supervise the implementation of those works; and research and review major policies and matters in the financial sector.
He Lifeng is the secretary of the Central Financial Commission.
The Central Financial Work Commission is a detached agency under the Party Central that is co-located with the office of the Central Financial Commission and is tasked with overseeing Party-building matters in the financial sector. The Commission is supposed to unify and lead the work of the CCP in the financial system, and guide the political, ideological, organizational, style, and discipline construction of the Party in the financial system.
He Lifeng is the secretary of the Central Financial Work Commission. The other two deputy secretaries are Wang Jiang and Qin Bin.
The establishment of the Central Financial Discipline Inspection and Supervision Working Commission appears to be derived from the Central Financial Work Commission’s task to guide the “discipline construction of the Party in the financial system.”
Purge of financial sector in Xi’s third term
1. The South China Morning Post counted 32 senior Chinese financial regulators, bankers, and financial executives detained in the first six months of 2024.
2. Three bank executives were investigated during the Third Plenum period (July 15 to July 18) according to information on the CCDI website:
- He Zeshu, Party secretary of the Sichuan branch of the Agricultural Development Bank of China and Party secretary of the bank’s business department.
- Wang Fade, former Party secretary and president of the Tianjin branch of the Export–Import Bank of China.
- Xu Yanfeng, Party Committee member and deputy general manager of the Shanghai branch of the Industrial and Commercial Bank of China.
3. The state-run Securities Times reported on July 14, 2024 that at least 21 bank executives from state-owned large banks, joint-stock banks, and policy banks were investigated for serious violations of discipline and the law in the first half of 2024, citing incomplete statistics. Additionally, at least 23 purged bank executives were expelled from the Party or dismissed from public office.
Securities Times said that the number of people investigated in the financial system has increased significantly since April 2024 after teams from the third round of inspections of the 20th Central Committee embedded themselves in multiple financial work units.
4. Shanghai Securities News reported on May 24, 2024 that 53 listed companies or their executives have been investigated this year as of May 23, with 21 of the 53 investigated in May alone.
5. According to our tally based on incomplete statistics, a total of 103 officials or executives in the PRC financial system were purged in 2023, including executives in banks, insurance, and securities institutions, as well as officials in the PBoC, the former China Banking Regulatory Commission, and the former China Insurance Regulatory Commission.
Our take
1. The creation of the Central Financial Discipline Inspection and Supervision Working Commission represents the latest effort by the Xi Jinping leadership to more tightly regulate and control the financial sector and system in China.
The Central Financial Commission established in March 2023 is focused on policy formulation and the coordination of policy implementation, while the Central Financial Work Commission is tasked with ensuring that the financial sector adheres to ideology. Elements in the financial sector that break Party discipline and are suspected of corruption will now be handled by the Central Financial Discipline Inspection and Supervision Working Commission.
The founding of an anti-corruption body specifically to handle an area of concern in the regime affirms our earlier observations of deep-rooted corruption in the financial sector (see here, here, and here). We noted on numerous occasions that the Jiang Zemin faction and other Party elites have long abused the financial sector to enrich themselves while leaving tremendous risks for successive leaders (Hu Jintao and Wen Jiabao from 2003 to 2011, Xi Jinping from 2012 to the present) to clean up.
The earlier strength of the Jiang faction and other influential Party elites meant Xi had to wait until his second term when he had consolidated power to a higher degree before moving against Tomorrow Group’s Xiao Jianhua and Jack Ma and his fintech businesses. With Xi having accrued even more power at the 20th Party Congress and the remnant Jiang faction and other CCP elites losing influence over time, the Xi leadership is now able to more openly target the financial sector.
Xi’s intensifying “rectification” of the financial sector is likely to encounter pushback and setbacks despite his increased political strength and the diminishing influence of his factional foes. Aside from ramping up Xi’s personal political risks, more focused financial sector “rectification” work will dampen business and investor confidence, as well as heighten China’s financial risks as problems are exposed.
2. The CCDI article mentioning the Central Financial Discipline Inspection and Supervision Working Commission is an early piece of post-Third Plenum propaganda. The article signals the CCDI’s adherence to the “spirit” of the Third Plenum and the strengthening of Party Central’s “centralized and unified leadership” over the financial sector.
The article and its revelation of the new Commission also underscore the rollback of economic and financial “liberalization” at the Third Plenum. For instance, Wang Weidong’s remarks in the piece represent the actualization of the CCP authorities’ attempt to so-called “balance deregulation with effective management” (既要“放得活”又“管得住”) even as they seek to “enhance the role of market mechanisms.”
