Same growth target, higher tolerance for lower growth

The December Politburo meeting and Central Economic Work Conference concluded and imply that an approximate 5% GDP growth will likely remain the target for 2025. However, with trade war 2.0 ahead, we think policy makers are psychologically preparing for lower growth in an extreme tariff scenario. To balance the growth target and the reality, we forecast China’s GDP growth for 2025 at 4.5%, which reflects elevated trade tension and increasing policy support to (partially) offset the external shock. In our base case scenario, we estimate that increasing tariffs will drag 2025 GDP by 1.2 percentage points (pp), and policy action can provide 0.8pp offset in general.

Policy response: A dynamic weighted average of structural and cyclical approach

A structural policy response function has been taking the center stage since 2021 when policy makers want to pursue high-quality growth rather than debt-driven growth, which differs greatly from previous episodes where cyclical measures often dominated policy decision making. Will policy makers continue to stay calm with the structural approach amid trade war 2.0? We think the answer is yes and no.

“Yes” reflects an unchanged long-term goal. We don’t think the trade war 2.0 shock is going to change the long-term development goal for China in general. The structural part of the policy response function is not just trying to address high debt to GDP ratio, unbearable damage to natural sources, diminishing labor dividend etc., it also reflects the intention to accommodate heightened geopolitical tensions (such as technology control and deglobalization), and a trade war is just part of the latter. Therefore, we think the structural approach will remain in the solution package; this would include elevated efforts to maintain stable supply chain and improve the weak links, further work on key technology to break the bottleneck and external curb.

“No” to avoid meaningful distraction from the long-term goal. We understand that high-quality growth is not equivalent to low growth and even requires a decent growth rate to support a smooth economic transition. If the 2035 and 2049 strategic targets are still valid¹, ~5% is supposed to be the key growth target even for the next few years. With that, cyclical measures will also be an essential part of the policy combo, especially with cyclical headwinds rising. Therefore, we expect increasing weight on cyclical measures in 2025 within the policy response function.

What to expect on cyclical supports?

Consumption as a top priority.

• We expect policy makers to scale up fiscal supports to goods trade-in with larger coverage, which is expected to directly boost household spending in a meaningful way;
• Policy makers vow to increase elderly pension, subsidies to medical insurance and allowance for maternity and child care, which is supposed to improve household revenue and lift up consumption propensity;
• We expect continued efforts on equity and housing markets stabilization, which should also help on the consumption propensity via the wealth effect.

Fixed Asset Investment (FAI) focus on equipment upgrades and national major projects. To support high-quality growth, we think there is still decent room to implement FAI in infrastructure, manufacturing, green development, education, medical and elderly economy. And we expect FAI will play a key role in offsetting external shocks.

Housing is getting closer to the bottom. Allowing local government special bonds to be used for idle land recycling and housing inventory purchases, along with more autonomy in local governments’ decision making, is expected to accelerate the rebalancing of housing supply and demand. In an extreme tariff case, special arrangements – such as establishing a centralized housing inventory purchase platform and capital injection in Privately owned enterprise (POE) developers – may also be considered. That said, we think the bar for such special arrangements remains high at the current stage.

¹ China’s target is to realize socialist modernization by 2035 and achieve full realization of Chinese modernization by 2049 (which is the 100th anniversary of China’s establishment in 1949).

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