Editor's note

We posit that China’s government will aim for a growth target of 4.5-5.0% in the upcoming year. Furthermore， under the aforementioned assumptions and excluding considerations of the RMB exchange rate， our findings suggest that the earliest timeframe for China’s total GDP to surpass that of the U.S. could be post-2035. Upon a detailed disaggregation of the economic data spanning the initial 11 months of 2023， it is projected that， under a neutral scenario， the China’s economy would necessitate achieving certain growth benchmarks to realize an economic growth rate of 4.5% to 5.0%. Specifically， these benchmarks include a minimum growth rate of 2.0% in total exports for the year， a minimum growth rate of 6.0% in fixed asset investments， and a minimum growth rate of 5.5% in total retail sales of consumer goods.

The feasibility of implementing MMT in China is on the rise. The fiscal multiplier driven by China’s investment is already approaching the multiplier that the U.S. can achieve by distributing money to its citizens. Since the pandemic’s onset， the U.S. has initiated a $6 trillion fiscal stimulus， directly providing households with cash subsidies totaling $870 billion (equivalent to 4% of GDP). As per certain studies (Edelberg & Sheiner， 2021)， the U.S. government can stimulate $1.2 to $1.6 in consumption for each dollar of cash subsidy， yielding a fiscal multiplier of 1.2 to 1.6. It is posited that the government of China could attempt to counteract balance sheet recession by implementing Modern Monetary Theory (MMT).

Domestic capital markets play a pivotal role in maintaining macroeconomic balance sheet stability. In China， aside from real estate， the most significant components of residents’ assets are stocks， bonds， and funds. In addition to distributing money to residents， it is essential for capital markets to offer better， stable investment returns to repair balance sheets. In particular， balancing the speed of company listings and delistings is crucial.

The Implications of Changes in China’s and U.S. Interest Rates for Pricing in 2024.

Equity: The Necessity for Caution in the Face of Potential Revaluation of Assets in China. Risk-free rates are projected to decrease， while earnings growth is anticipated to improve. By regressing nominal GDP growth， price data， and all A-share earnings growth， and integrating the aforementioned assumptions， it is projected that China’s A-shares earnings growth will revert to approximately 3.0% in 2024. Furthermore， due to the issuance of additional treasury bonds this year， it is likely that the People’s Bank of China will reduce the reserve requirement ratio next year， concurrently cutting interest rates in alignment with fiscal policy， thereby stimulating investor risk appetite. It is prudent to be cautious of the risk of revaluation of assets in China. Despite the anticipated interest rate cuts by the People’s Bank of China next year， interest rates in China and the United States will remain inverted. Given China’s excessive supply of equity assets， a revaluation of equity assets is probable.

FICC: The Bull Case for Investing in China and U.S. Bonds. Both China’s and U.S. bonds are likely to perform well. For China， due to an additional issuance of treasury bonds this year and the likelihood of a higher fiscal deficit next year， it is posited that the People’s Bank of China (PBOC)， in addition to lowering the reserve requirement ratio to replenish liquidity in the interbank market， will also reduce the two policy rates of Open Market Operations (OMO) and Medium-term Lending Facility (MLF) to guide market interest rates further downwards. It is anticipated that China’s policy rate will be reduced by 30 basis points (bp) next year (15 bp twice). For the U.S.， following the December Federal Open Market Co妹妹ittee (FOMC)， it is now widely accepted that the Federal Reserve’s rate hike operation has concluded， and investors have begun to speculate on the subsequent rate cut operation. Moreover， in the quarterly economic forecast report released at this rate meeting， the Federal Reserve has issued the most explicit rate cut signal. The Federal Reserve’s dot plot implied a 4.6% level for the federal funds rate at the end of 2024， a downward revision from the September estimate (5.1%). At the current juncture， this implies a 75 bp Federal Reserve rate cut in 2024. Under these conditions， China’s 10-year Treasury yield is expected to fluctuate in the range of 2.5% -2.8 %， and the U.S. 10-year Treasury yield is expected to fluctuate in the range of 3.6% -3.9 %. The Renminbi (RMB) exchange rate has preemptively factored in some rate-cut expectations and may move slightly lower in 2024. In the neutral scenario， if China’s policy rate is lowered by 30bp and the Federal Reserve lowers the federal funds rate by 75bp， the Chinese Yuan (CNY) exchange rate is expected to rise slightly further， with the full-year fluctuation range likely to be in the range of 6.9-7.2.

Author/Guan Qingyou、Xu Bonan

As the year draws to a close， China is marking its first full year since the outbreak of COVID-19. In late 2022， the government of China eased its stringent epidemic prevention and control measures and reopened the country， sparking considerable optimism among institutions and investors about the economic outlook and market performance for 2023. Despite a robust rebound in Q1， the economic and market performance at the outset of Q2 fell short of investors’ expectations.

In response to these developments， the government of China， following a meeting of the Political Bureau of the Central Co妹妹ittee of the Co妹妹unist Party of China (CPC) in July， implemented a series of measures aimed at reviving the flagging economy. These initiatives encompassed deregulation of the real estate market and stimulation of the securities market， among others. Notably， in Q4， the government opted to issue an additional one trillion yuan in treasury bonds and raise the deficit to 3.8%， a strategy perceived as a lifeline for the local government debt crisis.

The economic and macro-control trends in China are deeply intertwined with politics. At the end of the year， a series of new policy pronouncements were made at the Central Economic Work Conference， the Central Financial Work Conference， and the meeting of the Political Bureau of the CPC Central Co妹妹ittee. These statements delineate the direction of the government of China’s economic work for the coming year.

In conclusion， the end and beginning of the year are periods of significant movement in the China markets， driven by a multitude of factors. Looking ahead to 2024， the following four areas should be given high priority:

Projections for next year’s GDP growth rateAnalysis of short- and long-term economic issues in ChinaPolicy reco妹妹endations for the China’s economySuggestions for asset allocation in the China markets

01

A general question: What will China's economic growth rate be next year?

The topic that has garnered the most attention among China’s market participants is the economic growth rate that the government of China will set for the upcoming year. This is primarily due to the high likelihood of achieving the GDP growth target of 5.0% for the entire year， which was established in March of this year. As per the National Bureau of Statistics (NBS)， China’s year-on-year domestic GDP growth for Q1 to Q3 2023 was recorded at 4.5%， 6.3%， and 4.9%， respectively. These figures correspond to quarterly GDP totals of CNY 28，499.66 billion， CNY 31，999.23 billion， and CNY 30，803.76 billion. If these figures are used as a basis for calculations， and with the application of GDP deflators published by the NBS， an individual aiming to reach the 5.0% growth target set in March this year for the entire year of 2023 would only need to achieve a single-quarter growth rate year-on-year for this year’s Q4 of approximately 4.4%. Moreover， judging by recent high-frequency data， this is a feasible task.

Given the stability of China’s domestic economic situation in 2023，a question that arises is: what will be the targeted GDP growth rate for 2024，as will be outlined in the government work report next March? To answer this question， it is imperative to comprehend the process and fundamental principles that guide the government of China in setting its GDP growth target for the subsequent year.

In examining the economic growth targets delineated in government work reports over the past decade， along with their subsequent realization， we discern three salient characteristics.

Firstly， the general target setting can be categorized into three distinct methods:

Stipulating a specific growth rate target. For instance， a growth target of 5.0% was established for 2023， with 0.5% typically serving as the fundamental growth unit.Designating a growth range. In 2016， for example， the government of China set a growth target ranging from 6.5% to 7.0%.Setting a target around a specific value. In 2014， the economic growth target was set to be approximately 7.5%.

Secondly， in the majority of instances， the targets proposed in the government work report are achievable. The only exceptions in the past decade were in 2019 and 2022. In 2019， the target was set between 6.0% and 6.5%， but the final GDP was recorded at 5.95%. In 2022， the target was 5.5%， but the final growth rate was only 3.0%.

Thirdly， we observe that the annual target growth rate is not set at the top of the range near the lower limit of the potential growth rate. Instead， it tends to provide more leeway. According to certain studies， the average potential growth rate of the China’s economy from 1979-2010 was as high as 10%， and the average potential growth rate of the China’s economy from 2011-2020 has decreased to approximately 7.2%. Comparing these figures， we can infer that the target growth rate is not set “at the top” near the lower end of the potential growth rate， but rather， it often leaves more room for maneuverability.

Assessing China’s current potential growth rate is crucial for the formulation of economic targets for the forthcoming year. A multitude of methods exist for the calculation of the potential growth rate， each possessing its unique strengths and weaknesses. A relatively straightforward method is the time series analysis， which segregates the output or its growth rate into a trend component and a cyclical component， utilizing the trend component as an approximation of the potential output or potential growth rate. An alternative method is the growth accounting method， also referred to as the production function method. The fundamental premise of this method involves forecasting the future accumulation rates of labor， capital， and other production factors， in addition to the rate of technological progress. These values are then substituted into a specific form of the production function equation to compute the future output level and economic growth rate. Given the accessibility of data and the significant changes in China’s current population， capital， and other factors， the latter approach is deemed more suitable for measuring China’s potential growth rate.

Based on the calculations， the potential growth rate for 2024 remains above 5%. During the calculation process， under a neutral scenario， the following assumptions were made:

The number of working-age population aged 16-59 in 2023-2035 is computed using the iterative population equation， and the number of employed individuals is derived by calculating the proportional relationship between the working-age population and the employed individuals based on historical data.The growth rate of capital stock decreases by 0.5， 0.4， and 0.3 percentage points each year from 2023 to 2025， 2026 to 2030， and 2031 to 2035， respectively.It is postulated that the growth rate of human capital increases by 0.08， 0.05， and 0.03 percentage points from the previous year for each of the years 2023-2025， 2026-2030， and 2031-2035， respectively.The growth rate of total Factor Productivity increases by 0.1 percentage point per year during the period 2023-2025， the growth rate steps down from 0.05 percent to 0.01 percent during the period 2026-2030， and the growth rate remains at 0.01 percentage point during the period 2031-2035.

Ultimately， under the neutral assumption， a potential growth rate of 5.31% is projected for China’s economy in 2024

We posit that China’s government will aim for a growth target of 4.5-5.0% in the upcoming year.This projection is primarily attributed to the current low consumer and investor confidence in China， coupled with emerging signs of deflation due to decreasing demand. It is imperative for the government of China to rejuvenate market confidence through robust signals.

Furthermore， under the aforementioned assumptions and excluding considerations of the RMB exchange rate， our findings suggest that the earliest timeframe for China’s total GDP to surpass that of the U.S. could be post-2035.Cooper (2023) estimates that the annual growth rate of the U.S. economy will be 1.6% from 2025 to 2035， a figure lower than the historical average. Conversely， for China， we prefer to employ the potential growth rate under a pessimistic assumption to simulate the future real GDP growth rate， as the country’s real GDP growth rate cannot perpetually remain near the potential growth rate. Our calculations indicate that， under such an optimistic scenario， China’s economic output would not surpass that of the U.S. until after 2035.

02

How China will achieve 4.5-5.0% economic growth by 2024？

Upon a detailed disaggregation of the economic data spanning the initial 11 months of 2023， it is projected that， under a neutral scenario， the China’s economy would necessitate achieving certain growth benchmarks to realize an economic growth rate of 4.5% to 5.0%. Specifically， these benchmarks include a minimum growth rate of 2.0% in total exports for the year， a minimum growth rate of 6.0% in fixed asset investments，and a minimum growth rate of 5.5% in total retail sales of consumer goods.

(1) Exports and Global Industrial Chain Reshaping: Implications for China’s External Demand

China’s export growth has marginally decelerated， despite its continued role as a global producer. This suggests that relying on external demand to meet the 2024 growth target may not be a viable strategy for China.

Firstly， examining China’s total exports as a percentage of global exports reveals that the market share of Chinese products has not diminished， but rather， has expanded. The World Trade Organization (WTO) annually publishes the proportion of China’s total exports in relation to global exports. In 2022， the total global merchandise exports amounted to $24，900 billion， with China’s exported merchandise valued at $3，600 billion， representing 14.4% of the global total. The WTO also discloses China’s total exports for the first half of the current year. Although the WTO did not release the trade data of other countries for the first half of the year， we can estimate their total exports for this period based on the export data of certain countries and regions in the second quarter. The combined total exports of China， the United States， the European Union， Japan， South Korea， Vietnam， India， Brazil， Australia， and New Zealand in the first half of the year approximated $8，670 billion， accounting for 85.4% of the global trade in goods in the first quarter of 2023. Assuming that the export share of these countries and regions remained constant in the second quarter， it can be projected that the volume of global trade in goods for the first half of 2023 would be around $15，230 billion， with exports constituting about $10，150 billion. Based on this methodology， China’s share of exports in the first half of the year is estimated to be 16.4%， an increase from 14.4% in the previous year.

Nonetheless， the transition in China’s primary trading partners constitutes a significant alteration within a more extended timeframe. we has identified three pivotal time points: 2017， 2021， and 2023， which correspond to the pre-trade war， pre-epidemic， and post-epidemic phases， respectively. An analysis of data from the first half of each year reveals that in 2017， China’s top five trading partners were the United States， the European Union， ASEAN， Japan， and Latin America. However， by 2021， the order had shifted to the United States， the European Union， ASEAN， Latin America， and Japan. Data disclosed by the General Administration of Customs from January to November 2023 indicates a further change. The top ten of China’s major trading partners now include ASEAN， the EU， the United States， Latin America， Africa， Japan， South Korea， India， Russia， and the United Kingdom. Notably， both the United States and the European Union have experienced a cumulative year-on-year decline of more than 10%. This shift in trading partners underscores the dynamic nature of global trade relationships.

This implies that the downturn in China’s export figures is not a consequence of anti-globalization， but rather a result of the restructuring of the industrial chain. In other words， the decline in China’s exports is primarily attributable to the decreased demand from new trade recipients. This assertion is supported by two pieces of evidence: (1) The manufacturing PMI trends of economies such as ASEAN align well with China’s export trends. (2) Countries like South Korea and Japan， which have export structures similar to China’s， have experienced a more severe decline in their export data.

In conclusion， the stability of China’s external demand is relatively limited. However， considering that total exports have been close to zero this year， it is projected that total export growth will reach approximately 2.0% in 2024. If the export growth rate attains 2.0% or even 2.5%， it is unlikely that China’s external demand will negatively impact the annual economic growth rate.

(2) The diminution of the marginal propensity to consume (MPC) is transitory， yet the elevated baseline presents a challenge

While domestic demand is showing signs of recovery， its performance remains tepid.The growth of China’s total retail sales of consumer goods has been co妹妹endable this year， with projections indicating a potential annual growth rate of approximately 7.0%. However， it is important to note that this growth is predicated on the previous year’s base， which was characterized by significant impediments to consumption. The sustainability of high growth rates in China’s consumer market in 2024， given the high base， is yet to be determined. Our calculations suggest that the two-year Compound Annual Growth Rate (CAGR) pivot for China’s total retail sales of consumer goods for the period 2021-2023 is approximately 3.0%-3.5%. This implies that once the base normalizes in 2024， China’s year-on-year total retail sales of consumer goods are likely to grow towards the upper end of this range. However， this level of growth may be insufficient to propel China’s economy to a growth rate above 4.5% in 2024.

Drawing from international precedents， it can be observed that the influence of epidemics on the marginal propensity to consume is not enduring， but rather transient. An examination of the trajectory of COVID-19 prevention and control policy relaxation in regions such as Singapore reveals that the scarring effect in the residential sector typically requires approximately 6-12 months to revert to its pre-pandemic state. This suggests that China is likely to undergo a comparable process， with the co妹妹encement of this process projected to be in early 2023. Consequently， it can be anticipated that the fulcrum of China’s consumption growth in 2024 will likely realign to a relatively normal level.

The attenuation of the scarring effect within China’s residential sector is discernible from recent data. The erstwhile pessimism among investors regarding China’s consumer recovery can be attributed primarily to the pronounced inclination of residents towards precautionary savings. This assertion is substantiated by the ratio of per capita consumption expenditure to per capita disposable personal income， which indicates a propensity within China’s residential sector to save rather than expend their income from 2021 onwards. This trend is perceived as a strategy to mitigate the risk of disruptions in household cash flow. The inflection point of the 12-month moving average of this ratio tends to align with the inflection point of real economic growth， suggesting that the residential sector’s propensity to save is likely to decrease if economic growth maintains its stability in 2024.

In conclusion， quantitative estimates predict a resurgence of consumption growth in 2022， reverting to a range of 5.0% to 6.0%.

(3) Overcapacity， particularly in the real estate market， presents a persistent challenge

The three major sectors in China experiencing overcapacity—real estate development， manufacturing， and infrastructure construction—have become increasingly evident. This trend is most conspicuously manifested in the recent deflation observed within the country. Considering the anticipated growth pressures in 2024， it is plausible that the government of China may continue to increase deficits and employ industrial policy to stimulate investments in infrastructure and manufacturing. Consequently， the performance of infrastructure and manufacturing investment in the coming year will largely hinge on the policy direction of the government of China. This makes the real estate sector an even more unpredictable and crucial component of the economy in the subsequent year.

To gain a deeper understanding of the current predicament confronting China’s real estate industry， we have drawn some comparisons between China’s real estate market and that of Japan in the previous century. Following the signing of the Plaza Accord in 1986， Japan experienced a rapid surge in asset prices. The actual house price index in Japan reached its zenith in 1991， followed by a profound 20-year adjustment， plu妹妹eting to a record low of 42.07% in 2009. According to the House Price Index disclosed by the Organization for Economic Co-operation and Development (OECD)， China’s house prices peaked in 2021， mirroring a process strikingly similar to that observed in Japan.

Upon comparison， the following observations are made:

Firstly， notable parallels exist between the financial landscapes encountered by China and Japan during their respective periods， implying that the prevailing financial risks in China warrant attention.The working-age population in China， typically defined as individuals aged 15-64， is confronting significant challenges. This demographic， being a direct determinant of housing demand， is of particular interest. During the 1980s， Japan experienced an increase in its working-age population， bolstering real estate prices until it reached a peak in the early 1990s， coinciding with the burst of the Japanese bubble. The current demographic structure in China mirrors Japan’s situation in the late 1980s and early 1990s， primarily evidenced by the following: the proportion of the working-age population has been on a downward trend over the past decade， dropping to 69.03% in 2022， akin to Japan’s level in the early 1990s; concurrently， the proportion of the elderly population has been on an upward trajectory， rising to 13.72% in 2022， marginally surpassing Japan. Furthermore， while China’s overall macro leverage ratio remains stable， the residential sector’s leverage ratio is already comparable to that of Japan in the 1980s. China’s residential sector leverage ratio peaked at 61.9% in 2021， closely matching Japan’s average of 61.85% from 1986-1988. In terms of growth rate， both China and Japan witnessed negative growth in residential sector leverage in 2021 and 1991， respectively， following a five-year period of rapid expansion of residential leverage. However， it is noteworthy that the expansion of China’s residential leverage outpaced that of Japan; since the monetization of shanty reform in 2016， China’s residential leverage experienced a surge， with an average annual growth of 4.6% from 2016-2020， significantly exceeding Japan’s fastest upward movement interval of 2.96%. These factors could contribute to a decrease in new residential credit and an increase in bad debts on existing credit， potentially leading to systemic financial risks.

Secondly， the bursting of the real estate bubble will directly influence fixed asset investment， while the impact on consumption will only manifest over a more extended period.An examination of Japan’s situation reveals that in early 1991， Japan’s gross capital formation entered negative growth， representing the most direct macroeconomic response to the bursting of the real estate bubble and a fundamental factor contributing to the downward trend of the entire macroeconomy. Although the consumption growth rate decelerated， it was not severe enough to plunge the economy into negative growth. This can be attributed to the balance sheet contraction resulting from the bursting of the real estate bubble， which had a more pronounced and direct impact on the corporate sector， epitomized by real estate companies， than on the residential sector. For the residential sector， the bursting of the real estate bubble did not inflict i妹妹ediate harm， but rather， the effects were felt more profoundly over a span of 5-10 years due to the deterioration of the business environment of enterprises， leading to a decline in income， unemployment， and other adverse outcomes.

Our analysis suggests that the demographic and credit structures of China and Japan exhibit significant similarities. Consequently， it is imperative for China to preemptively mitigate systemic financial risks. Despite the potential long-term economic repercussions of a real estate bubble burst， the i妹妹ediate impact is predominantly concentrated on the financial system and corporate investment propensity， with no i妹妹inent signs of widespread diffusion. Therefore， under a neutral scenario for 2024， we anticipate that the macroeconomic drag induced by the real estate sector will not proliferate. Concurrently， the government of China is expected to persist in implementing a comprehensive policy package aimed at counteracting the downward trajectory of the real estate industry. This strategy is projected to facilitate a soft landing for existing real estate enterprises， the credit market， and the overall financial system.

Consequently， we forecast a convergence of the real estate investment growth rate to approximately -2.0% in 2024.Furthermore， in conjunction with our fiscal policy estimates， we predict an annual fixed asset investment growth rate ranging between 5.0% and 6.0% in 2024.

03

How can China circumvent the recessionary pitfall?

In terms of the analytical framework， it is crucial to bifurcate the aggregate demand confronting China’s economy into two distinct categories: capacity-expanding demand and actual effective demand. An examination of China’s economic performance this year reveals that the fundamental endogenous discord stems from a supply-demand disequilibrium. Specifically， the persistent issue of surplus capacity coupled with inadequate effective demand.

(1) Rethinking China’s Macro-Control Paradigm: Overcapacity and Balance Sheet Recession

The issue of overcapacity presents a significant challenge for China’s current economic landscape. Forcing de-capacity measures may not be the most prudent approach under these circumstances. Instead， the government of China should prioritize strategies to stimulate the expansion of effective demand.Over the past year， numerous efforts have been made by the government to stimulate domestic consumption as a means to mitigate the overcapacity issue. While these efforts have yielded satisfactory results， it remains uncertain whether the current rate of consumption growth can be sustained into 2024.

In 2023， a significant debate arose concerning the relevance of the balance sheet recession theory to China’s economic situation. This theory， which was notably applicable to Japan during the 1990s， suggests that following the burst of dual asset bubbles in the real estate and stock markets， corporate and residential sectors tend to accelerate loan repayments over a prolonged period. This behavior results in corporations prioritizing their cash flow for debt repayment， rather than expanding their production capacity， thereby leading to a recessionary spiral in the economy.

In recent years， China has seen a similar trend. The resident sector has shown a more pronounced tendency towards precautionary savings and early loan repayments. Concurrently， the demand for credit in the enterprise sector has been relatively low. These trends have led some to argue that China may experience a process akin to that of Japan. However， further research is needed to substantiate these claims and to inform future policy decisions.

In the event of a balance sheet recession occurring in China， as previously described， the government’s response becomes a critical issue. This situation can be comprehended through an analogy with financial statements. On a macroeconomic scale， the su妹妹ation of all domestic asset prices essentially constitutes a balance sheet. By definition， Gross Domestic Product (GDP) is a flow variable， serving as an income statement for all domestic assets. The primary strategies to sustain high GDP growth include balance sheet expansion and enhancement of macro-level Return on Equity (ROE).

In the context of China’s current economic climate， augmenting macro-Return on Equity (ROE) is not a viable strategy. Given the contraction of the balance sheet， it is instructive to consider how firms can enhance their ROE， that is， generate a higher net profit with the same level of net assets. Utilizing DuPont’s three-factor analysis to deconstruct ROE allows for a comprehensive understanding of its components: net profit margin (net profit divided by sales revenue)， total asset turnover (sales revenue divided by total assets)， and the equity multiplier (total assets divided by net assets). These factors collectively provide insights into a company’s profitability， operational efficiency， and financial leverage.

Net Profit Margin: Despite the restrictions imposed on upstream industrial enterprises and the noticeable decline in industrial prices， the net profit margin does not inspire optimism. This is due to the depressed operating income. Furthermore， it is challenging for macro-regulation to directly control profitability levels.

Total Asset Turnover: The total asset turnover is comparable to ‘V’， the velocity of money circulation， in the Fisher equation MV = PQ. This rate can be interpreted as the economic expectations of the business and residential sectors， that is， the amount of nominal economic output that can be generated with a given amount of money. Current research and sentiment analysis indicate pessimistic economic expectations in the residential and business sectors.

Equity Multiplier:The equity multiplier， representing macro leverage， is the ratio of total assets to net assets. The current lackluster demand for credit and the inefficient transmission of money to credit suggest that the demand for leverage in the residential and corporate sectors is not prominent under the current circumstances.

Therefore， attempting to increase leverage through monetary policy to enhance Return on Equity (ROE) does not appear to be a viable strategy.

(2) The primary emphasis should be placed on the rectification of the residential sector’s balance sheet

The cyclical nature of the epidemic’s economic impact is evident: an economic downturn precipitates a decline in the future expectations of businesses and residents， thereby weakening the propensity of residents to consume and businesses to invest， which in turn exacerbates the economic downturn. This cycle is particularly challenging to break during a balance sheet recession， as it is difficult to restore GDP growth to normal levels. The primary obstacle stems from the increased difficulty in enhancing macro-ROE. Therefore， one potential strategy to disrupt this cycle is to undertake the repair of macro balance sheets.

The experience of the United States in implementing Modern Monetary Theory (MMT) during the recession holds significant relevance for China.It is widely recognized that the COVID-19 pandemic precipitated a profound economic and social crisis in the U.S. in 2020， resulting in widespread unemployment， loss of income， and business closures. In response to the pandemic’s impact， the U.S. government implemented several stimulus packages， amounting to over $5 trillion. These packages aimed to provide direct payments， unemployment benefits， small business loans， health care funding， and other forms of assistance to individuals， households， and businesses. The financing of these stimulus measures was achieved through the issuance of new debt， elevating the U.S. federal debt to over $28 trillion， or more than 100% of the GDP. Despite this， certain economists and policymakers have posited that such stimulus spending is both necessary and justified， and that the level of debt should not be a cause for concern provided the U.S. maintains its monetary sovereignty and mitigates inflationary pressures. These arguments are rooted in the principles of MMT， a heterodox macroeconomic theory that challenges traditional beliefs about government-economic interactions， the nature of money， the role of taxes， and the implications of budget deficits. While this approach did lead to severe inflation within the U.S.， it also facilitated a swift recovery from the recession， primarily due to MMT enabling a rapid expansion of U.S. residents’ balance sheets.

The government of China has refrained from stimulating the economy through direct monetary distribution to its citizens， primarily due to three considerations:

The China’s economy has been historically driven by investments in fixed assets， particularly infrastructure development， which boasts a substantial fiscal multiplier and has been extensively utilized by the government.Besides the high fiscal multiplier， infrastructure investment enhances the quality of life for citizens， and the economic benefits of a robust infrastructure system have enduring effects.The United States experienced hyperinflation following the implementation of Modern Monetary Theory (MMT)， a scenario China similarly encountered post-2008， which the government of China seeks to avoid.

The feasibility of implementing MMT in China is on the rise.Given China’s existing overcapacity， there has been a marked decrease in the fiscal multiplier. Various studies have estimated China’s fiscal multiplier using diverse models and methodologies， resulting in a wide range of outcomes. For instance， the International Monetary Fund (IMF， 2017) utilized a conventional estimation model to measure China’s fiscal multipliers， reporting an average fiscal multiplier of approximately 1.4 during 2010-2015. Furthermore， the fiscal multiplier is strongly positively correlated with the marginal propensity to consume. As such， the higher the population’s marginal propensity to consume， the greater the multiplier effect， implying that the achievable fiscal multiplier in 2024 is likely to be lower than 1.4.

The fiscal multiplier driven by China’s investment is already approaching the multiplier that the U.S. can achieve by distributing money to its citizens. Since the pandemic’s onset， the U.S. has initiated a $6 trillion fiscal stimulus， directly providing households with cash subsidies totaling $870 billion (equivalent to 4% of GDP). As per certain studies (Edelberg & Sheiner， 2021)， the U.S. government can stimulate $1.2 to $1.6 in consumption for each dollar of cash subsidy， yielding a fiscal multiplier of 1.2 to 1.6.

In conclusion， it is posited that the government of China could attempt to counteract balance sheet recession by implementing Modern Monetary Theory (MMT). The government of China could follow the U.S.'s example and distribute cash to households by issuing special treasury bonds. However， on October 24， 2023， the National People’s Congress Standing Co妹妹ittee (NPCSC) of China approved a proposal to increase the issuance of government bonds by 1 trillion yuan (approximately 15.5 billion U.S. dollars) in the fourth quarter of 2023. This led to an increase in the annual fiscal deficit to 3.8%， a move interpreted as an effort to aid local governments in expanding their fiscal deficit. Consequently， if the government of China continues to set the fiscal deficit above 3.5% in 2024， it will result in a significant drain on monetary liquidity. Therefore， these initiatives must be accompanied by a substantial injection of monetary liquidity， indicating that China will be implementing MMT.

(3) Domestic capital markets play a pivotal role in maintaining macroeconomic balance sheet stability

In China， aside from real estate， the most significant components of residents’ assets are stocks， bonds， and funds. As of the first half of 2023， the combined market value of companies listed on the Shanghai and Shenzhen stock exchanges was approximately 83.26 trillion yuan. By the end of the second quarter of 2023， the total market value of A-share companies had risen to about 89.99 trillion yuan. Excluding the challenging-to-estimate total value of co妹妹ercial properties， the stock market represents the largest portion of China residents’ assets.

Despite its robust financing function，China’s capital market has underperformed in terms of investment returns. From 2021 to August 31， 2023， the Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange (SZSE) saw a total of 11，971 IPOs， raising funds totaling 14，363.89 billion yuan. However， the rapid expansion of companies on the SSE and SZSE， due to the mismatch between the rates of listing and delisting， has been a concern. A frequently discussed issue is the lack of synchronization between China’s M2 growth and asset price growth. While the U.S. market has seen long-term stable growth of stock indices with the Federal Reserve’s increased M2， this trend does not apply to the SSE， which has fluctuated between the 3，000-4，000 level for years despite China’s rapidly accelerating M2 growth rate.

The Fisher equation provides an explanation for this phenomenon: when the velocity of money (V) and the quantity of goods and services produced (Q) are relatively stable， the amount of money in circulation (M) determines the price level (P). However， the registration system has led to a significant increase in the Q of the stock market， causing a diversion from the total number of listed companies to the total amount of capital that can be acco妹妹odated by the A shares. This is corroborated by the positive correlation between China’s total M2 and the total market capitalization of the A-share market. Therefore， in addition to distributing money to residents，it is essential for capital markets to offer better， stable investment returns to repair balance sheets.In particular， balancing the speed of company listings and delistings is crucial.

04

Asset Allocation: The Implications of Changes in China’s and U.S. Interest Rates for Pricing in 2024

(1) Equity: The Necessity for Caution in the Face of Potential Revaluation of Assets in China

The performance of China’s stock market has been relatively underwhelming since the second quarter of 2023， primarily attributable to the interplay of risk appetite and earnings growth. The Dividend Discount Model (DDM) valuation can be deconstructed into three primary drivers: earnings growth， risk-free rate， and risk appetite. Initially， the economic downturn from the second quarter， the swift correction in the two-year Compound Annual Growth Rate (CAGR) of GDP， and the increasingly volatile international situation have precipitated a rapid decrease in investors’ risk appetite in the stock market， prompting a shift towards lower-risk assets. Concurrent trends in China’s bonds and gold corroborate this perspective. Secondly， the subpar earnings performance of China’s A-share listed companies is evident. The cumulative net profit growth rate， after deducting non-recurring items for all of China’s A-shares in the third quarter of 2023， was -1.56%.

Risk-free rates are projected to decrease， while earnings growth is anticipated to improve.By regressing nominal GDP growth， price data， and all A-share earnings growth， and integrating the aforementioned assumptions， it is projected that China’s A-shares earnings growth will revert to approximately 3.0% in 2024. Furthermore， due to the issuance of additional treasury bonds this year， it is likely that the People’s Bank of China will reduce the reserve requirement ratio next year， concurrently cutting interest rates in alignment with fiscal policy， thereby stimulating investor risk appetite.

It is prudent to be cautious of the risk of revaluation of assets in China.Despite the anticipated interest rate cuts by the People’s Bank of China next year， interest rates in China and the United States will remain inverted. Given China’s excessive supply of equity assets， a revaluation of equity assets is probable.

(2) FICC: The Bull Case for Investing in China and U.S. Bonds

Both China’s and U.S. bonds are likely to perform well.For China， due to an additional issuance of treasury bonds this year and the likelihood of a higher fiscal deficit next year， it is posited that the People’s Bank of China (PBOC)， in addition to lowering the reserve requirement ratio to replenish liquidity in the interbank market， will also reduce the two policy rates of Open Market Operations (OMO) and Medium-term Lending Facility (MLF) to guide market interest rates further downwards. It is anticipated that China’s policy rate will be reduced by 30 basis points (bp) next year (15 bp twice).For the U.S.， following the December Federal Open Market Co妹妹ittee (FOMC)， it is now widely accepted that the Federal Reserve’s rate hike operation has concluded， and investors have begun to speculate on the subsequent rate cut operation. Moreover， in the quarterly economic forecast report released at this rate meeting， the Federal Reserve has issued the most explicit rate cut signal. The Federal Reserve’s dot plot implied a 4.6% level for the federal funds rate at the end of 2024， a downward revision from the September estimate (5.1%). At the current juncture， this implies a 75 bp Federal Reserve rate cut in 2024. Under these conditions， China’s 10-year Treasury yield is expected to fluctuate in the range of2.5% -2.8 %， and the U.S. 10-year Treasury yield is expected to fluctuate in the range of 3.6% -3.9 %.

The Renminbi (RMB) exchange rate has preemptively factored in some rate-cut expectations and may move slightly lower in 2024. In the neutral scenario， if China’s policy rate is lowered by 30bp and the Federal Reserve lowers the federal funds rate by 75bp， the Chinese Yuan (CNY) exchange rate is expected to rise slightly further， with the full-year fluctuation range likely to be in the range of 6.9-7.2.

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颁布于：南京市