Source: Wind
How should China respond to rising tariffs? And most importantly, what concrete steps can be taken to reduce China’s high savings rate?
Over the past three months, a widely accepted notion among investors is that policy support from Beijing will essentially set a floor for the highly volatile domestic stock market, but it will not be enough to rekindle animal spirits or fundamentally resolve the fiscal difficulties faced by most local governments. The perception is that the government’s commitment to boosting domestic demand remains incremental and vague.
Against this backdrop, the Central Economic Work Conference, held on December 11 and 12 in Beijing and presided over by President Xi Jinping, provided additional clues about how policymakers plan to lend relief to the economy. According to President Xi, the economic growth target of around 5% for 2024 will be met. However, going forward, due to a challenging external environment and the economic transition in the post-real estate era, inadequate demand will remain a key feature of the economy. Therefore, appropriately loose monetary policy and fiscal expansion will be undertaken in 2025. Stabilizing the property and stock markets was also cited as a near-term objective.
Despite these measures, skepticism persists. Questions have been raised around the gap between the central government’s pledge to roll over local governments’ debt and the fiscal shortfalls faced by many local administrations. The fiscal deficit-to-GDP ratio will undoubtably rise above the 3% ceiling in 2025 but is unlikely to increase significantly beyond 4%.
Why does the central government maintain such a seemingly conservative stance when most sovereign governments, especially in the developed world, have recently resorted to maximum stimulus measures? There are three primary reasons. First, China seeks to avoid the side effects and pitfalls associated with the «RMB 4 trillion» stimulus rolled out in late 2008. Second, the government aims to preserve fiscal ammunition in case tariffs rise substantially. Finally, policymakers are hesitant to provide a blank check to local governments, which have historically depended heavily on windfalls from the booming real estate sector.
The bigger question is whether these policy responses will allow the economy to avoid a potential deflationary spiral, assuming the property market will not fully completed its downcycle in 2025.
In our view, all these reasons are valid, but higher tariffs require immediate policy countermeasures, making concerns about moral hazard less pressing. Bolder monetary easing must be accompanied by a significant adjustment of the RMB exchange rate, otherwise real interest rates would remain elevated. Additionally, increased fiscal support—beyond savings on interest rate charges—is needed to stabilize local governments’ finances, which is a direct way to support the real estate market.
In practical terms, relying on external demand to replace the real estate sector as a growth driver or exporting overcapacity will be extremely challenging for China. Unlike the trade war during the first Trump administration, it is reasonable to assume that the U.S. may target all surplus economies, including those benefiting from China’s relocated supply chains and investments, while applying tougher measures specifically against China.
For China, it is prudent to prepare for the worst: a substantial increase in tariffs and the distinct possibility of losing its Permanent Normal Trade Relations (PNTR) status with the U.S. Additionally, the U.S. may further stress «reciprocity,» a principle emphasized during the 2018 trade war.
What would be China’s policy response to such an external shock? There are numerous potential combinations of reflationary measures, possibly alongside some tit-for-tat moves. However, fiscal policy will remain a crucial instrument, complemented by adjustments to the RMB exchange rate. We anticipate that Beijing’s retaliatory actions will be largely symbolic, with the RMB depreciating by 5–7% in 2025. As a result, China’s growth rate for 2025 is expected to hover at around 4%.
In the long run, for consumers to take on a greater role in driving growth by reducing their savings rate, a more robust social safety net will be essential. Additionally, the services sector must be liberalized to create new job opportunities that cannot be met by manufacturing alone. However, given that approximately 70% of consumers’ wealth is tied to the property sector, bolder monetary easing should be the starting point. If the RMB faces increasing downward pressure due to widening interest rate differentials between the U.S. and China, the government should avoid intervening in the foreign exchange market.
Asia has successfully weathered a slumping yen over the past two years, as most Asian currencies are undervalued, and many economies maintain a relatively strong balance of payments position. However, a significant depreciation of the RMB could further highlight China’s extraordinary competitiveness. Even with a relatively stable RMB, numerous countries—including those on friendly terms with China (e.g., Thailand, Brazil, and Pakistan)—have imposed tariffs in 2024. If China redirects exports from the U.S. to other markets using a weaker RMB, backlash is likely. Thus, improving market access remains the best way to counter potential protectionism. What could China do to placate its trading partners?
Chart: Export front-loading ahead of higher tariffs
