Asia FX 2025 Outlook Podcast Series #2: The levers to stimulate China's growth

Welcome to the MUFG Global Market Asia podcast. I'm Ling Li, head of MUFG Global Market Asia research team. Today is December 15, 2024.

The following podcast is for informational purposes only. It's intended for professional investors and eligible counterparties, not for retail clients. Any content should not be regarded as an offer to conduct investment business or investment recommendations.

Today's episode, Levers to Stimulate China Growth, is part of AsiaFX 2025 Outlook podcast series. In this podcast, I discuss our view on China's economy in 2025, an impact of potential Trump's tariff on China's economy and its ripple effect on Asian peers, the levers to stimulate China's growth, as well as U.S. dollar CNY forecasts for next year. China's economy faces various cyclical and structural challenges and incoming trade war 2.0.

China's economy started this year with a good 5.3% growth in Q1, followed by a 4.8% growth in Q2 and a 4.6% growth in Q3, making a 4.8% growth in the first three quarters of this year compared to the relevant time period a year ahead. A sequential contraction of major activity indicators of the property sector and a continued decline of property prices in October indicate that the property sector is not yet stabilized. The weak real estate sector, elevated housing stocks, overcapacity, worsening demographic conditions, low income share of GDP, and other structural factors have been the main reasons weighing on consumption and investment demand and resulting in a deflationary environment for China.

China has been running a negative GDP deflator since the third quarter of last year. The potential Trump's tariffs could bring additional large pressure on China's economy and the currency. The trade war 2.0 arrives at a more challenging time for China.

Out of this 4.8% growth in the first one to three quarters this year, 1.1 percentage points was contributed by the net exports. Now exports matter more to China's economic performance than it did in 2018. We expect US average tariffs on China products to increase to 40% from current 19.3%, lower than the 60% tariffs on China products mentioned by Trump during his presidential campaign.

There also exists a risk of revoking of China's permanent normal trade relations status. We see limited room for Chinese exporters to reduce the negative impact caused by tariffs through reducing exports prices. To mitigate the negative impact, an extra 1% to 1.5% of GDP worth of fiscal support are needed probably, or a sizable CNY depreciation is needed to bring the economy into balance.

Since September, Chinese government has been rolling out a quite comprehensive set of policies, including lowering policy rates and minimum down payment ratio for the second home mortgage to 15%, programs to support the stock market and banking sector, and a RMB10 trillion worth of swap plan for local government to reduce their hidden debt. This debt swap plan is important. It is for reducing local government's hidden debt and improving their fiscal stability, rather than traditional stimulus directly working on stimulating consumption and investment.

Existing policies still are not sufficient to stabilize Chinese economic activities. We see government's strong intention to stimulate growth. On the monetary side, it is PBOC's policy stance to be more expansionary.

Aside from a 20 BPS policy rate cut in Q1 and a 50 to 70 BPS RRR cut that we expect to reduce the cost of funding and increase liquidity, we expect more monetary structural tools or programs, like special loan programs, to stimulate technological innovation and transformation, additional swap facilities for security firms, etc., special refinancing instruments for listed companies, etc. Fiscal stimulus is likely to be the key approach in the next year. We expect government to set an above 4% budgeted fiscal deficit for 2025.

We expect additional equipment upgrading and consumer goods trading programs, direct subsidies for unemployed, especially young people, child care, disabled, etc. Particularly we expect fiscal support to improve people's livelihood and social safety net. That would help reduce structural issues of insufficient consumption demand.

Because households have a high savings rate of around 43%, that could be a reflection of lack of a sufficient social safety net. Increasing the minimum subsidy for basic pension insurance for urban and rural residents scheme can be a good lever for stimulating growth. There are 165 million people receiving this pension.

However, the nationwide minimum standard is only about RMB123 yuan. According to academic experts, a monthly subsidy of RMB500 to 600 yuan is needed to satisfy elderly basic needs. It translates into around RMB800 billion to RMB1 trillion government spending, which is equivalent to 0.7% to 0.8% of GDP.

Urbanization 2.0 is another important lever where fiscal policy can focus on. Latest numbers show that China's urbanization rate was 66.2% in 2023. This rate exaggerated the true level of China's urbanization process.

Our calculation shows that there are only 40% population living in the total 695 cities in China. Rest population included in this 66.2% urbanization rate actually live in county towns and designated towns. The huge contrast of an average 813,000 population per city for 695 cities, an average 105,000 population per county towns, and an average 10,000 population per designated towns indicate that county towns and designated towns do not have the same mass to qualify the strict definition of a city, given their far less advanced industries and public services.

Additionally, not all people living in the city like migrant workers. They do not really enjoy the same social benefits including education, health care, and social housing, which are offered to peoples with hukou. The gap means room for further stimulus.

Moving forward, the tone for policy easing is positive. More concrete numbers for stimulus will follow in next month. We expect a 5% growth target for 2025 to be set in next March's MPC meeting.

However, this target is unlikely to be delivered in the end, given the lingering structural drag and nature of slow process of property de-stocking. We expect a 4.5% growth for China GDP growth in 2025. For a assumed additional 20% tariff increase, bringing U.S. average tariff on China goods to 40%, we expect U.S. dollars in white pair to reach 7.5 by second quarter next year.

However, a scenario of a 6% tariff on China products would require a 10% to 12% of CNY depreciation against a dollar to rebalancing the imbalances, from the level in mid-September when Trump's trade started, everything else being equal. The widening negative China and U.S. yield spread likely provides some support, too, for the U.S. dollar CNY to go up in the next quarter, too. Risk to our U.S. dollar CNY forecast remains on both sides.

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