Market Focus: How are the four major policies being implemented?

Key Points

Real Estate Policy: Adaptation to Supply and Demand Changes, Bottoming Out Instead of Strong Stimulus

The overall expression of real estate policy at the Political Bureau meeting last week exceeded expectations. Subsequently, the Ministry of Housing and Urban-Rural Development and the meeting on the renovation of urban villages also released positive signals. We have a few simple judgments on the real estate industry: 1. In the long term, the real estate industry is no longer the driving force behind stimulating the economy, and the policy of "housing for living, not for speculation" remains an implicit constraint; 2. In the short term, the industry is still in a downward cycle, and adjustments to policies are needed from the perspective of stabilizing growth and preventing risks; 3. On the demand side, attention should be paid to policies related to delivery of completed buildings, purchase restrictions, loan restrictions, recognition of property but not of debt, and tax incentives, as well as the impact of the renovation of urban villages. On the supply side, we will continue to pay attention to the implementation of the three arrows and whether iconic real estate enterprises can avoid default risks.

Resolution of Local Government Debt: What Might be Included in the "Package Debt Resolution Plan"?

In terms of feasibility, the following order can be observed: 1. Implementing the responsibility of local authorities, transforming and integrating urban investment, and revitalizing assets, etc. 2. Issuing special refinancing bonds within the quota to replace hidden debts, which has less resistance and is easy to promote. 3. Debt restructuring/extension. 4. Coordinating financial resources from top to bottom, such as encouraging large banks and policy banks to provide financial support, establishing relief and smoothing funds, and involving asset management companies in debt resolution. 5. Whether a new round of replacement bonds can be introduced remains to be seen. It should be pointed out that: first, these debt resolution measures alleviate the exposure of the problem, but the financial gap of local governments has not been substantially resolved. Second, from a long-term perspective combined with overseas experience, debt resolution requires a capital return rate that exceeds the financing cost, and more often it requires debt transfer. The pros and cons of resolving debt problems through monetization are worth discussing.

Capital Market Policy: Risk Appetite and Asset Pricing

Looking back at the Political Bureau meetings since 2018, there have been four mentions of the capital market, mostly at the bottom of the stock index. Last week, the sentiment in the stock market clearly improved. In addition to the expression of "active capital market" releasing warmth, the reasons include reduced concerns about economic slowdown, the imminent end of the Federal Reserve's interest rate hikes, and the bottoming out of valuation and transaction volume. At the same time, specific measures are also being promoted. The China Securities Regulatory Commission, the Beijing Stock Exchange, and the China Financial Futures Exchange have successively issued policies, and it is expected that there will be more practical measures in the future to introduce long-term funds and optimize the introduction of foreign capital through mutual access.

Monetary Policy: Mainly Stable with a Slight Easing Bias

Looking back at each round of stabilizing growth, monetary policy often takes the lead, followed by fiscal, real estate, and industrial policies. The interest rate cut in June can be regarded as the "first half" of monetary policy, and there may be a reserve requirement ratio cut in the second half. After that, it is highly likely to enter a stage of releasing real estate demand, advancing the renovation of urban villages, and a slow recovery in physical work volume and loan demand. Under this assumption, interest rates may first decrease and then increase. In addition, the level of broad money supply should be measured by the level of liquidity. This year, the central bank has implemented the principle of "market interest rates fluctuating around policy interest rates." The future interest rates may run at a slightly lower position than the policy interest rates, but a significant downward movement requires new triggers. The neutral characteristics of reserve requirement ratio cuts are more pronounced, which determines that long-term interest rates are difficult to rise significantly, but it is also difficult to break through last year's lows. Main Text

Last Monday, the Political Bureau meeting was held, and the market volatility increased significantly. A simple review of the situation is as follows:

(1) Prior to the Political Bureau meeting, the market initially believed that the policy measures would fall short of expectations. The 10-year government bond yield briefly challenged 2.6%, and the long-term bond rates also declined significantly. Looking back, there was no solid fundamental or news support at that time, and both stocks and bonds showed clear signs of speculation.

(2) Subsequently, the meeting was held earlier than usual, and the shift in policy towards the demand side, more proactive real estate policies, and the risk appetite brought by an active capital market were all unfavorable for bonds, leading to a rapid reversal in bond market sentiment.

(3) However, there was a general pressure to increase bond allocations, causing many institutions to view the adjustment as a buying opportunity, coupled with the short-term difficulty in confirming the implementation of policies.

(4) Subsequently, various ministries and commissions began to express their policies. The National Development and Reform Commission (NDRC) expressed encouragement for private investment, and the China Securities Regulatory Commission (CSRC) stated the need to maintain IPOs and refinancing as normal practices. The most crucial statement came from the Ministry of Housing and Urban-Rural Development (MOHURD) on Thursday evening, which announced measures such as reducing the down payment ratio for first-time homebuyers, lowering loan interest rates, implementing a policy of recognizing houses without requiring proof of loan repayment, and implementing tax and fee reductions for home exchanges. As a result, brokerage and real estate stocks soared the next day.

Overall, the market performance after the important meeting was very consistent with our expectations, including: a short-term adjustment is undoubtedly expected, the probability of record-low interest rates in the medium term has greatly decreased, and the trend reversal still needs to be observed.

Looking ahead, what investors are most concerned about is how policies will be implemented, executed, and the extent of their impact. Among them, the four major policies are the most critical:

First, real estate policies

The biggest difference in expectations from this meeting lies in the expression of real estate policies. Firstly, there was no mention of "housing is for living, not for speculation." Secondly, it was pointed out that "there have been significant changes in the supply and demand relationship in the real estate market." Thirdly, it was required to "timely adjust and optimize real estate policies." With the slowdown in population growth and urbanization in China, the concept of "housing is for living, not for speculation" has become deeply rooted and has achieved positive results. Investment and speculative demand have become more rational, and there is indeed a need to adjust some of the previously strict policies.

Two days after the Political Bureau meeting set the tone, the Ministry of Housing and Urban-Rural Development held a symposium with enterprises, proposing further implementation of policies such as reducing the down payment ratio and loan interest rates for first-time homebuyers, tax and fee reductions for home exchanges, and the policy of "recognizing houses without requiring proof of loan repayment" for individual housing loans. The information conveyed in this meeting is worth noting:

1. This is the first time "recognizing houses without requiring proof of loan repayment" has been mentioned at the policy level since the current real estate cycle began to decline. Currently, the strict implementation of the "recognizing houses with proof of loan repayment" standard is mainly in first-tier cities, especially in core cities with high housing prices. If this policy is implemented in the future, it is expected to release more demand for improved housing in first-tier cities, and its impact on housing prices is worth paying attention to.

**2. Expectations can be placed on preferential tax policies for home exchanges. The "Announcement on Personal Income Tax Policies for Supporting Residents in Exchanging Homes" issued in September last year stated that from October 2022 to the end of 2023, taxpayers who sell their own homes and repurchase homes within one year after the sale will be eligible for a refund of the personal income tax already paid on the sale of their current homes. The symposium proposed further implementation of tax and fee reductions for home exchanges. We need to observe whether the current tax refund policy will be extended, whether existing tax and fee preferential policies will be strengthened, and whether new tax and fee preferential policies will be introduced. 3. The down payment ratio for first-time homebuyers and mortgage interest rates are expected to be further reduced. The focus is on the policy actions of first-tier and strong second-tier cities. However, interest rate policies fall under the category of monetary policy, and local policies are also key constraints. Therefore, further unified coordination is needed.

In addition, a teleconference on the renovation of urban villages was held last Friday. The meeting pointed out that the renovation of urban villages will adopt methods such as "demolition and reconstruction, improvement and upgrading, and a combination of demolition and improvement." It aims to "promote comprehensive and dynamic balance of funds" and emphasizes that "land must be sold after the renovation of urban villages." This means that local governments will play an important role in land acquisition and storage. Especially, it is necessary to explore new approaches to solve the difficulties in the renovation of urban villages, such as how to calculate accounts, how to use funds, how to acquire land, and how to relocate people and industries, in order to adapt to the new situation. Compared with the monetization of shantytown renovation, the renovation of urban villages faces greater difficulties in implementation and forming a complete commercial logic. It is expected to make breakthroughs in practice. On the same day, a real estate special meeting was held in Hefei, which pointed out that the renovation of "urban villages" is a public welfare project rather than a for-profit project, and it will boldly explore the "targeted listing and agreement transfer" of land supply. Overall, it is expected that the pace of the current round of urban village renovation will be more stable and the impact period will be longer. The short-term scale should not be exaggerated. However, the flexibility of the policies may lead to deviations in the execution process, so it is necessary to closely monitor information such as funding sources, implementation plans, and arrangements for new scale.

We have a few simple judgments on the real estate industry:

1. In the long term, the real estate industry is no longer the main driver of economic stimulation. New models such as rental and sale are being explored, and the policy constraint of "housing is for living, not for speculation" still exists.

2. In the short term, the industry is in a downward cycle, and there have been significant changes in the supply-demand relationship. Adjustments to industry policies are needed from the perspective of stabilizing growth and preventing risks.

3. On the demand side, attention should be paid to policies such as guaranteeing the delivery of completed houses, restrictions on home purchases and loans, not recognizing houses as collateral for loans, and tax incentives. On the supply side, continue to pay attention to the implementation of the three arrows policy and whether landmark real estate companies can avoid the risk of default.

Overall, the current round of policies is likely to focus on providing support and avoiding transmission to the financial system. The probability of strong stimulation is low, and the progress of urban village renovation may be a source of deviation in expectations. The Beijing Municipal Commission of Housing and Urban-Rural Development has expressed support for both rigid and improved housing demand. If first-tier cities relax restrictions on home purchases and loans and "do not recognize houses as collateral for loans," attention should be paid to the spillover effects on third- and fourth-tier cities.

Second, local government debt resolution policies

The issue of local government debt is currently a significant problem, which fundamentally stems from the mismatch between local powers and financial powers, and time is not on our side. Since 2018, local governments have taken on tasks such as poverty alleviation, people's livelihood, and epidemic prevention. Rigid expenditures have increased, and the reduction in taxes and fees in recent years has also had a certain impact on local finances. Under the imbalance of revenue and expenditure, the hidden debt problem deserves more attention.

This year, as the impact of the epidemic recedes and economic growth gradually improves, the issue of local government debt becomes even more important, due to the following reasons:

1) Reduction in land finance. Land sales revenue in the first half of the year was 1.87 trillion yuan, a year-on-year decrease of 20.9% compared to the relatively low base of last year. 2) Limited growth in tax revenue, decline in non-tax revenue. The internal driving force of the economy is not strong, and the recovery of tax revenue is relatively slow. Last year, the low base was caused by factors such as accumulated tax credits, resulting in limited actual growth in tax revenue this year. The growth rate of non-tax revenue has been declining for five consecutive months, mainly due to the increase in revenue from the activation of stock assets by some local governments last year, but this space has narrowed this year.

3) It is difficult to compress rigid fiscal expenditures at the local level. However, there is a lack of tools such as profit contributions and policy-based finance to supplement financial resources like last year.

4) Strict fiscal discipline on treasury funds and control of hidden debts reduce the ability of local governments to maneuver.

Under the background of rigid expenditures, limited income, and fiscal discipline control, the maneuvering space of local governments has weakened, and the risk of debt has increased. In the first half of this year, there were 54 cases of non-standard defaults and 100 cases of bill overdue in urban investment, which increased compared to the same period last year, mainly concentrated in low-rated and county-level platforms. Technical default events have occurred successively in the past two months. Against this background, discussions on local debt in the market have been increasing.

The Politburo meeting this time clearly proposed "to effectively prevent and resolve the risks of local government debt and formulate and implement a comprehensive debt reduction plan," and did not mention "strict control of new hidden debts," which to some extent alleviated the previous concerns about the "hard landing" of debt problems. However, what does the "comprehensive debt reduction plan" include? It is not yet clear.

Relatively certain is that the term "comprehensive" indicates that this round of debt reduction will not be a single policy. It is highly probable that the central government, local governments, and banks will share the responsibility. Based on the feasibility ranking, it can be seen as follows:

① Implement local government's main responsibility, transform and integrate urban investment, activate assets, etc., which depends more on the local self-rescue ability.

② Issue special refinancing bonds within the quota to replace hidden debts, which faces less resistance and is easy to promote. On the one hand, some provinces have already had experience in issuing such bonds from 2020 to 2022. On the other hand, the use of the quota-balance space does not require approval from the National People's Congress and does not occupy the new quota. By the end of 2022, the difference between the local government quota and the balance nationwide is about 2.5 trillion yuan, which is also the upper limit for the issuance of special refinancing bonds this year. If it is launched later, it is expected to mainly target regions with high debt pressure. When necessary, the central government may allocate quotas uniformly, and the scope and amount may exceed previous levels.

③ Debt restructuring/extension. For example, the previous models in Zhenjiang and Zunyi mainly involved one-on-one negotiations between local governments and financial institutions (commercial banks/policy banks). However, the debt resolution plan needs to be more scientific and transparent, and it is not ruled out that the central government will introduce a unified plan or specific tools to support bank debt reduction.

④ The central government takes the lead in coordinating financial resources, such as encouraging large banks and policy banks to provide long-term funding support, establishing relief and smoothing funds, and involving asset management companies in debt reduction, etc. Of course, this plan objectively requires strengthened coordination between fiscal and monetary policies, and it is not ruled out that fiscal interest subsidies, the establishment of special tools by the central bank, and the reduction of financial institution debt costs, etc., will be implemented. ⑤ Whether a new round of debt-for-equity swaps can be launched remains to be seen. Objectively speaking, a comprehensive audit is needed, which is expected to take a long time. The focus should be on the debts that have real repayment responsibilities, and it is highly unlikely that they will be "muddied". As for whether it is the central government or local governments that are leveraging up, there is no fundamental difference.

Two points need to be pointed out:

First, these debt-for-equity measures have alleviated the exposure of the problem, but the fiscal gap of local governments has not been substantially resolved. Therefore, a package of debt-for-equity solutions should not be limited to short-term measures. There may also be long-term institutional reforms, such as the division of powers and financial powers between the central and local governments, and tax reforms.

Second, from a long-term perspective and combined with overseas experience, debt resolution requires a capital return rate that exceeds the cost of debt. Most of the time, it needs to be transferred, and the topic of solving debt problems through monetization needs to be explored.

In summary, the formulation and implementation of debt-for-equity policies require a process. In combination with the various expressions such as "debt-for-equity pilot" and "debt restructuring" that have emerged in various places in the past six months, the "package of debt-for-equity solutions" is more likely to be a collection of previous debt-for-equity measures.

For the bond market, the introduction of debt-for-equity solutions is expected to alleviate market concerns about debt risks and reduce the probability of systemic risks in local government bonds. However, in the absence of a perfect debt-for-equity solution, concerns about the problem of debt-driven pressure still exist. The impact on interest rates is relatively indirect. If it is resolved through bond issuance, it will increase the supply of local government bonds. If it is resolved through loans, it will lead to credit growth. However, regardless of the method, monetary policy is likely to cooperate, requiring a relatively low interest rate environment while guiding the downward pressure on bank liability-side interest rates.

Third, capital market-related policies

Looking back at the Politburo meetings since 2018, there have been four mentions of the capital market, mostly at the bottom of the stock index. Among them, in October 2018, it was about "stimulating market vitality", in July 2020, it was about "stable and healthy development", in April 2022, it was about "smooth operation", and this time it was about "activating the capital market", sending positive signals.

Last week, the market sentiment in the stock market clearly improved. In addition to the expression of "activating the capital market" releasing warm signals: 1. Policies related to real estate, debt, etc. exceeded expectations, reducing market concerns about economic slowdown and tail risks; 2. The inventory cycle has bottomed out, and it is expected to enter a restocking cycle next year, which traditionally A-shares will reflect in advance; 3. The Federal Reserve's interest rate hike is about to end, and it is expected to enter an interest rate cut phase next year, which is beneficial to northbound funds; 4. The stock market has low valuations and trading volume has bottomed out. At this time, positive news is generally more sensitive than negative news.

Specific measures to activate the market are also being promoted. For example, last week, the China Securities Regulatory Commission held a mid-year work symposium for 2023, emphasizing "scientifically and reasonably maintaining the normalization of IPOs and refinancing, and coordinating the dynamic balance between the primary and secondary markets." And on Friday, top securities firms were convened to solicit opinions on activating the capital market (media such as Daily Economic News). In addition, last week, the Beijing Stock Exchange drafted the "Special Regulations on Market Making of the Beijing Stock Exchange", adjusted the admission conditions for market-making securities firms, expanded the market-making team, and the China Financial Futures Exchange issued the "Long Wind Plan", proposing to consolidate the efforts of all parties in the market and improve the quality of institutional investors, especially medium and long-term funds, participating in the financial futures market. Overall, policies are synergistically exerting efforts from the investment side, financing side, trading side, etc., and it is expected that there will be more practical measures in the future to introduce long-term funds and optimize the introduction of foreign capital through mutual access.

Fourth, Monetary Policy

Compared to the previous major policies, monetary policy has relatively lower attention, mainly because investors currently have consistent expectations for monetary policy. The Political Bureau meeting this time stated the need to "utilize both quantity and structural monetary policy tools," which means that the orientation of monetary policy remains stable with a slight easing bias. There is a high probability of a reserve requirement ratio cut within the year, and there is also room for interest rate cuts.

It is worth noting that the current market is concerned about the risks of rising interest rates due to policies related to real estate and the stock market, while at the same time generally acknowledging that there is further room for monetary policy to loosen, which corresponds to the opportunity for interest rates to decline. How should we view this somewhat "contradictory" mentality?

We believe that the two are not conflicting:

Different types of policies have a sequence, and in each round of stabilizing growth, monetary policy often takes the lead, followed by fiscal, real estate, and industrial policies. The interest rate cut in June can be seen as the "first half" of monetary policy, and there may be a reserve requirement ratio cut in the second half. After that, there is a high probability of entering a stage of releasing real estate demand, advancing urban village transformation, and gradually increasing physical workload and loan demand. Under this benchmark assumption, interest rates may first decline and then rise. In short, loose monetary policy and loose credit have a clear sequence, which has been repeatedly verified in the past few cycles.