Why China's fiscal revenues are suddenly on the decline

Communist Party seeks to stabilise capital markets. China's banking stocks leap amidst asset drought.

Our briefing on critical economic and financial developments in China as of Tuesday, 27 August, 2024:

• The Communist Party’s top leadership has committed to efforts to stabilise China’s capital markets, in order to ensure they can play a more effective economic policy role in areas such as tech innovation.

• China’s fiscal revenues posted a sizeable decline in 2024, with analysts highlighting the impact of easing growth as well as deflationary pressure.

• Long-lagging Chinese bank stocks are last posting a surge, as domestic investors search for safety amidst an asset drought.

Communist Party outlines plans for "raising internal stability" of China's capital markets

The Politburo of China's Communist Party recently convened a meeting that called for measures to "raise the internal stability" of China's capital markets, via coordinated efforts to "prevent risk, strengthen regulation, spur development and invigorate investor confidence."

China's capital market is currently the world's second largest, with over 5300 listed companies that have a total market capitalisation of around 80 trillion yuan, as well as around 220 million participating investors.

Beijing has recently flagged an increaseD role for the Chinese capital market in supporting innovative enterprise, amidst efforts to decouple technologically from the United States.

According to the state-owned Economic Daily, general themes for shoring up capital market stability are set to include:

Increasing the quality of listed companies

"Listed companies are the cornerstone of the market, and raising the quality of listed companies is the necessary requirement for stable development of the capital market."

To this end, the China Securities Regulatory Commission (CSRC) has heightened its scrutiny of companies planning IPOs, targeting "fake science and tech" firms in particular, in a bid to "lift the quality of listed companies at the source."

"Every link of the review and registration process is becoming stricter, and those who fail to qualify will be barred outside the door of the capital market."

Introducing more medium and long-term capital

"Medium and long-term capital is the ballast of the market...from a financing perspective, the introduction of more medium and long-term capital and the expansion of patient capital is a key path for raising the internal stability of the capital market."

As of the end of last year, institutional investors held 16 trillion yuan in circulating A-shares, more than doubling over the past five years. They also increased their share of the equity market from 17% to 23% over the same period.

Publicly offered funds hold 5.1 trillion yuan in A-shares, becoming the largest class of institutional investors on the A-share market.

Chinese policymakers remain concerned, however, that "China's medium and long-term funds on the capital market are inadequate," and that the policy environment remains incomplete.

CSRC official Zhang Wangjun (张望军) has called for optimising market entry policies for potential providers of medium and long-term funds, including insurance funds, social security funds and pension funds, by "dealing with their blockages and pain points in the system."

CSRC will also support securities funds operators in releasing more products and services that better suit medium and long-term capital needs.

Strengthening counter-cyclical adjustments

"At present, external conditions are complex and highly variable. In order to stabilise the market, it's absolutely necessary to strengthen counter-cyclical adjustments, effectively coordinate primary and secondary market development, and provide open and fair transaction conditions and market environments for all types of investors."

In response to the adverse impact of high-frequency quantitative trading on the market and investor concerns about securities lending and re-lending, since the start of the year CSRC has adopted measures that include suspending the securities re-lending business, further strengthening countercyclical adjustments in relation to securities lending, and strengthening the supervision of algorithmic trading.

Why are China's fiscal revenues on the decline?

China has just seen a sizeable decline in its fiscal revenues and a plunge in revenues from government investment funds, as the country continues to grapple with insufficient domestic demand.

National general public budget revenues were 13.5663 trillion yuan for the period from January to July, for a decline of 2.6% compared to the same period last year.

Central government general public budget revenues saw an especially marked decline, falling 6.4% year-on-year (YoY) to 5.9745 trillion yuan.

By comparison, local government general public budget revenues were 7.5918 trillion yuan, for a slight rise of 0.6%.

While tax revenues for January to July fell 5.4% YoY to 11.124 trillion yuan, non-tax revenues saw a rise of 12% to 2.4423 trillion yuan.

The Ministry of Finance (MOFCOM) has imputed the slide in national revenue to the high base set in 2023 by 2022 tax deferrals for micro, small and medium-sized manufacturing companies.

It also pointed to the impacts of the launch of tax and fee reductions by the Chinese central government in 2023.

According to MOF, when adjustments are made for these impacts, national revenues rose around 1.2% in comparable terms for the first seven months of 2024.

Luo Zhiheng (罗志恒), chief economist with Yuekai Securities, also highlighted the impacts of China's easing economic growth in tandem with deflation in some areas.

"Economic growth is the foundation for growth in tax revenues...when economic growth eases, growth in tax revenues is constrained.

"Additionally, price levels are on the decline, with prices for certain energy and mining commodities continuing to slide, which is dragging on tax revenue growth."

MOF data also points to a drop in revenues from government investment funds.

National government fund budgetary revenues dropped 18.5% for the period from January to July.

This included a 20.7% plunge in budgetary revenues from local government funds to 2.0909 trillion yuan, and a 22.3% drop in state-owned land use right transfers to 1.7763 trillion yuan.

Why are China's bank stocks only now belatedly surging?

An abrupt rise in China's A-share banking stocks last week drew widespread attention, with many lenders tapping new highs.

The China Chengxin Bank Index has risen 20% year-to-date, while a number of banks have posted gains of over 40%.

China's banking stocks have long been neglected by A-share investors, despite their low PE ratios and comparatively safety as a state-backed sector performing an essential role in the Chinese economy.

A recent shift in China's macroeconomic conditions may have brought about a change in their fortunes, however.

Chinese investors are becoming increasingly risk averse and evincing a greater preference for dividend stocks, following untoward shifts in the Chinese economy in 2024.

These include the continued weakness of the property sector, lacklustre domestic demand and unresolved overcapacity in certain key sectors, all of which have prompted calls for greater macroeconomic policy action in the second half.

21st Century Business Herald argues that banking stocks are the best option amongst dividend assets.

It highlights factors including a PE ratio of around 3 -5, as compared to a median non-bank PE ratio for A-shares of 30 - 35. Chinese bank shares enjoy a PB ratio of 0.4 - 0.8, as compared to 2 for the non-bank A-share market.

Yields on Chinese banking stocks still hover around 5%, despite the recent spate of price gains.

Efforts by Chinese regulators to widen net interest margins by bringing down deposit rates should also maintain their lustre, particularly amidst an "asset drought" for Chinese investors following the property market slump.

"Capital is starting to pursue bank assets that possess certainty and security," Business Herald reports.

"This certainty is derived from the stability of their profits and dividends.

“Even if China is in the midst of a rates cutting cycle, regulatory authorities are highly focused on maintaining rational net interest margins for banks.

“In the past few months, the crackdown on discretionary interest rate adjustments has brought down the liabilities costs of banks."

Chinese regulators have reportedly also pushed for banks to abandon their "drive for scale," instead driving them to focus more on sustainable lending practices and profitability.