China has seen a marked deceleration in its rate of credit growth over the past decade, prompting pessimistic assessments from some pundits over the viability of its current economic development model.

For observers who have criticised Beijing for excessive dependence on credit supply to reach GDP targets, this easing growth is bound to have dire implications for China’s economic performance moving ahead.

Others argue, however, that China’s growth has never been dependent on excessive credit provision, and that any upticks in lending have simply been temporary episodes of counter-cyclical macroeconomic policy designed to compensate for short-term headwinds.

They instead view the slowing of credit growth as a clear sign that China is shifting towards a more sustainable, innovation-driven development model characterised by higher credit efficiency, following decades spent developing domestic human capital and R&D capabilities.

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Chinese credit growth on the wane

Writing for the Wall Street Journal, Joseph C. Sternberg highlights a sustained decline in China’s rates of credit growth for at least the past decade.

“Despite robust new bank lending of around $680 billion, the total rate of credit growth is slowing dramatically: to 6.1% year-on-year in January, compared with an average of 9% a year in 2017 -24 and 18.1% in 2007- 16,” he writes.

The Chinese central bank’s adoption of “moderately loose monetary policy” for the first time since 2011 failed to whet the appetite of households or enterprises for greater leverage last year, with new bank loans dropping to a seven-year low of 16.27 trillion yuan.

Domestic commentators have highlighted the impact of China’s housing slump on credit growth, arguing that it has resulted in the same dynamics that underlie balance sheet recessions.

The bust in the property market which began in 2021 has prompted Chinese households and businesses to deleverage as opposed to borrow, as they repair the damage inflicted on their net worth by the drop in asset prices.

China’s own policymakers and pundits often point to this as the core reason behind the nation’s “insufficient domestic demand” - which consensus opinion views as its chief macroeconomic challenge.

Prominent commentators such as Michael Pettis have further argued that China suffers from an excessive and perilous dependence upon credit to motivate economic growth.

Sternberg contends that “the rapid expansion [of credit] has been Beijing’s primary means of achieving growth…for decades.”

As a consequence, the ailing rates of credit growth he highlights could be viewed as a sign that this risk-fraught growth model has run its course, and will no longer prove a viable means of priming GDP in future.

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The perils of credit binges for Chinese banks

Wang Jian (王剑), chief financial sector analyst at Guosen Securities, points to a raft of problems that excessive credit supply can create for the banking sector.

“Credit allocation in excess of economic demand, or what is commonly referred to as insufficient effective demand, means that the demand for credit that satisfies lending standards falls short of the lending target,” Wang writes in the opinion piece “The Importance of Maintaining Rational Credit Growth” (王剑：保持合理信贷增速的重要性).

When Chinese banks are compelled to extend credit in excess of what the economy actually demands, then this can lead to an asset drought as well as the “dumping” of loans.

These artificial credit binges then negatively impact the asset quality of banks, by forcing them to relax lending standards and provide loans to less creditworthy borrowers in order to satisfy the growth targets set by policymakers.

These policy-driven credit binges can also undermine the profitability of banks, by warping the yield curves for their assets and squeezing their net interest margins. This in turn can have adverse impact on the capital adequacy ratios that serve as the key metric for the health of bank balance sheets.

“Excessive lending can disrupt the balance [of capital ratios],” Wang writes. “For example, in 2023, credit growth exceeded 10%, surpassing bank ROE, indicating an unsustainable level of capital adequacy.”

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Is China’s credit growth rational or excessive?

While Wang Jian agrees that excess credit creation can spawn problems for the banking system, he parts ways from Pettis and Sternberg on the matter of whether or not credit supply in China has historically been excessive.

As proof of this, Wang Jian points to the concept of “rational credit growth” - which he deems to be “growth in credit that matches different stages of economic development.”

“China has long made use of a comparatively rough means of determining rational growth in credit, simply comparing growth in a broad credit measure - such as the M2 money supply or aggregate social financing - to growth in nominal GDP,” he writes.

Based on this method, Wang argues that China’s credit growth has remained at comparatively “rational” levels since the end of the Global Financial Crisis.

Wang points out that for at least the past decade, the growth in the lending balances of Chinese financial institutions have been roughly in line with nominal GDP growth, consistently maintaining a gap of five percentage points.

He further points out that the gap itself is likely the result of economic activity which isn’t captured in official GDP data - such as purchases of pre-owned homes and credit provided to China’s informal economy or to fledgling micro-enterprises.

“As a consequence, credit growth is just slightly higher than nominal GDP growth,” he writes.

“This is perhaps the meaning of matching, where matching isn’t at all a matter of strict equality.”

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Credit binges as macroeconomic balancing tools

While Wang does not believe that China’s GDP growth has been dependent on excess credit supply, he does highlight the occasional use of credit quotas by Beijing as an macroeconomic tool of sweeping importance.

He considers China’s credit binges to be part and parcel of counter-cyclical stimulus, which is subsequently withdrawn once GDP growth resumes its apt course.

“Although there’s no doubt that China’s policies no longer make use of the credit quotas of the planned economy era, they still influence lending by banks,” he writes.

“Especially after 2018 when economic growth slowed, growth in credit instead stabilised, reflecting the ‘counter-cyclical’ nature of credit policy.

“That is, when the economy is under pressure, policymakers require that banks increase lending to support the economy, while when the economy overheats, the government suppresses credit growth.

“During the economic downturn in 2018, policymakers promoted rapid credit expansion, which was part of the counter-cyclical policy and cannot be considered excessive lending.

“Subsequently, as economic growth slowed and the economic structure adjusted, counter-cyclical policies gave way to cross-cyclical policies.

“Credit growth began to decline slowly, and began to decline significantly from 2024.”

Wang notes that by the end of 2025, the gap between nominal GDP growth and credit growth was only 2.21 percentage points, which he believes is far more “rational” than the prior long-standing gap of five percentage points.

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Credit growth to ease as China’s economy transitions

Given that Wang does not believe China to have ever been excessively dependent on credit to fuel GDP expansion, he also remains unalarmed by the recent slowdown in loan growth.

Rather than view it as a harbinger of economic problems ahead, he instead views it as firm evidence that China has already shifted towards a healthier and more sustainable form of innovation-driven development which is less credit dependent.

“The extension of credit is a primary means for the banking sector to support economic growth,” Wang writes.

“However, this level of importance can differ at different stages of economic development.

“For example, as economic drivers shift from investment to technological innovation, the economy’s demand for credit will decline.”

Wang believes that China’s economy is now undergoing such a shift towards more credit-efficient sectors that require less leverage to maintain healthy growth.

“As China’s economic transformation yields major results, the industrial structure per unit of nominal GDP is upgrading, and the demand for credit from emerging industries will decrease, or even experience negative growth as existing loans mature, and new credit issuance falls below the amount maturing,” he writes.

“The fall in demand for credit is consistent with the experience of a change in economic models.”

Wang notes that this view is congruent with the official position of the Chinese central bank, as outlined by its monetary policy execution report for the third quarter of 2025.

“A slight slowdown in the growth rate of total financing is natural and consistent with the shift of China’s economy from high-speed growth to high-quality development,” the report reads.

“While the growth of social financing and the money supply is generally in line with nominal economic growth, a slightly lower loan growth rate is also reasonable, reflecting changes in the financial supply-side structure.”

China’s top economists and bankers remain highly concerned about the potential for the ailing health of regional lenders to trigger a financial crisis.

They’ve called for local governments to help bail them out, by issuing special bonds to fund capital injections for unsteady balance sheets.

While the move would bolster China’s beleaguered smaller banks, it could also compound long-standing problems with the financial system.

These include the immense leverage burden of local governments, as well as the collusion between regional officials and lenders which has historically been a source of debilitating debt risk.

Leading pundits argue, however, that increasing local government influence over regional banks via bailouts will prove advantageous for the Chinese economy, by enhancing the state’s ability to control credit allocation and tightening the coordination of fiscal and financial policy.

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China’s smaller banks still source of crisis anxiety

Liu Ya (刘亚), a representative to the National People’s Congress and party secretary for the Beijing branch of China Export-Import Bank, voiced concern about the capital health of smaller lenders at the Two Sessions congressional event held in March.

“Capital is a reflection of the operating strength of banks,” she said during an interview at the sidelines of the Two Sessions.

“For small and medium-banks, it is of the utmost importance when it comes to stable and healthy development, absorbing losses and the prevention of risk,”

Prominent financial commentator Mo Kaiwei (莫开伟) echoed Liu’s concerns in a follow-up opinion piece entitled “China’s Small and Medium-sized Banks Urgently Need the Establishment of Long-term Effective Mechanisms for Capital Supplementation” (“莫开伟：我国中小银行亟需构建资本补充长效机制).

“High-risk institutions are concentrated in the small and medium-sized banking system, and their lack of sufficient capital buffers could readily trigger regional financial risk,” Mo writes.

“It is very clear that expanding support for capital supplementation by smaller banks has become an extremely urgent task.”

As of the end of 2025, the core tier-1 capital adequacy ratios for all categories of Chinese banks were safely above the regulatory baseline.

They stood at 17.56% for the large-scale commercial banks and 13.43% for the joint-stock banks - the traditional mainstays of the Chinese banking sector.

For municipal commercial banks and rural commercial banks - considered smaller lenders, the figures stood at 12.63% and 12.22% respectively.

Mo points out, however, that some of the smaller municipal and rural commercial banks have “already seen their capital adequacy ratios fall to quite low levels, with some posting on-quarter declines.”

He further notes that the bad debt levels for certain regional lenders have reached perilous heights, while the Chinese banking sector as a whole still faces headwinds which will continue to diminish the health of their balance sheets.

“At present, China’s small and medium-sized banks suffer from constraining factors such as low profit levels and high non-performing asset ratios,” Mo writes.

“On top of this, China’s economic growth is slowing, with the trends of financial risk prevention, crack downs on malfeasance and strict regulation still ongoing.

“The return of corresponding operations to balance sheets will further accelerate the erosion of capital at smaller banks, affecting their capital adequacy ratios to varying degrees.”

Smaller regional banks have remained an acute source of concern for China’s financial authorities for much of the past decade - despite ownership by the state and tight oversight by regulatory agencies.

In 2019 Yi Gang, the then-governor of China’s central bank highlighted problems with asset quality at China’s smaller lenders, stating that a rise in NPLs comprised the greatest threat to the stability of the banking sector.

The summer of that year saw the failure of three regional lenders - Inner Mongolia’s Baoshang Bank, Bank of Jinzhou in Liaoning and Shandong’s Hengfeng Bank.

In May 2019 the Chinese central bank and the China Banking and Insurance Regulatory Commission (CBIRC) made the bold move of taking over Baoshang Bank - the first such nationalisation of a Chinese commercial lenders in more than two decades.

The episode marked the end of implicit government guarantees for Chinese financial institutions, with creditors to the trio of capsized banks left to eat their losses.

It also ushered in a wave of mergers and takeovers of China’s smaller regional lenders, in a bid to shore up the sector’s overall health.

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Local governments asked to borrow to save their banks

Because smaller banks tend to be China’s most vulnerable and risk-fraught financial institutions, they also suffer from the disadvantage of finding it far harder than larger lenders to boost their capital levels.

Mo points out that it’s much more difficult for them to supplement their capital internally via retained earnings, if their profits have come under pressure due to poor operations.

These same difficulties make it harder for smaller banks to use external market-based financing channels - such as IPOs - as sources of capital, since they invariably fail to satisfy investment requirements.

For this reason, Liu Ya and Mo Kaiwei both believe that the only way to boost the health of China’s vulnerable lenders will be for local governments to come to their aid, by sourcing funds for capital injections via debt issues.

“Small and medium-sized banks urgently need to use issues of [local government] special bonds to expand the support for capital supplementation,” Liu said.

“We need to establish long-term effective mechanisms for the supplementation of capital for smaller banks.”

“The proposal by bank chief Liu Ya is congruent with the current state of China’s capital conditions of China’s smaller banks and the need to prevent risk, and is a critical measure that greatly warrants attention and promotion,” Mo writes.

“It is very clear that small and medium-sized banks urgently need issues of special purpose bonds, and that expanding support for capital supplementation has been an extremely urgent task.”

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Bailing out banks conflicts with reforms

While local governments could help to bailout vulnerable regional banks by issuing special bonds, the move would also run against the grain of one of China’s top economic missions at present - dealing with the issue of opaque, risk-fraught regional debt.

China is still grappling with the dilemma of the huge amount of hidden debt amassed by local governments since 2009, when Wen Jiabao launched a four trillion yuan stimulus package to deal with the fallout of the Global Financial Crisis.

To this end, Beijing’s latest budget has approved the issuance of 4.4 trillion yuan in special bonds by local governments this year, much of which will be used to defuse debt risk by rolling over hidden liabilities.

Mo Kaiwei also points out that local governments will acquire far greater control of banks within their jurisdiction as a result of the bailouts.

This too runs against the grain of China’s long-standing financial reforms, which have sought to increase the autonomy of smaller banks vis-a-vis local governments and prevent official collusion seeking to tap into them as cash cows.

In the 1980s and 1990s, the ability of China’s local governments to exercise administrative control of banks in their regions was a key driver of the surge in non-performing loans that brought the financial system to the brink of collapse.

Local governments abused their authority to compel the banks to lend to preferred businesses or investment projects, in order to pump up growth figures and keep ailing state-owned enterprises afloat. This resulted in wasteful credit binges and the endemic accumulation of defective debt.

Is state control of banks intrinsic to the Chinese model?

Several decades later, however, Mo Kaiwei considers the reassertion of local government control over the regional banking sector to be a thoroughly positive development - as well as one which is wholly consistent with “socialism with Chinese characteristics.”

In Mo’s opinion, the move will serve to further cement the signature advantages of the China’s economic model - chief amongst them the tight coordination of fiscal, monetary and financial policy and the control of credit allocation by the state.

“The issuance of special-purpose bonds (for the banks) can deeply cement the relationship between fiscal and financial systems,” he writes.

“State-owned capital can strengthen the management of local financial institutions and better leverage the synergies between fiscal and financial policies.

“It also improves the allocation of credit resources in line with the development of sectors with competitive advantages, continuously enhancing the ability of banks to serve the real economy.”

While collusion between local governments and the financial institutions under their oversight was once considered a source of debilitating risk, Mo contends it could now become a regulatory advantage that stymies emerging perils and enhances the health of the banks.

“Most importantly, this move helps prevent local financial risks, enhances market confidence, spurs credit financing and serves the local real economy,” he writes.

“It helps increase the equity concentration of small and medium-sized banks, streamlines shareholder interests and improves board structures, thus improving the operational quality of small and medium-sized banks.”

China just convened its Two Sessions congressional meeting for 2026 - the most important annual event on the nation’s political calendar.

Typically held each year in March, the Two Sessions refers to the annual plenary meetings of China’s two top legislative bodies - the National People’s Congress (NPC) and the National Committee of the Chinese People’s Political Consultative Conference (CPPCC).

Western analysts often dismiss the Two Sessions as a rubber stamp parliament, whose role is to give perfunctory approval to decisions already made behind closed doors by the Communist Party’s top leadership.

The Two Sessions nonetheless serves as a pivotal event for Beijing to articulate its key policy goals and priorities, as well as release the main economic and budgetary targets for the year.

The 2026 Two Sessions is also one of heightened importance, given that it marks the launch of the 15th Five Year Plan which is scheduled to run from 2026 to 2030.

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The chief themes of the 2026 Two Sessions

The Government Work Report, delivered at the opening of every Two Sessions by the Chinese Premier, is the keystone document for outlining Beijing top priorities and policy goals for the upcoming year.

This year’s Government Work Report indicates that Beijing is now heavily focused on three economic goals in particular

• Boosting domestic demand and household consumption. The goal here is to reduce the Chinese economy’s dependence upon potentially unreliable export markets. Greater domestic demand will also help to shore up imports, ameliorating the trade imbalances that are a source of contention with other nations.

• Strengthening the Chinese tech sector. A key goal here is to reduce the reliance of Chinese supply chains on imported technologies that are susceptible to embargoes. The longer-term priority is the creation of new drivers for the Chinese economy that serve as reliable sources of sustainable growth.

• The prevention of economic risk. Beijing is focused in particular on local government debt risk, property market risk and financial system risk.

“The core mission of economic work in 2026 is resolving these three issues,” writes Luo Zhiheng (罗志恒), chief economist at Yuekai Securities and director with the China Chief Economists Forum.

“Of these three areas, demand is number one, scientific, technological and industrial innovation is number two, and the prevention of risk is number three.”

Beijing’s preoccupation with these policy goals is underpinned by concerns over unresolved Cold War tensions with the US, and their potential impacts upon China’s economic growth and security.

This is one of the reasons that the 2026 Two Sessions has made a downwards adjustment to China’s annual GDP growth target, setting it at 4.5% - 5% as compared to 5% during the three year period from 2022 to 2025.

Boosting consumption

The Government Work Report has put the expansion of domestic demand - and consumption in particular - at the top of this year’s core economic missions, reiterating a policy position first outlined by Beijing at the end of 2024.

The Report calls specifically for the “deep implementation of specialist campaigns to spur consumption,” while also mandating the establishment of a 100 billion yuan “specialist fund for the coordinated use of fiscal and financial policy to drive domestic demand.”

The fund will “comprehensively employ tools such as loan subsidies, financing guarantees, and risk compensation” to drive the provision of personal consumer loans and loans to enterprises in the services sector.

“At present, Chinese consumption still needs to develop rapidly, and also has ample room for growth,” writes Lian Ping (连平), chief economist at the Guangkai Industrial Research Institute and director with the China Chief Economists Forum.

“In 2025, the economic growth contribution rate of consumption in China was 52%, driving 2.6 percentage points of GDP growth, and playing its proper role in stabilising growth.

“However, in terms of potential growth, China’s household consumption rate is still 10 - 30 percentage points below developed countries, and should play a more active role in stabilising the economy in 2026.”

Chinese tech sovereignty

The Government Work Report’s second and third top missions both concern China’s tech sector.

The report’s second most important mission is “accelerating the cultivation and expansion of new growth drivers” - a roundabout reference to development of Chinese tech, while mission number three sets the goal of “accelerating [the development of] scientific and technological self-strengthening and independence.”

In order to achieve these goals, the Work Report calls for “strengthening original innovation and breakthroughs in core technologies,” as well as the “unified advance of education and the development of science and tech personnel.”

Xue Hongyan (薛洪言), deputy-head of the Xingtu Financial Research Institute, says the dialling back of Beijing’s growth target for 2026 is at least partially intended to give the Chinese economy breathing room to shift gears towards “high-quality” development of the domestic tech sector.

“The 4.5%-5% growth target is about securing future technological sovereignty through more moderate growth,” Xue writes.

“Against the backdrop of a protracted Sino-US rivalry, technological self-reliance is crucial to our ability to maintain a foothold at the high end of the global industrial chain.

“Rather than wasting resources on inefficient, ‘involutionary’ competition, it’s better to focus on ‘investing in people’ and ‘investing in innovation.’

“This means increasing investment in basic research, supporting enterprises in leading the development of key technologies, and strengthening the leading role of enterprises in innovation.”

Risk prevention

The Government Work Report also lists the “dissolution of risk” as one of its top economic mission for 2026.

Wen Bin (温彬), chief economist at China Minsheng Bank, writes that the focus here will be on three key areas of risk in particular - real estate market risk, local government debt risk, and financial system risk.

He sees the launch of extensive measures this year to stabilise China’s housing market, as well as further address risk in relation to the hidden debts of local government

The issue of local government debt emerged as an acute headache for China’s policymakers in the wake of the four trillion yuan stimulus package launched by Premier Wen Jiabao in 2009, to deal with fallout of the Global Financial Crisis.

Local governments bore a disproportionate share of the spending burden for the stimulus package - as they have for government expenditures in general ever since Zhu Rongji’s reform of China’s fiscal system in 1994.

The situation prompted China’s local governments to fund such expenditures via local government financing vehicles (LGFV), which resulted in the accumulation of copious volumes of hidden, risk-fraught debt.

In the past several years the issue has been further compounded by the property slump which kicked off in 2021, depriving local governments of a mainstay source of revenue in the form of land usage transfer fees.

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Fiscal Policy

The 2026 Two Sessions extends the expansionary fiscal policy settings that Beijing first signalled at the end of 2024, in anticipation of the headwinds created by Donald Trump’s second term in office.

The Work Report calls for “continuing to implement even more active fiscal policy,” as well as “employing the integrated effects of existing [fiscal] policies and additional policies, to expand the intensity of counter-cyclical and cross-cyclical adjustments.”

The deficit ratio for 2026 has been kept at the record-high of 4.0% - the same as in 2025, which marked the first year that Beijing opted to raise the figure above the long-established ceiling of 3.0%.

Lian Ping points out that if China achieves its nominal GDP growth target of 4.5% - 5.0%, this will mean a 230 billion yuan increase in China’s deficit from 5.66 trillion yuan to 5.89 trillion yuan, providing “even more stable funds for fiscal expenditures.”

China’s broad deficit - referring to the sum of the deficit plus special treasury bonds and local government special bonds, is set to come in at 11.89 trillion yuan.

While this marks an increase of 30 billion yuan compared to the 2025 budget, Wen Bin points out that it will likely translate into a broad deficit ratio of 8.1% - 0.3 percentage points lower than the figure outlined at last year’s Two Sessions.

This is in keeping with the call from last year’s Central Economic Work Conference to “maintain the required deficit ratio, total scale of debt and total volume of payments.”

Beijing’s treasury bonds

The Two Sessions has set the full year quota for the issuance of ultra-long special treasury bonds by the Chinese central government at 1.3 trillion yuan - on par with the figure for last year.

Funds raised will be used to support fiscal policies already in place that are designed to shore up domestic demand.

These include:

• 800 billion yuan for Beijing’s “Two Keys” (两重) infrastructure and strategic development projects.

• 250 billion yuan for the “cash-for-clunkers” program to subsidise consumer purchases of goods and services. While the scope of the program has expanded to encompass services, the scale of funds allocated has fallen by 50 billion yuan compared to last year.

• 200 billion yuan to subsidise capital equipment upgrades by Chinese businesses.

Beijing will also raise 300 billion yuan via special treasury bond issues to supplement the capital of China’s big state-owned banks - a sizeable reduction from the 500 billion yuan allocated to the same task last year.

One of the goals here is to give Chinese banks the ammunition to help stabilise capital markets, just in case stock prices succumb to undue volatility this year.

This measure is part of Xi Jinping’s push to expand the role of the stock market in China’s financial system and improve the ability of innovative tech companies to access funds.

Given that innovative tech ventures are characterised by high risk and high reward, Chinese policymakers consider equity funding to be a far preferable means of financing them than loans sourced from the state-owned banks.

Fiscal spending to focus on boosting consumption

Luo Zhiheng sees the Chinese central government making further structural adjustments to fiscal policy to support the headline priority of boosting domestic demand via growth in consumption.

“Demand has been weak as a result of insufficient focus on consumer demand and the household sector,” he writes.

“If the pattern of fiscal expenditures does not change, then it will be difficult to change the situation of supply being strong, yet demand being weak.”

Luo expects this structural adjustment to involve greater spending on transfer payments and the beefing up of China’s social welfare system.

“The structure of expenditures must shift from the previous focus on ‘things’ to a greater focus on people.

“The method for the implementation of fiscal policy may need to switch from a focus on investment to equal emphasis on investment and consumption, and from a focus on enterprises towards equal emphasis on enterprises and households.

“Additionally, the internal structure of transfer payments must be further optimised.”

Local government bonds to tackle regional debt risk

This year’s Two Sessions has set a quota of 4.4 trillion yuan for local government special bond issues - the same as the figure for last year.

In addition to the development of key infrastructure projects, this year’s Two Sessions has put heavy emphasis on using the funds from these bond issues to defuse regional debt risk by rolling over the “hidden liabilities” of local governments.

Local government debt risk is one of three areas of economic risk highlighted by the Government Work Report, alongside real estate risk and financial sector risk.

Luo Zhiheng points out that dealing with regional debt risk is especially critical for the effectiveness of Chinese fiscal policy, given that local governments currently account for 85% of total fiscal expenditures, while the central government’s share is just 15%.

“Resolving the fiscal challenges of local governments and dissolving regional debt risk is one of the duties of active fiscal policy,” he writes.

“If the capabilities of local government are inadequate, then the effectiveness of active fiscal policy could weaken.

“The focus should be on resolving local government fiscal difficulties, whether by expanding transfer payments or providing local governments with larger bond quotas and allowing them to raise more debt.”

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Monetary policy

As with fiscal policy, this year’s Two Sessions reiterates Beijing’s existing stance on the need for expansionary monetary policy.

2026 will see the continued implementation of “moderately loose monetary policy,” as well as the “flexible and high efficiency usage of multiple monetary policy tools - including cuts to the required reserve ratio and interest rates.”

While Luo Zhiheng expects the Chinese central bank to proceed with cuts to both the required reserve ratio and interest rates this year, he expects such reductions to be limited in scope - particularly given that the short-term policy rate (the seven-day reverse repo rate) sits at just 1.4%.

Lian Ping expects a 0.1 to 0.3 percentage point cut to the central bank’s policy rate, when the appropriate window of opportunity arises.

Credit guidance to play a greater role

An area of greater emphasis this year is set to be China’s “structured monetary policy tools” - instruments used by the Chinese central bank to channel funds in higher volumes and at lower cost to priority areas of the economy.

This year’s Government Work Report flags expanded deployment of the instruments, calling for “optimisation and innovation in the use of structured monetary policy tools.”

“There will be greater emphasis on structured tools, in order to expand support for consumption, aged care and science and technology,” Luo Zhiheng writes.

“In a certain sense this is the embodiment of coordination between fiscal and financial policy, taking credit resources occupied by low-efficiency areas and directing them towards key areas such as science and tech innovation, green transformation, financial inclusion and the digital economy.”

In January, the Chinese central bank reduced the rates for a slew of its re-loan facilities (a key form of structured monetary policy tool) by 0.25 percentage points, while also expanding the size of their quotas.

Lian Ping expects that 2026 could see a further 0.2 - 0.4 percentage point cut to certain re-loan rates, which he believes will enhance the ability of structured monetary policy tools to “strengthen support for key areas such as the expansion of domestic demand, scientific and technological innovation, and small and medium-sized enterprises.”

Despite marquee differences in political ideologies, China and the West have much in common when it comes to the social contract that they’ve established with citizens on core matters of economic management.

Like any Western nation, the Chinese government is entrusted with the twin yet conflicting missions of maintaining enough economic growth to provide employment, while at the same time keeping a lid on unchecked price inflation.

The tools that China uses to fulfil these missions are also the same as in other major world economies.

Beijing employs macroeconomic policy - in the form of fiscal policy (government spending and taxation) and monetary policy (interest rates and the money supply) - to regulate levels of growth in both output and prices.

As with other nations, China is similarly host to heated debate between policymakers and pundits on how to best use these tools to achieve the twin macroeconomic mandates of steady growth and stable inflation.

At present, China’s economic opinion-makers have reached significant consensus on the need for expansionary macroeconomic policy and higher deficit levels - given Beijing has made both an explicit part of its development agenda since the end of 2024.

The key area of contention currently concerns whether fiscal policy or monetary policy is the best tool for effectively priming China’s economy.

Sheng Songcheng (盛松成), formerly the head of the Chinese central bank’s statistical office, argues that monetary policy has lost much of its power to move the economy, due to low official interest rates and the ailing profitability of the state-owned banks.

The ex-central bank official believes that fiscal policy - not monetary policy - is the best means for boosting growth at present, as China continues to confront the dilemmas of insufficient domestic demand and unresolved tensions with the West.

In sharp contrast Zhang Bin (张斌), a senior researcher with the China Finance 40 (CF40) Forum and the deputy-head of the World Economy and Political Research Institute at the Chinese Academy of Social Sciences (CASS), argues that fiscal policy is fast losing its effectiveness as the economy matures.

Zhang believes that what the Chinese economy needs most right now is more vigorous rate cuts from the central bank.

He goes as far as to argue that China can cut interest rates to zero without fear of adverse consequences, pointing to what he considers to be the positive experiences of the US Federal Reserve and the Japanese central bank with such extreme monetary policy expedients.

This policy issue has recently become one of acute urgency for the Chinese central government’s senior-most decision-makers.

Beijing signalled the launch of more expansive macroeconomic measures at the end of 2024, in anticipation of the headwinds created by Trump’s second term in office.

The official stance of Communist Party is that Beijing will maintain expansionary macroeconomic policy settings in 2026 - a period of heightened symbolic importance as the inaugural year of China’s 15th Five Year Plan.

In this briefing:

• Why China shelved its unleashing of monetary policy.

• Fiscal policy seen as only short-term fix for China’s economy.

• How China’s monetary policy supports fiscal policy.

• Could zero interest rates save China’s housing market?

• Fiscal policy in China destined to lose its effectiveness.

• Advances in monetary policy make it the inevitable choice.

• China to follow the historic precedent of advanced economies.

• Bernanke and Abenomics as models for China.

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Why China’s shelved its unleashing of monetary policy

Despite Beijing signalling at the end of 2024 that it would loosen monetary policy to levels last witnessed in the wake of the Global Financial Crisis (GFC), the central bank’s actions have thus far fallen short of expectations.

The loosening of monetary policy typically assumes the form of cuts by the central bank to short-term interest rates. Standard macroeconomic theory holds that cuts to interest rates benefit the economy, by making it cheaper for enterprises to borrow and thus fund their investment spending,

The Chinese central bank waited until May of last year to implement cuts to the policy rate (its official interest rate) and the required reserve ratio - it’s only such adjustments in 2025. It reduced the policy rate by a modest 10 basis points, and the required reserve ratio by just 50 basis points.

This stands in sharp contrast to two cuts to the policy rate in 2024 - which reduced it by 30 basis points, and two cuts to the reserve ratio that same year, bringing it down by a cumulative 100 basis points.

Since May 2025, the Chinese central bank’s only other adjustment has been its decision in January to make 25 basis point cuts to the interest rates for its structured monetary policy tools - instruments that channel credit to priority sectors of the economy via re-loans to the commercial banks.

Many pundits in China argue that the central bank has held back on the loosening of monetary policy because interest rate cuts are poorly positioned at present to boost economic activity.

The reason for this is that Chinese households and businesses are still reeling from the adverse impacts of the housing slump which commenced in 2021, as well as the lingering economic effects of Covid.

This means that even if the cost of borrowing declines, households and businesses will be hard pressed to take on more debt to spend and invest, given damage to their balance sheets and their dour expectations of future opportunities.

Domestic economists have raised the possibility that China is currently in the type of liquidity trap described by Keynes, where declines in borrowing costs are of no avail in boosting economic activity.

Another key factor is the low level of the Chinese central bank’s seven day reverse repo rate - its main policy rate, which stands at just 1.4% following the 10 basis point cut made in May last year.

The low level of the policy rate compounds the problem of Chinese banks struggling with profitability issues, due to the narrowing of their net interest margins in the wake of prior cuts.

The net interest margin is a key measure of the profitability of commercial banks in their role as financial intermediaries.

It’s the difference between the costs that lenders incur by borrowing funds from depositors and other sources, and what they earn by lending money onwards to borrowers such as businesses.

“In the current low interest rate environment, the net interest margin pressure of commercial banks does not support large-scale cuts to interest rates,’ Sheng Songcheng said in an interview with Shanghai Securities Journal (“盛松成：宏观调控精准施策 护航经济高质量发展”).

“This viewpoint already has a considerable amount of common consensus on the market.”

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Fiscal policy seen as only short-term fix for China’s economy

Sheng Songcheng’s contention is that Beijing should make greater use of fiscal policy to enable the Chinese economy to maintain growth at a rate of roughly 5%.

He argues that China’s current macroeconomic system is intrinsically tilted towards the use of fiscal policy, with monetary policy designed to play a supporting role.

“In China’s macroeconomic adjustment system, fiscal policy plays the leading role and monetary policy is responsible for ‘the game of coordination,’” Sheng said.

Sheng further believes that fiscal policy is intrinsically better suited to the task of short-term economic stabilisation, given the immediacy of its impacts compared to monetary policy adjustments.

“Monetary policy - from implementation to transmission to impacts on the real economy, is often subject to a definite time delay,” Sheng said.

“Fiscal policy can directly intervene in economic activity, while monetary policy plays its role mainly through indirect measures.”

Sheng’s views are consistent with Beijing’s commitment to more expansionary fiscal policy made at the end of 2024, as well as its decision to raise the official deficit ratio to a China’s high of 4% in 2025 - a full percentage point above the 3% threshold long established as the deficit ceiling.

They’re also consistent with China’s current fixation on boosting domestic demand, with an especial focus on drumming up consumption.

One of Beijing’s chief proposals for raising domestic consumption is to step up fiscal transfer payments. This measure could kill two birds with one stone, by increasing economic growth in the short-term, while also adjusting the demand structure to give greater long-term play to consumption.

“At the current phase, fiscal transfer payments should be the leader and guide, rapidly stabilising the market for consumption,” Sheng said.

“In the short-term, targeted transfer payments can directly increase the cash flows of households - especially low and medium-income demographics - thus rapidly raising their propensity to consume.

“This has an immediate impact when it comes to boosting consumption. It’s also especially applicable to dealing with the pressure of short-term external shocks and inadequate domestic demand.”

Sheng believes that China will have ample room to make use of transfer payments as a means of boosting consumption moving ahead, given long-standing inequities in wealth distribution and shortfalls in welfare expenditures.

“Data indicates that in developed nations social welfare expenditures account for a share of between 10 to 20% of GDP,” he said.

“By comparison, China’s government expenditures on living standards are under 10%. There is still considerable room for increase.”

How China’s monetary policy supports fiscal policy

The question then arises of what the Chinese central bank should do, if interest rate cuts won’t shift the economy, and China’s macroeconomic system is characterised by the dominance of fiscal policy.

Sheng believes that instead of focusing on cuts to short-term interest rates like the US, the best thing is for the Chinese central bank to preoccupy itself with cuts to the required reserve ratio.

The reserve ratio determines the volume of money that commercial lenders are required to stow with the central bank, acting as a restraint upon their lending activities.

The higher the reserve ratio, the less lending the banks can undertake, as more of their funds are tied up in their central bank accounts.

Conversely, reductions to the reserve ratio serve to free up liquidity for the banks, giving them greater latitude to create credit and supply loans to the rest of economy.

“I have long held the view that reserve cuts are better than interest rate cuts,” Sheng said.

“This does not at all deny the necessity of interest rate cuts, but is a case of reserve ratio cuts better suiting our current national conditions.”

Reserve ratio cuts are seen as especially complementary to fiscal policy in China, because the commercial banks are the chief purchasers of the government bonds that fund spending by the state.

The Chinese central bank is forbidden by law from purchasing government bonds directly, putting the kibosh on the direct monetisation of public debt.

The main buyers of government bonds in the Chinese financial system, however, are still state-owned commercial banks.

Sheng cites data indicating that Chinese commercial banks currently hold around 68% of central government bonds, as well as 75% of local government bonds.

This means that the government wing of China’s financial sector remains responsible for the direct monetisation of government debt, via the state-owned banks placing them on their own balance sheets.

Cutting the reserve ratio would give them more room to take on these issues of public debt. by freeing up liquidity.

Unlike interest rate cuts, cuts to the reserve ratio still retain their potency as an instrument of Chinese monetary policy. Sheng estimates that every reduction of 0.5 percentage points injects the banking system with around one trillion yuan in long-term liquidity.

China also still has ample room for reductions to the required reserve ratio, unlike many advanced economies where the ratio has long sat at zero and adjustments have fallen into disuse as a policy tool.

While the reserve ratio for active deposits in the US stood at 0% by the start of the Covid pandemic, in China the average reserve ratio for depository financial institutions currently sits at 6.3%.

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Could zero interest rates save China’s housing market?

Sheng and his like-minded peers believe interest rates and bank profitability are currently too low for further cuts to be a viable path for Chinese monetary policy at present.

Zhang Bin argues, however, that more aggressive rate cuts from the central bank are the best solution for China’s economic challenges at present.

He goes as far as to argue that the Chinese central bank should consider slashing its policy rate to zero, given the positive experiences of advanced economies with the use of such radical measures.

In the CF40 research report entitled “Using Macroeconomic Policy to Spur Endogenous Drivers to Expand Domestic Demand (“以货币政策激发扩大内需的内生动力”), Zhang and co-authors Zhu He (朱鹤) and Zhao Manyi (招曼仪) contend that monetary policy is still “the most important matter of all” when it comes to supporting China’s economy in 2026.

“We should not believe that there is no further room for operation - even if the policy rate is approaching zero,” he writes. “There are still other tools we can use.

“The experiences of Japan, Europe and the US all clearly indicate that the space for policy action is ample.”

Zhang wants the Chinese central bank to make “even larger scale reductions” to the policy rate (the seven-day reverse repo rate which currently sits at 1.4%), as well as drive reductions to bank deposit rates and the benchmark loan prime rate (LPR).

In Zhang’s view, if the Chinese central bank had the gumption to reduce the policy rate close to zero, this would shift the profit metrics enough for both corporations and homebuyers to resume investment and purchasing activity.

He highlights the profound shift since 2021 - when China’s housing slump first commenced - in the cost of financing vis-a-vis corporate profits and home price gains.

From 2010 to 2021, the average net return on assets was 6.7% for China’s listed companies, while the yield on 10-year government bonds during this period (representing the risk-free cost of funds) was around 3.3%.

This meant there was a 3.4 percentage point positive spread between the two, making investment profitable for the vast majority of Chinese corporations.

The situation has shifted sharply since the start of China’s housing slump, however.

The 10-year government bond yield has fallen to around 2%, while the ROA for listed companies has simultaneously fallen to about 2%. This means that the ROA and financing costs are fundamentally the same, or under certain circumstances even negative.

“In this kind of environment, enterprises lack the impetus to expand investment,” Zhang observes in an opinion piece on the CF40 research report (“张斌：重建经济增长内生机制，还需依靠货币政策”).

Zhang says the central bank is in a position to use active monetary policy to remedy the issue, by firstly promising to raise inflation from to 1% at present to 2% within one to two years, as well make large-scale cuts to the policy rate to put downwards pressure on the cost of borrowing.

This could expand the spread between corporate ROA and ten-year bond yields to three percentage points, which would “markedly enliven the willingness of the private sector to invest.”

“At present, out of over 5000 listed companies, only around 20 - 25% of enterprises have the conditions to achieve an ROA that is three or more percentage points higher than financing costs, and thus have the willingness to invest,” Zhang writes.

“However, if the spread can expand to three percentage points, this would bring 35 - 40% of enterprises into the ‘investible’ zone, where the financial returns of investment would be assured.”

A similar logic applies to China’s housing market, where investor demand has crumbled as a result of home price gains sinking beneath financing costs.

“Prior to 2021, purchasing homes made more sense than renting for Chinese households,” Zhang writes.

“The reason for this was at the time the residential mortgage rate was 3 - 4%. During the same period nationwide housing prices were rising at 5 - 6% (and even higher in major cities).

“This meant that homebuyers not only could live in homes for free, but they could profit from asset value increases.

“By comparison, the rental return rate was in general only 1.5 - 2% (slightly higher in smaller cities).

“For this reason, the rational choice was to ‘buy if you can buy - just buy even if you don’t know where you’ll borrow the money.’”

After the housing slump that began in 2021, however, Zhang says this logic was flipped on its head. Home prices were no longer rising, the rental yield stood at around 2%, yet home mortgage rates remained at a lofty 3%.

Zhang says further adjustments to interest rates could upend this situation completely, reviving the housing market and helping Beijing to achieve its much vaunted goal of boosting domestic demand via wealth effects.

“If the rental yield and the mortgage rate are the same - such as 3% - then the cost of renting and buying is equal,” he writes.

“If the central bank reduces interest rates by one percentage point - from 3% to 2%, then this means that up until the point that housing prices rise 50%, buying a house will be more economically sound than renting a house.

“This provides huge room for home price increases.”

Fiscal policy in China destined to lose its effectiveness

Sheng is convinced that the short-term fix for China’s macroeconomic challenges lies in leaning more on the nation’s traditional dependence on fiscal policy, with monetary policy playing a supporting role,

Zhang Bin considers this policy arrangement to be largely unsustainable, however, as a result of the fundamentals of the Chinese economy continuing to shift.

“In the past, when China was confronted with inadequate demand, it would customarily lean on fiscal policy, and use public investment projects to drive aggregate demand,” he writes.

“While the results were pronounced, this model will need to undergo adjustment in future.

“Looking at things from a longer-term perspective, in future China’s counter-cyclical policy will need to lean more on monetary policy, and not fiscal policy.”

According to Zhang, the effectiveness of fiscal policy is fast declining, with most of the low-hanging fruit of infrastructure projects that promise longer term benefits now gone.

This has left fiscal policymakers with projects that only offer lower returns, and are also less likely to translate into rapid-fire spending.

“In the past, fiscal investment was made in bridges, roads and underground pipe systems, which would immediately drive demand and was also of benefit to long-term development” Zhang writes.

“Today, however, the conditions for large-scale short-term fiscal investment are far from what they were in the past.

“On the one hand, urban boundaries are expanding, and space for new construction on empty land is already very limited.

“Fiscal expenditures have already shifted towards urban upgrades and other adjustments to existing buildings and infrastructure stock.

“These projects are usually far more time-consuming, and it is difficult for them to rapidly create large-scale expenditures.

“Under such conditions, it’s very hard for fiscal policy to form large-scale support in the short-term the way it did in the past, to thoroughly turnaround insufficient demand.”

Zhang finally highlights concerns over the government debt incurred by fiscal spending, and the impacts that this can have on market sentiment.

“In the past, China’s debt levels were low and its deficits weren’t high,” he writes.

“Even if I personally believe that public debt problems are not a source of excess concern, there is definitely a considerable mood of anxiety on the market [about them].

Advances in monetary policy make it the inevitable choice

Zhang believes that monetary policy is destined to play a greater role in Chinese macroeconomic management, taking over the dominant position long enjoyed by fiscal policy.

As the potency of fiscal policy dwindles, Zhang sees the effectiveness of monetary policy rising in tandem with the expansion of the financial sector and the refinement of the central bank’s methods.

“Compared with Keynes’s time, the tools and understanding of monetary policy have undergone fundamental changes, benefiting from advances in the financial environment and the diversification of policy methods,” he writes.

“Following massive shifts in the financial environment, the scope and impact of monetary policy has markedly expanded.

“Households participate more widely in credit and capital markets, which means monetary policy not only affects the balance sheets of enterprises, but also deeply impacts the financial condition of households.

“It is precisely because of these changes that monetary policy can play an increasingly strong and prominent role.

“At present and in future, we will need to depend more on monetary policy to expand domestic demand.”

Zhang sees the key to effective monetary policy as lying in the ability of a central bank to shift expectations of future rates of inflation, via the credibility of its signalling as the economy’s supreme monetary authority.

“The central logic is the use of the central bank’s authoritative promise to influence the public in its future inflationary expectations, and enable everyone to expect future prices to rise, thus removing their deflationary mindset.

“This in turn spurs economic activity, by making “enterprises willing to invest and households willing to consume.”

In China’s specific case, Zhang advocates a simplification of the central bank’s monetary policy targets, in order to avoid causing the market undue confusion.

“We should concentrate on a single target, such as vigorously driving a recovery in inflation this year and sparing no measures to achieve this.

“Targets must be as clear and few as possible.”

China to follow the historic precedent of developed economies

In switching its focus from fiscal policy to monetary policy, Zhang argues China will simply be embarking upon a journey already undertaken by the world’s advanced economies.

Those nations needed to adjust their macroeconomic policy tools in the second half of the 20th century in response to shifting conditions, such as the maturation of their infrastructure assets and the rising sophistication of their financial systems.

“I believe that China is in a similar phase of transition,” he writes, pointing out that the macroeconomic conditions of mid-20th century developed economies closely resembled those in China until just recently.

“From the 1950s to the 1970s, the main tool for countercyclical adjustments in developed economies was fiscal policy, with monetary policy playing an ancillary role.

“This was because the economy was at the peak period of industrialisation, undergoing rapid growth and urbanisation.

“Counter-cyclical public investment undertaken by fiscal policy could stabilise current demand, while its construction projects (bridges and roads) could also prove useful over the long term.”

Zhang points out that because these projects resulted in high growth and thus stronger tax returns, governments did not suffer from major deficit or debt problems as a result of fiscal spending.

For the past four decades since the start of the 1980s, however, the main force for counter-cyclical policy in developed nations has become monetary policy. Fiscal policy has only risen to the fore on rare occasions, during major contingencies such as the Global Financial Crisis (GFC) and the Covid pandemic.

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Bernanke and Abenomics as models for China

Zhang points specifically to the actions of the central banks of the US and Japan as exemplifying the power of monetary policy as a wing of macroeconomic management, as well as worthy models of emulation for China.

According to Zhang, the central banks of these two nations made exceptional use of monetary policy during two key periods of recent economic history - Benjamin Bernanke’s time as head of the Federal Reserve during the GFC, and Shinzo Abe’s implementation of “Abenomics” during his second term as Japanese prime minister.

“The 2008 sub-prime crisis was a once-in-a-century financial crisis,” Zhang writes.

“The US household sector suffered severe damage to its balance sheet, consumption and investment sharply contracted, and demand hit extreme levels of insufficiency.

“Under Bernanke’s leadership, the US Fed implemented large scale interest rate reductions and implemented multiple rounds of QE, as well as coordinated with fiscal policy, successfully turning around market expectations.

“The path to recovery was an extremely typical textbook case. First was the mood of financial markets improving and share prices recovering.

“Enterprise profit expectations subsequently recovered, driving investment recovery, before household consumption, employment and housing markets all gradually warmed up.

“The economy steadily emerged from the crisis. This is a classic episode of dealing with an urgent case of deep-seated demand insufficiency.”

Zhang further argues that Shinzo Abe’s adept use of monetary policy enabled Japan to finally bring an end to decades of lost growth, by depreciating the yen and stimulating the domestic economy.

“Prior to 2013, Japan was in a state of long-term deflation,” he writes. “Deflationary expectations had taken deep root and structural problems were complex.

“The rest of the world believed that it would be difficult to reverse this. However, once Abe was elected and promoted Abenomics, the situation rapidly changed.

“That same year Japanese stocks rose 50% and housing prices ended their multi-year decline, with Tokyo home prices rising 3 - 5%.

“The unemployment rate rapidly fell from 4% prior to Abe taking office to 3%, then soon stabilised at around 2.5%.”

While Abenomics consisted of the “three arrows” of monetary policy, fiscal policy and structural reform, Zhang points out that Koichi Hamada - the economist who designed Abenomics, gave pride of place to the effectiveness of monetary policy in rescuing Japan from its doldrums.

Hamada gave second place to fiscal policy in terms of impact, while declaring that structural reforms were wholly ineffective.

Zhang points to these episodes as providing empirical support for China’s own expanded use of monetary policy in future.

“These two historical episodes I believe explain the effectiveness of monetary policy,” he writes.

The challenges and perils faced by China’s economy have changed tremendously in character over the past half-century period.

This is of course an inevitable byproduct of the vast transformation in China’s economic life, wrought by the dismantling of its Soviet-inspired command economy and the journey of reform and liberalisation launched by Deng Xiaoping in 1978.

A critical area of change has been on the monetary and inflationary front - the nature of the price movements that have such a profound impact upon consumption and investment decisions, as well as the stores of wealth amassed by households and businesses.

Throughout the formative years of the People’s Republic of China, a recurring adversary for its economic leadership would be torrid levels of inflation.

In the 1950s, the freshly victorious Communist Party first needed to grapple with the residual hyperinflation created by the Chinese Civil War, and the money printing used by the fleeing Nationalist government to fund its military expenditures.

Barry Naughton - one of redoubtable doyens of Chinese economic history, considers the quelling of this hyperinflation to be the key policy accomplishment of the first generation of Communist Party leaders.

This accomplishment was all the more impressive given that it coincided with huge fiscal outlays needed to support the war in the Korean Peninsula.

Inflation would once again emerge as the most vexing challenge for China’s economic decision-makers during the opening stages of the reform and opening era, throughout the 1980s and 90s.

While reform led to surging levels of economic growth, it also had the attendant effect of driving painful inflationary spikes, as China’s regional governments dialled up credit and monetary expansion to foster development.

China underwent three such bouts of inflation during the 1980s, the last of which culminated in the widespread public unrest and political turmoil that rocked the nation’s capital in 1989.

Each one of these inflationary episodes led to an abrupt, albeit temporary, retrenchment of China’s reform agenda.

They triggered a touchpaper reaction from China’s geriatric party conservatives - chief amongst them economics tsar Chen Yun, who harboured traumatic memories of the post-war hyperinflation of the 1950s.

Inflation remained an acute concern for China up until the eve of the Global Financial Crisis (GFC) in 2008. China’s consumer price index (CPI) posted a rise of 4.8% for 2007, prompting an initial tightening of macroeconomic policy by Beijing.

China’s leaders were of course forced by subsequent events to hastily backpedal, with Premier Wen Jiabao eventually launching a mammoth four trillion yuan stimulus package to deal with the economic fallout of the 2008 crisis.

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China’s post-Covid PPI struggles

Matters have changed profoundly since the GFC. Beijing’s long-standing struggle with the malignant djinn of inflation now appears to be well and truly the painful recollection of a bygone era.

China stands alone amongst the world’s major economies in averting a torrid episode of inflation in the wake of the Covid pandemic.

It’s instead weathered protracted deflationary pressure over the past several years - a phenomenon which points to supply chain shocks as the culprit for rapid price gains in other countries, as opposed to the fiscal and monetary loosening used by their governments to shore up their economic health.

China’s Producer Price Index (PPI) first began to slide in 2021, entering negative growth territory in year-on-year (YoY) terms in October of the following year.

This decline coincided with the peak period of the pandemic, when municipal lock-downs and restrictions on cross-border travel would be expected to undermine the demand that fuels price growth.

Chinese PPI has continued to languish, however, even following the curtailment of Covid-related movement restrictions.

As of the end of 2025, China had posted 39 consecutive months of negative YoY PPI growth, with the print for December coming in at -1.9%.

The mystery of China’s 15 years of deflation

Li Xunlei (李迅雷), chief economist at Zhongtai International, argues that Chinese deflationary pressure is far from just a post-Covid phenomenon.

He points out that China’s current problems with deflation extend for at least the past fifteen years, to the very start of Xi Jinping’s time in office as paramount leader.

According to Li, 2012 is the watershed year in China’s economic history when it comes to inflation.

He sees it as marking the divide between the long-standing struggle with inflation since the founding of the People’s Republic, and a protracted period of deflationary pressure coinciding with China’s emergence as the world’s preeminent manufacturing power during Xi’s term as president.

“This is far from the first time that China has seen sustained episodes of negative growth in PPI,” Li writes in the opinion piece “The Mystery of PPI’s Lost 15 Years” (李迅雷：PPI“失去十五年”之谜) published by Yicai.

“From March 2012 to August 2016 - during Xi Jinping’s honeymoon period as China’s paramount leader, PPI posted 54 consecutive months of negative YoY growth.

“Even during the height of the pandemic, China saw its producer prices decline, with negative YoY PPI growth from July 2019 to January 2021.”

As a consequence of these repeated bouts of deflation, Li conclude that “from 2012 until the present, China’s long-term PPI growth has been negative.”

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Chinese deflation defies Milton Friedman

The economist Milton Friedman is renowned for having opined that “inflation is always and everywhere a monetary phenomenon” - that it’s the inevitable product of too much money and credit chasing too few goods and services.

This is generally considered to be the culprit for Chinese inflation in the 1950s - with the outgoing Nationalist government having printed an excess money to fund the war, as well as in the 1980s - when China’s local governments extended a surfeit of credit via control of the state-owned banks.

China’s ongoing bout of deflation, however, would appear to defy Friedman’s signature dictum.

Li points out that China’s money supply growth has boomed over the past decade and a half, as Beijing has turned up the spigots of credit to oil the nation’s economic development.

In 2010, China’s GDP was less than 40 trillion yuan. By 2025, Chinese GDP had more than tripled in nominal terms to 140 trillion yuan.

From the end of 2010 to the end of 2015, China’s broad M2 money supply posted an even greater increase of 368%, expanding from 72.6 trillion yuan to 340 trillion yuan.

In spite of all this, China’s PPI index has failed to budge upwards over the same time period, let alone post a commensurate surge in growth.

Li consequently refers to the fifteen year period of PPI deflation in China as a “mystery that warrants unravelling.”

Supply-demand mismatches the real culprit

The cause of China’s protracted deflation would appear to lie in fateful changes to supply and demand relations. Over the past 15 years, the two have moved in contrary directions that would both serve to exacerbate deflationary pressures.

China has seen a dramatic expansion in supply during Xi’s time in office - as a result of its emergence as the world’s preeminent full-spectrum manufacturing power.

During this same period Chinese demand has confronted considerable headwinds, with exports hampered by trade tensions, and domestic consumption undermined by sub-par growth in household wealth levels.

“In analysing the fundamental reason that for the past 15 years PPI has been unable to rise, a single line summary would be that supply has been greater than demand,” Li writes.

Chinese economists identify a range of factors that have held back domestic demand and contributed to ongoing deflationary pressure.

These include a decline in government investment spending after Wen Jiabao’s GFC rescue package; easing growth in household incomes which have fallen beneath long-term rates of increase, as well as the high level of real interest rates - a factor which is both caused by and contributes to deflation.

Chief amongst the factors contributing to China’s weak demand would appear to be the property slump that kicked off towards the end of 2021, and its subsequent impact upon levels of household wealth.

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The baleful impact of China’s housing slump

Lian Ping (连平), director of the China Chief Economist Forum, has highlighted the role of the property market slump in undermining the wealth of Chinese households.

He points to these negative wealth effects as the key factor behind the weakness of domestic demand and the ensuing rise in deflationary pressure.

“A contraction in the prices of major assets means that the asset-based incomes of workers has been reduced,” Lian writes in the opinion piece “What we still need to do to suppress deflationary risk” (连平：抑制通缩风险还需要做些什么) published by the Chief Economist Forum.

“The decline in asset-based incomes of the private economy increases their aversion to various types of financial risk assets, as well as reduces large-scale expenditures on things such as luxury items, big-ticket commercial goods and housing.”

“For the household sector, real estate is the main area for their asset allocations,” Li Xunlei observes.

“During cycles of home price increases, their asset-based income rises, but during declines, their asset-based income is reduced.

“This is of no benefit to growth in household consumption.”

Li further points out that the property slump has had adverse impacts on demand in other spheres of the economy - chief amongst them fiscal expenditures.

The pivotal role of the property market in China’s economy means that a slump hits local government revenues and fiscal spending, in addition to having negative wealth effects on households.

This is because China’s local governments have long depended on land transfer revenues to fund their spending.

The Chinese fiscal system as a whole is characterised by an imbalance which sees the central government take a disproportionate share of tax revenue, while local governments bear a greater burden of expenditures.

“Real estate is closely related to local government fiscal revenues,” Li writes.

“From 2021 until the present, local government land transfer revenues have fallen by nearly 60%.

“The fall in local government land fiscal revenues will inevitably impact its spending capability, and thus have a negative impact upon the expansion of demand.”

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Boosting domestic demand viewed as the solution

Despite recent reports that Xi Jinping was oblivious to the negative impacts of deflation, China’s economic policymakers and experts are keenly aware of the need to stymie further downward pressure on prices.

“Historical experience has clearly proven that relative to gentle inflation, deflation brings with it even more dangerous potential risks for the economy,” Lian Ping writes.

“These include liquidity traps, severe contraction of enterprise balance sheets and systemic financial risk.

“The threat is extremely great, and warrants a high level of attention, as well as medium and long-term systemic and targeted counter strategies.”

If a supply-demand mismatch - as opposed to parsimonious money creation by the banking system - is the cause of China’s deflationary dilemma, then the solution would naturally lie in counter adjustments to supply-demand relations.

Beijing is very unlikely to significantly dial back on supply growth. In large part due to renewed Cold War tensions, Xi is relentlessly focused on the growth of China’s real economy - in particular high-end manufacturing - and expanding China’s ability to supply goods and services coveted by the poor and affluent alike.

As a consequence, Chinese economists view the fix for deflation as lying in measures to expand aggregate demand - in particular domestic demand, with an especial focus on household consumption.

This is one of the reasons that China’s top economic pundits have repeatedly avered that the greatest problem for the national economy is insufficient demand.

“In future, we still need to continue to launch expansionary policy measures, whose chief mission and goal will be the expansion of aggregate demand,” Lian writes.

Fortunately for Beijing, boosting domestic demand and consumption already lies at the centre of its economic policy ambitions - including the 15th Five Year Plan which is scheduled to run from 2026 to 2030.

This focus is in line with China’s strategic exigencies ever since the worsening of Sino-US relations during the inaugural terms of US presidents Trump and Biden.

Increasing China’s domestic demand will make its economy far less dependent upon export markets, which are subject to heightened uncertainty amidst worsening geopolitical tensions. A similar line of reasoning lies behind Beijing’s quest for “sovereign scientific and technological independence.”

The standard line amongst both China’s policymakers and economists is that growth in domestic demand requires a rise in household wealth - whether this be achieved by means of transfer payments, wage increases, or the wealth effects of buoyed asset markets.

“The key to expediting a gentle rise in price levels lies in adjustments to supply-demand relations - in particular the expansion of effective demand,” Li Xunlei writes.

“It’s recommended that the focus for the expansion of domestic demand (investment and consumption) be placed on increases to the incomes of low-income households and expediting consumption.

“It isn’t necessary to fixate on stabilisation of the manufacturing sector, because if manufacturing enterprises can achieve profits, then they will naturally expand investment.”

Given the central role that China’s multi-year property slump has had in restraining consumption, Beijing views support for both the housing market and other asset markets as a key means of driving consumer demand via wealth effects.

Lian Ping calls for “vigorous support for capital market development, to increase asset-based household incomes,” while Li Xunlei points out that “stabilising the housing market is also an effective means for spurring consumption.”

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Macroeconomic policy implications

Lian Ping wants macroeconomic policy to remain in expansionary territory for the foreseeable future, as part of China’s campaign to combat deflation by boosting demand.

As a consequence, he’s in favour of significantly stepping up debt-driven fiscal spending by the Chinese central government.

“In terms of active policy, the first recommendation for dealing with deflation is to increase fiscal expenditures and expand effective investment by the government,” he writes.

“Given that the funds of local governments for expanding investment expenditures are limited, I propose that the central government implement even more active [fiscal] policy, and continue to appropriately increase leverage.”

Lian has called for China’s deficit ratio to be held at around 4% - well above the long-standing threshold of 3%, as well as for an expansion in Beijing’s issuance of ultra-long-term treasury bonds to an average of at least two trillion yuan per year across a five year time period.

He also wants net local government debt financing to rise to at least 5% of national GDP.

The counterpart to increases in debt-driven fiscal spending will be cuts to taxes and government fees, in order to whet spending by households and businesses.

Lian recommends “increases in long-term discount policies, such as reductions to personal income tax rates.”

“For private businesses, in addition to general reductions to taxes and administrative fees, there should also be a reduction in needless regulatory pressure, in order to lighten the burden for market actors,” he writes.

Lian also wants the Chinese government to use its control of the state-owned financial sector to provide support to enterprises in struggling industries, in order to stymie spiralling price cuts.

“The main goal will be to reduce the deflationary impacts brought about by a contraction in the balance sheets of traditional sectors that are in decline,” he writes.

“[We should] provide greater financial support to those enterprises whose main operations are clear and whose business is stable…to reduce the likelihood of such enterprise further engaging in large-scale price cuts.”

Finally, “moderately loose monetary policy” will serve as the necessary complement to increases in fiscal expenditures and state-driven financial support for designated sectors.

In addition to maintaining “rationally ample” levels of liquidity to support expansionary fiscal spending, the goal will be to achieve reductions in real interest rate levels.

Lian views this as an especially critical task, given that deflation naturally raises borrowing costs by reducing the amount of money that businesses earn from their sales of goods and services.

“High real interest rates suppress consumption and investment, and have a negative impact upon economic growth and price levels,” Lian writes.

“[This] increases the cost of consumer spending by households and the expansion of investment by enterprises.

“Households and enterprises are then subject to marked slowdowns in credit growth, which suppresses the release of domestic demand.”

Much ado is being made right now about Xi Jinping’s ambitions to transform the renminbi into a global reserve currency, potentially ousting the US dollar from its hegemonic position in the world monetary system.

The source of this uptick in Western discussion of renminbi internationalisation is a recent Financial Times article entitled “Xi Jinping calls for China’s renminbi to attain global reserve currency status.”

That article, and others that followed swiftly in its wake, cited remarks made by Xi in an article published on 31 January by Qiushi - the Communist Party’s theoretical journal.

The article “Walking the Path of Financial Development with Chinese Characteristics and Establishing a Great Financial Nation” (“走好中国特色金融发展之路，建设金融强国”) is in turn based largely upon a speech delivered by Xi at a meeting of the Central Financial Work Conference in October 2023 - over two years prior.

Xi is quoted as saying that a “great financial power” must possess a “great currency that is widely used in international trade and investment and on forex markets, and possesses global reserve currency status.”

The source of the Qiushi piece firstly indicates that China’s plans for greater renminbi internationalisation have been brewing for quite some time, and do not mark an abrupt departure from course for Beijing.

The timing of its publication further indicates that China’s plans for renminbi internationalisation are now gathering greater impetus, no doubt due to Donald Trump policy decisions since the start of his second term in office as US president.

The Chinese Politburo’s proposal for the 15th Five Year Plan - the blueprint for China’s economic and social development from 2026 to 2030 - calls for “driving renminbi internationalisation, raising capital account opening and establishing a sovereign and controllable renminbi cross-border payments system.”

Further scrutiny of China’s economic discourse would indicate, however, that Beijing views renminbi internationalisation as a timely - and necessary - strategic response to US policy, as opposed to a play for global monetary dominance which would impose upon it needless burdens and costs.

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“Dollar weaponisation” as driver of renminbi internationalisation

A highly prevalent view within China is that this greater push for internationalisation of the renminbi is a natural and inevitable response to mounting tensions between Beijing and Washington ever since Trump’s first term in office.

Domestic pundits such as Lian Ping (连平), director of the China Chief Economist Forum, make frequent reference to the need to counter what they refer to as “weaponisation of the dollar” by Washington, as embodied by its demonstrable propensity to apply financial sanctions against Russia and Iran.

“Accelerating the internationalisation of the renminbi isn’t just an economic necessity - it’s even more a critical means for raising national financial security and strategic sovereignty,” Lian said during the keynote speech delivered at the 2025 Yicai FInancial Value Summit held in November last year.

Lian expects the period of the 15th Five Year Year Plan to provide especially propitious conditions for driving greater international usage of the renminbi, as part of Beijing’s efforts to shore up China’s strategic economic interests.

Chief amongst these conditions is what he believes to be declining confidence in the US as world leader, in the wake of Trump’s mercurial tariffs war, which has prompted major Western powers to make surprise overtures towards Beijing.

Xi Jinping’s push for capital markets to play a greater role in China’s financial system is another factor that will support renminbi internationalisation over the upcoming five years.

Beijing’s plan is for capital markets to give much needed support to the funding of innovative tech companies, while also creating wealth effects for retail investors which could help to boost domestic consumption.

Should capital controls be suitably relaxed, this plan will provide international investors with a broader smorgasbord of yuan-denominated assets, as well as convenient opportunities to profit from the rise of the Chinese tech sector.

Finally, Lian expects rapid expansion of trade relations with other nations - especially in ASEAN and Latin America, to continue, as China’s export sector seeks to compensate for potential roadblocks to trade with the US and EU.

This growth in multi-polar trade will provide far greater opportunity for renminbi settlement during cross-border transactions, as well as support use of the renminbi for the purchase of critical goods and commodities.

“The renminbi’s share in energy and mining deals is steadily rising - including for oil, natural gas and iron ore transactions,” Lian said.

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Renminbi internationalisation will spur the rise of Chinese finance

In addition to serving as a strategic necessity, top economists in China also see internationalisation of the renminbi as having positive impacts on the financial system - in particular the ongoing process of reform and opening.

Miao Yanliang (缪延亮), chief strategist with China International Capital Corporation (CICC) and formerly the chief economist of the State Administration of Foreign Exchange, views renminbi internationalisation as a powerful engine for driving the maturation of China’s financial sector and addressing its long-standing defects.

“The development and openness of China’s financial system is inadequate,” Miao wrote in a recent opinion piece entitled “Raising the Status of the Renminbi as Reserve Currency” (提升人民币储备货币地位) published by CICC.

In addition to spurring the development and openness of China’s financial sector, Miao expects renminbi internationalisation to drive improvements to credit and risk assessment systems, as well as mechanisms for dealing with bond defaults.

He sees renminbi internationalisation as having especially strong benefits for China’s debt markets on two key fronts.

Miao firstly expects it to push regulators to improve liquidity conditions on China’s bond market, by dealing with the issue of a lack of market makers.

“Because of the lack of market makers, if the market sees a large-scale withdrawal, it’s very easy for liquidity events to arise,” he writes.

Miao wants China’s bond market to gradually shift towards a mature two-tiered structure that segregates the market for dealers from the market for investors, while expanding the scope of participants in the market for treasury bond futures to augment liquidity conditions.

At a deeper level, Miao sees the participation of a greater number of foreign investors in China’s bond market as pushing Beijing to deal with embedded defects in the credit ratings system.

These include distorted incentives arising from China’s use of the same issuer-paid commission model that caused problems in the US prior to the Global Financial Crisis, as well as the presence of “implicit guarantees” and “soft budget constraints” for local government issuers, making it difficult for investors to apply a unified framework to the pricing of credit.

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Monetary hegemony is too burdensome for Beijing

Despite all the positive collateral benefits that China could derive from pushing for renminbi internationalisation, other top pundits caution against overstepping the mark and seeking outright monetary hegemony.

At the end of January Zhang Chun (张春), professor of finance at Shanghai Jiaotong University, issued a public warning against the perils of China pursuing global monetary dominance on its own.

“In the event that the US dollar rapidly declines, China should still not try to be number one, or seek monetary hegemony,” Zhang said in an interview with Guancha.

Zhang sees renminbi hegemony as having dire impacts upon China’s real economy that would outweigh the strategic advantages it confers.

“If China claims monetary hegemony, then it will immediately encounter the same problems as the US,” he said.

“The currency will be greatly overvalued, people will all buy up the renminbi, and as a consequence, the competitiveness of China’s export sector could disappear.

“It would be better for us to put the real economy first - as monetary hegemony definitely has negative impacts on the development of the real economy.”

Zhang instead advocates divvying up the burden of serving as global reserve currency with the US - an arrangement which would shore up China’s economic security without saddling it with needless disadvantages.

“In actuality, China could shift towards sharing the burden of costs between the renminbi and the US dollar,” he writes.

“Becoming the monetary hegemony or the chief international currency certainly has many great advantages, but it also requires bearing very great costs.

“If a nation bears these costs, it will eventually run into the problems that the US has.

“As a consequence, I do not believe that China should pursue the path of monetary hegemony.”

In this briefing:

• Why China’s deleveraging strategy is struggling, in the wake of a global debt-fuelled growth strategy, and what the Politburo plans to do instead.

• Why China’s state-owned assets are “an advantage unmatched by any other nation,” for supporting debt-fuelled expansionary fiscal policy.

• Beijing’s precondition for allowing the yuan to appreciate, and why Chinese economists believe Washington is to blame for its undervaluation.

• Why Chinese households are on track to diversify from property into stocks, as Xi Jinping seeks a greater role for capital markets, to advance tech sovereignty and achieve consumption-boosting wealth effects.

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Why China’s deleveraging strategy is struggling

Zhao Jian (赵建), chief economist at Atlantis Capital and former chief economist at Bank of Qingdao, says China’s current deleveraging strategy is ineffective, and instead only resulting in an increase in the national debt burden.

Zhao highlights the baneful impacts of the debt-fuelled economic growth model that has emerged in the wake of the Global Financial Crisis (GFC).

“In the decade or so since the subprime mortgage crisis, the driving force of the global economy has shifted from the asset side to the debt side, with the debt side merely serving to expand aggregate demand,” Zhao writes in the opinion piece “The Three Main Focal Points for Investment Over the Next Five Years” (赵建：未来五年的投资可聚焦三条主线) published by Sina.

“This has led to a global debt trap, which I refer to as a ‘debt disease.’

“Debt is a part of modern civilization, but also a disease of modern civilization. The evolution from civilization to disease is the period when debt-driven recessions arise.”

While nations around the world are working hard to scale back their debt burdens, Zhao sees a critical difference between the strategies employed by China versus other nations.

The US and Japan are pursuing what Zhao refers to as “inflation-driven deleveraging.”

This form of deleveraging allows debt to persist for longer, so that sustained gains in asset prices, yields and incomes can reduce its relative scale.

China, however, remains in the grip of deflationary pressure, thanks to the confluence of industrial oversupply and insufficient domestic demand

For this reason, Zhao sees China pursuing a “deflation-driven deleveraging” which seeks to scrupulously reduce absolute debt levels in order to avert crisis.

Zhao considers this a failed strategy, which has instead led to a rise in leverage ratios.

“On the one hand, old debt is being reduced, but on the other hand, this debt reduction has created greater pressure for the maintenance of growth,” he writes.

“This has forced the central government to increase debt-driven investment, thus leading to a rapid rise in the overall macro-leverage ratio.”

Zhao says Beijing has already taken pains to correct course, with the adoption of a new macroeconomic strategy over a year ago that focuses on boosting the asset side of the nation’s balance sheets.

“A series of landmark macroeconomic policy moves has driven a top-down revaluation of Chinese assets,” he writes.

“This shift can be seen as a move from a rigid debt-tightening mindset to a flexible asset expansion mindset.”

For Zhao, this is critical because he views the core driver of financial crises as being calamity on the asset side of balance sheets.

“What we commonly refer to as debt defaults and debt crises are essentially situations where assets deteriorate, and the returns on those assets are insufficient to repay principal and interest, plunging debtors into a Minsky moment,” he writes.

According to Zhao, the landmark Third Plenary Session held in July 2024 saw China’s policymakers “adopt a more open-minded, pragmatic, and proactive approach, initiating a shift in debt reduction policies and the overall macroeconomic policy package.”

A key meeting of the Politburo held on 24 September 2024 established a new monetary policy orientation that focused on stabilizing asset prices.

The Politburo also made an explicit call for “stabilisation of the housing and stock markets.”

In the wake of these top-level announcements, China’s fiscal policy saw the launch of ultra-long-term special treasury bonds, while monetary policy saw the introduction of outright reverse repurchase agreements, major reforms of open market operations, and innovations in the use of structured instruments that permit the targeted allocation of credit.

By 2025, China’s top policymakers made the announcement that ‘debt reduction should occur within development, and development should occur within debt reduction.’

Zhao expects the deleveraging process to be a priority mission for Beijing over the remainder of the decade.

“Over the next five years, we not only need to reforge the aggregate supply and demand curves and resolve the problem of inadequate comparative purchasing ability - we also need to restructure the national balance street.”

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China’s state-owned assets are “an advantage unmatched by any other nation”

In the same vein Xu Qiyuan (徐奇渊), a scholar from the World Economy and Politics Research Institute at the Chinese Academy of Social Sciences, highlights the critical role of the aggregated balance sheets of China’s state-owned enterprises (SOEs) in supporting Beijing’s plans for more debt-fuelled expansionary fiscal policy.

He sees the sheer scale of China’s SOE assets as compensating for the onerous debt burdens of local governments - long considered a major source of potential systemic risk for the financial sector.

“Although local government debt is heavy, the consolidated balance sheets of state-owned enterprises shows that their asset reserves and financial resources remain vast, creating an advantage unmatched by any other nation,” he writes in the opinion piece “The Three Angles for Looking at China’s Economy in 2026” (徐奇渊：展望2026年中国经济的三个角度) published by the China Macroeconomic Forum.

“As of the end of 2024, the total assets of state-owned enterprises (SOEs) exceeded 400 trillion yuan (USD$57.4 trillion) nationally, with total liabilities of 260 trillion yuan, resulting in a debt-to-asset ratio of approximately 65% ​ - a reasonable range for enterprises.

“From the perspective of state-owned assets, revitalizing existing assets holds enormous policy potential.”

Xu believes that the key challenge will be creating the liquidity conditions that can foster the “revitalisation” of this vast mass of SOE assets.

“Activating this huge stock of state-owned assets and creating synergies with policies is a crucial direction for exploring potential policy options in the future” he writes.

“Tools much discussed by the market - such as real estate investment trusts - face constraints from the tax system and management policies, while the yield on some projects (such as policy-based affordable housing) is relatively low.

“The solution lies in a multi-pronged approach, such as providing a suitable liquidity environment through monetary policy, improving asset ratings through credit enhancement measures, and raising project feasibility through tax reform.”

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Beijing’s precondition for allowing the yuan to appreciate

China’s exchange rate has risen to the fore of heated debate over the nation’s trading practices, particularly following the release of customs data indicating that it posted a record trade surplus of nearly US$1.189 trillion in 2025.

US economists such as Brad Setser and Michael Pettis have reiterated their long-standing calls for Beijing to permit appreciation of the yuan, in order to redress China’s mounting trade imbalance.

Chinese economists - such as Xu Qiyuan - also acknowledge an ineluctable trend towards appreciation of the yuan.

They stress, however, that Beijing shouldn’t permit an undue appreciation of the renminbi without first starting to solve its biggest macroeconomic challenge - inadequate domestic demand (in particular consumption).

“Any appreciation of the exchange rate should proceed in tandem with the expansion of domestic demand, and policies for the expansion of domestic demand should precede an appreciation of the exchange rate,” Xu writes.

“In terms of scope, [such policies] should also be greater than the appreciation of the exchange rate.

“If we only allow the renminbi to rise without other conditions changing, then this will exacerbate the pressure of supply being too great, and demand being too weak.

“Because appreciation will suppress exports and spur imports, it will lead to supply further increasing on the domestic market.

“Existing problems with supply-demand relations will thus become more pronounced.”

While outside observers say Beijing is undervaluing the renminbi, Xu argues that Washington is the real cause of China’s exchange rate challenges.

In his estimation, this is because tensions between China and the US put downward pressure on the yuan.

“The main reason for undervaluation is not economic factors, but geopolitical factors,” he writes.

“I regularly say to American friends that when Sino-US relations are poor, this will cause the renminbi exchange rate to be undervalued, and will lead to even greater exports.

“So for the renminbi exchange rate to change, things must start with improvements to Sino-US relations.”

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Why Chinese households are on track to diversify from property into stocks

Zhang Yu (张瑜) , a researcher from the Monetary Policy Institute of Renmin University in Beijing, expects Chinese households to rapidly diversify away from real estate into stocks and other financial assets in 2026.

The development arrives in response to a multi-year property slump since the peak of the Covid pandemic, which has negated the appeal of housing as China’s preferred investment opinion.

It’s also driven by the Xi government’s push for capital markets to play a greater role in the Chinese financial system, and for households to acquire greater exposure to equities via mutual funds, pension funds, as well as their own direct investments.

The plan is for a boom in the stock market to improve funding prospects for Chinese tech firms, while also creating wealth effects for everyday households which will make them more willing to spend, thus helping to resolve the dilemma of insufficient domestic demand.

“We expect that in 2026, financial assets will outperform residential property assets,” Zhang writes in an opinion piece entitled “Four Major Hedging Forces Are Strengthening - Comments on December Economic Data” (张瑜：四大对冲力量在增强——12月经济数据点评).

Zhang highlights a decline in the contribution of Chinese households to domestic demand ever since 2021 - when Beijing first engineered the start of the property slump via adjustments to credit allocation conditions.

“As a result of the reduction in new home purchases by households, as well as weak consumption propensity, the propensity of households to spend has continued to decline, from 101.4% in 2021 to 80% in 2025.”

This trend has forced policymakers to rely on fiscal spending and exports to compensate for inadequate domestic demand - which is currently viewed as China’s biggest macroeconomic challenge.

China has seen a decline in the effectiveness of its traditional monetary policy tools, just as Beijing steps up stimulus measures in response to ailing domestic demand and heightened geopolitical tensions.

Top domestic pundits impute the problem to a dynamic much akin to Japan’s balance sheet recession of the 1990s, alongside a deflationary environment that raises the real cost of borrowing above nominal costs.

They argue that Chinese households and enterprises are loathe to borrow and spend - irrespective of the cost of credit - due to the damage inflicted upon their asset holdings by a multi-year property slump.

Leading economists believe a solution lies in the state exercising precision control of credit distribution and interest rate cuts, via the Chinese central bank’s “structured monetary policy tools.”

The Chinese central bank has already unveiled a raft of bold adjustments to its structured monetary policy tools since the start of 2026, indicating that state credit guidance is set to play a more prominent role in the near-future.

The best cure for China’s sluggish credit growth, however, is expected to lie in Beijing’s plans to engineer a recovery in the stock and property markets, as the most expedient means of healing the nation’s hampered balance sheets.

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Why traditional monetary policy won’t work for China right now

Zhang Ming (张明), deputy-head of the Chinese Academy of Social Sciences Financial Research Institute, argues that the traditional time-and-tested means for central banks to boost economic activity - trimming short-term interest rates - will prove to be of limited effectiveness under China’s current conditions.

This is because China is still struggling with the fallout of a multi-year property slump, which has caused widespread damage to household balance sheets and undermined the confidence of businesses.

China’s economy now faces the same challenges that Japan did in the 1990s, when the Land of Rising Sun found itself in the grip of a protracted balance sheet recession.

“Monetary policy is more effective when the economy is flourishing, but it declines in effectiveness when economic growth is easing” Zhang writes in an opinion piece for Caijing entitled “How to raise the effectiveness of monetary policy” (“张明：如何提高货币政策效力？”)

“The effectiveness of monetary policy transmission is related to the condition of the balance sheets of micro-economic actors such as households and businesses.

“When the balance sheets of households and enterprises are healthy, then the transmission effects of monetary policy are usually higher, as households and enterprises find it easier to use leveraging to expand consumption and investment.

“However, if the balance sheets of households and enterprises are subject to pronounced damage due to a shock of some kind - such as a sizeable drop in property prices, then the transmission effects of expansionary monetary policy will markedly decline.

“This is because the number one mission of households and enterprises that have suffered damage is to restore their balance sheets…the preference for micro-economic actors is to reduce their debts.”

Zhang’s assertion would appear to be vindicated by the cratering of growth in Chinese bank loans last year.

In 2025, new bank loans posted their second straight year of decline, falling 1.83 trillion yuan - for a drop of -10%. This dragged China’s new bank loans down to 16.27 trillion yuan, for their lowest level since 2018.

While Beijing signalled large-scale monetary loosening at the end of 2024, last year the central bank implemented only a single reduction to its main policy rate - the seven-day reverse repo rate, with a cut of 10 basis points in May.

The move brought the seven-day reverse repo rate down to just 1.4%.

In addition to being left with little room to maneuver, domestic analysts believe the Chinese central bank may have held off on further rate cuts due to senior officials concurring with Zhang’s view - that households and businesses are too busy repairing their balance sheets to take out loans for investment or consumption.

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Deflation further undermines monetary policy

The challenges for monetary policy created by balance sheet damage are further compounded by China’s deflationary environment, which raises the real cost of credit for borrowers.

In 2025, China full-year CPI growth came in well below the target of 2% for the second consecutive year.

As of December 2025, year-on-year PPI growth had posted 39 consecutive months of negative prints, while as of the third quarter of 2025 China’s GDP deflator had seen its tenth consecutive quarter of negative performance.

This deflationary pressure means that real interest rates are higher than nominal interest rates, because borrowers need to pay back loans using money that requires the sale of more goods and services to acquire.

While deflation undermines the effectiveness of interest rate cuts, Zhang argues that it also makes them a more urgent necessity.

Reductions to nominal interest rates are needed, to ensure that the real cost of borrowing is kept low enough to preserve whatever demand for credit remains available.

For this reason, Zhang believes that the central bank has no choice but to further reduce its policy rate - already sitting at just 1.4% - to deal with the dilemma of deflation raising the real cost of borrowing.

“Under current conditions, rate cuts are of greater necessity than cuts to the required reserve ratio,” he writes.

“Because CPI is weak, the actual interest rate on loans is markedly higher than nominal interest rates.

“Reducing rates can spur reductions in real interest rates on loans, which will help drive demand for loans.”

Given the low level of the seven-day reverse repo rate, China nonetheless faces the possibility of monetary policy in the form of rate cuts further losing its ability to budge the economy.

“Downward adjustments could cause interest rates to hit the zero lower bound and encounter a liquidity trap,” Zhang writes.

“Even if the nominal interest rate is reduced to zero, households could continue to choose not to consume, and enterprises could continue to choose to continue to not invest.”

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Credit guidance viewed as the solution

While broad-stroke interest rate cuts are unlikely to prove a strong enough tonic for boosting economic activity in China at present, the central bank has recourse to other monetary policy tools that it hopes will do the trick.

Zhang points in particular to structured monetary policy as likely the best means for the Chinese central bank to boost the nation’s economic health.

Structured monetary policy has emerged as the signature innovation of the Chinese central bank in the post-Covid era.

It in essence involves the selective provision of credit at reduced interest rates to targeted sectors of the economy.

This process involves the Chinese central bank providing re-loans to commercial banks at discounted rates, for funding they channel to sectors of the economy prioritised by policymakers - chief amongst them tech innovation, green and low carbon development, as well as small private enterprise.

Zhang Ming refers to structured monetary policy as a form of “precision irrigation.”

“Monetary policy is originally a classic form of quantitative policy,” Zhang writes

“However, structured monetary policy is distinguished by its ability to both expand aggregate quantities and undertake structural adjustments.”

Sheng Songcheng (盛松成), the former head of the Chinese central bank’s statistical office, highlights the rising prominence of structured monetary policy as a form of innovative credit guidance since the Covid pandemic.

“Especially in the past several years, China’s structured monetary policy tools have seen continuous innovation, playing an increasingly important role, and serving as an effective means of driving high-quality economic development,” Sheng writes in an opinion piece for Yicai entitled “Structured interest rate reductions are more apt and precise” (“盛松成：结构性“降息”更为精准和适宜”)

“The implementation of structured monetary policy has certainly helped to raise the transmission efficiency of monetary policy, and can compel commercial banks to extend loan resources to areas targeted by policy.”

Sheng also draws parallels between the Chinese central bank’s use of structured monetary policy, and the US Federal Reserve’s adoption of innovative monetary policy expedients during the Covid pandemic.

“In terms of international experience, China is far from the only nation to make use of structured tools in its implementation of monetary policy,” he writes.

“When dealing with the shock of the Covid pandemic, the Federal Reserve, in addition to large-scale purchases of Treasuries to provide the market with liquidity, also included mortgage-backed securities in its asset purchase plan, to provide targeted support to the housing market, and put direct pressure on mortgage rates.

“This was a far more direct and effective means of influencing the housing market than simply reducing Treasury rates.”

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Central bank signals greater credit guidance in 2026

Zhang and Sheng’s praise for structured monetary policy tools arrives just as the Chinese central bank makes its first adjustments to settings for the instruments since the new year, in bid to get the economy off to a running start in 2026.

On 15 January, the Chinese central bank announced the launch of eight new monetary policy measures to support the economy, including a raft of adjustments to its structured tools.

The measures included:

1. A 0.25 percentage point reduction to the interest rate for various structured monetary policy tools, and a reduction in the one-year re-loan rate from 1.5% to 1.25%.

2. A 500 billion yuan increase in the quota for re-loans to support agriculture and small enterprise, as well as the establishment of a 1 trillion yuan re-loan quota for private businesses.

3. Raising the quota for science and tech innovation re-loans to 1.2 trillion yuan, with a focus on small and medium-sized private enterprises.

4. The integration of the private enterprise bond financing support instrument and the science and tech innovation bond risk sharing instrument, to provide a combined re-loan quota of 200 billion yuan.

5. Expanding the scope of carbon emissions reduction support tools; expanding the scope of eligible green projects, and guiding banks to provide support for China’s green transition.

6. Expanding the scope of support for re-loans in the areas of services consumption and aged care - including the fitness industry.

7. Reducing the initial down payment ratio for commercial housing loans to 30%, to assist the reduction of real estate inventories.

8. Encouraging financial institutions to improve their exchange rate hedging services and reduce enterprise risk.

“This is markedly different from just an interest rate cut in the classical sense,” Sheng Songcheng writes.

“[The measures] directly guide financial institutions to lower financing costs for key areas of the real economy.

“With regard to the policy support required by economic conditions at present, it’s far more targeted and apt.”

“They support key areas and weak linkages including scientific and technological innovation, green and low carbon development and the private economy.”

Chinese economic commentator Mo Kaiwei (莫开伟) writes that the eight monetary policy measures are “unprecedented” in nature.

“They indicate that the central bank’s earnest implementation of the call from the Central Economic Work Conference for the continuation of moderately loose monetary policy has already commenced,” Mo writes in an opinion piece published by Sina entitled “The role of the eight structured monetary policy tools unveiled by the central bank” (“莫开伟：央行推出八项结构性货币政策工具将产生哪些作用？”)

“They also indicate that the central bank - in accordance with the Party Central Committee and the State Council’s decisions, are expanding the intensity of counter-cyclical and cross-cyclical adjustments, to ensure that the 15th Five Year Plan (2026 - 2030) has a strong start.”

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The real solution to China’s monetary policy dilemma

Zhang Ming argues that for a truly sustainable restoration of the effectiveness of monetary policy, Chinese policymakers will need to engineer a recovery in asset prices - with an especial focus on the housing market.

This is because the precondition for the return of healthy borrowing levels will be the broad-based recovery of household balance sheets - a task which can best be achieved via a rebound in stock and property prices.

“If we want to raise the transmission efficiency of monetary policy, then we need to help micro-economic actors to stabilise and restore their balance sheets,” Zhang writes.

“This means enabling asset prices to stymie their declines and return to stability as soon as possible, or even stabilise and rebound.”

Beijing signalled that a recovery in asset markets would be a policy priority at the Central Economic Work Conference held at the end of 2024, when it highlighted the need to “stabilise property and stocks.”

Zhang has called for “raising the intensity of stabilisation of the housing market” moving ahead, with measures that could include expanding purchases of commercial housing by government authorities for conversion into social homes.

Other policies for boosting China’s housing market could include the cancellation of purchasing and lending restrictions in tier-1 cities,; actively dealing with the debt risk of systemically important property developers, as well as deepening reforms of the housing provident funds.

In addition to wealth effects, Zhang points out that a rebound in property prices will provide Chinese households with the high quality collateral they need to secure loans from commercial banks.

“The effectiveness of monetary policy transmission is related to the quality of the collateral for commercial banks,” he writes.

“Real estate has always been the most important form of collateral for China’s banking system.

“From this perspective, if we want to raise the effectiveness of monetary policy transition, the Chinese government will either need to adopt measures to enable the property market to recover as quickly as possible, or it should provide the commercial banking system with new supplementary forms of high-quality collateral.”

In the same vein, Zhang argues for Beijing to increase the issuance of Treasury bonds across different maturities, in order to expand the volume of high-quality collateral available to the banking system.

The move has the added advantages of already being needed to fund Beijing’s plans for more profligate fiscal spending.

It will also help the central bank to manage the yield curve, as well as drive internationalisation of the renminbi via the provision of a greater volume of secure assets for global investors.

The standard narrative is that post-Mao China saw a rapid rise in wealth on the back of market reforms that dramatically reduced the role of the state in the workings of the economy.

The 1980s and 1990s saw the gradual dismantling of the Soviet-style command economy, the swift introduction of markets powered by private enterprise, and the scaling back of party influence upon management decisions and resource allocation.

A top economist at China’s largest bank, however, has just mounted an argument for the superior efficacy of the Chinese system which runs significantly against the grain of this long-standing narrative.

Cheng Shi (程实) - chief economist at Industrial and Commercial Bank of China International, believes that the ability of the Chinese state to exercise the coordination of key economic resources - chief amongst them financial capital - will prove to be its biggest comparative advantage when it comes to AI development.

He expects high-level coordination by the central government, in tandem with fast evolving energy and human resources endowments, to give China sufficient impetus to pull ahead of the US when it comes to leadership of the global AI sector.

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Institutional advantages are the key to technological dominance

In a recent opinion piece entitled “China’s Comparative Advantages in the Era of Artificial Intelligence” (“人工智能时代的中国比较优势”), Cheng points to the crucial role that institutional features play in abetting the widespread adoption of new technologies.

“During the steam era, Britain’s advantages were derived from capital markets and its system of property rights,” he writes.

“In the era of electricity, the USA’s advantages came from its scientific research capabilities and corporate system.”

He expects the era of artificial intelligence to be no different, requiring its own set of unique institutional features to drive the profitable adoption of new innovations.

This will mean the development of a “highly organised innovation system,” whose chief features will include:

• Cross-sector resource coordination,

• The large-scale deployment of national computing infrastructure,

• The coordinated development of overlapping industrial chains, as well as

• Long-term financial support.

Cheng’s contention is that China’s unique brand of state capitalism is best equipped to rapidly assemble this suite of necessary institutional features.

“It’s China that possesses these system capabilities,” he writes.

“In a brief period of time, China is capable of deploying national computing networks, establishing clusters of large-scale data centres, driving reforms of the market for data as a factor of production, and forging cross-sector chain coordination systems.”

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Control of financial capital is critical

Cheng believes the control that the Chinese state wields over the financial sector - giving it the ability to channel credit to sectors of priority importance - to be one of its most important tools in the competition for AI preeminence.

“The quality and effectiveness of financing for AI development will to a great extent determine whether AI technologies can transition from ideal to reality,” he writes.

In Cheng’s estimation, the foresight and prudence of China’s policymakers can overcome the shortcomings of financial markets when it comes to long duration investments.

“What’s most important is that China’s financial system can provide the ‘patient capital’ that AI requires,” he writes.

“AI is a classic case of an investment-intensive, long time-cycle sector with strong externalities…it’s hard to come by enough capital for investment by relying on the market alone.

“[China’s] policy banks, industry funds, government guidance funds and the multi-tier capital market jointly comprise a financial system that can adapt to such needs.”

Cheng’s remarks arrive just as Beijing steps up financial policies to channel more funds to the tech sector, in order to achieve scientific and technological “sovereignty” and wean Chinese industry off dependence upon the R&D of other nations.

Beijing is pushing for capital market reforms that will see regulators provide more overt support to the Chinese stock market, with a view to improving the equity financing prospects of promising tech firms.

This will include driving more “medium and long-term funds” to invest in stocks, as well as the use of China’s sovereign investors to play the role of “stabilisation funds,” stymieing excess price volatility with share purchases made at the behest of regulators.

Beijing is also using window guidance to drive commercial banks to lend to tech companies, as part of China’s “Five Great Chapters” of financial policy - the first and foremost of which is financing for scientific and technological innovation.

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China’s new factor endowment advantages

Critics of Maoist era economic policies point out that China’s development strategy during the period was an extremely poor fit for its factor endowments.

From 1949 to 1978, China sought to follow the lead of the Soviet Union, focusing primarily on the development of heavy industry, while giving far less attention to the agricultural sector or the production of consumer goods.

This development strategy was highly capital intensive, yet did not require commensurate amounts of labour.

China’s factor endowments during the period were the opposite of those required by such a strategy, being characterised by a scarcity of capital, in tandem with a vast abundance of low cost labour.

Much has changed since the founding of the People’s Republic, however. Cheng opines that China’s current resource endowments give it another comparative advantage when it comes to the development of the AI sector specifically.

Clean energy

Cheng firstly highlights the critical role that abundant energy resources will play in the race for AI leadership.

“Whoever possesses a lower cost, more stable, and more scalable power system will have the stronger, underlying competitive advantage in AI,” he writes.

The high energy intensity of the AI sector is set to drive rapid growth in both data centre project and related power consumption moving ahead.

Cheng believes that China’s focus on the development of clean energy should put it in good stead when it comes powering the data centres that are indispensable to AI development.

“China holds a competitive advantage in the energy race for AI,” he writes.

“It possesses the world’s largest incremental capacity for renewable energy, an industrial chain system for converting energy into computing power, and the organizational capability to coordinate across regions and industries through state-level projects.”

China accounted for 61.2% (276.8 GW) of new global solar capacity and 69.4% (79.4 GW) of new global wind power capacity in 2024, according to figures from the International Renewable Energy Agency (IRENA).

This has translated into significant cost advantages, with China’s levelized cost of electricity (LCOE) for onshore wind power ($0.029/kWh) and for solar power ($0.033/kWh) both lower than the global average.

Beijing has also invested heavily in the transmission infrastructure needed to fully capitalise upon the country’s newly developed energy resources, with the development of UHV lines that connect climate rich regions in the west of China with hubs of demand on the eastern coast.

Cheng stresses the role of high-level coordination by the state in the development of these clean energy capabilities.

“This capability was not formed overnight, but rather is a structural advantage accumulated over the long-term, from power grid construction to energy structure adjustment, and from industrial policies to the project system.”

Human capital

Cheng points to China’s abundance of well-trained engineering talent as the other key resource that will power the rapid development of its AI sector.

He once again highlights the role of the state in the coordinated development of this critical factor endowment.

Top policymakers have driven the development of an engineering cohort with a focus on commercial applications, and the ability to fully capitalise upon the economic value of emerging technological innovations.

“Chinese engineers are highly integrated with the industrial chain, and possess a strong orientation towards applications as well as strong engineering capability,” Cheng writes.

“This enables technologies to be transformed into products more rapidly, incorporated into industries more rapidly, and validated and iterated into large-scale applications more rapidly.”

The scale of this talent pool is also considerable.

Figures from Georgetown University’s Center for Security and Emerging Technology indicates that by 2020 China had the world’s largest supply of engineers. It ranked first in terms of STEM graduates, exceeding the combined volume of the second and third-ranked nations.

Prominent Chinese economists expect the central bank to show further restraint on the monetary policy front in 2026, despite Beijing’s use of bold language to signal major loosening since the end of 2024.

They expect only modest cuts to both the policy interest rate and the required reserve ratio this year, as households and businesses remain reluctant to borrow and spend, and fiscal policy does most of the heavy lifting needed to keep China’s economy on a sound footing.

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Central bank holds key 2026 meeting

The Chinese central bank just held its inaugural work meeting for the year from 5 - 6 January, sending key signals as to the direction of monetary policy in 2026.

The meeting’s headline statement was that it would “continue the implementation of moderately loose monetary policy in 2026,” as part of Beijing’s broader macroeconomic stimulus drive.

The central bank also said that it would “maintain ample liquidity and relatively loose social financing conditions,” with a view to “guiding rational growth in aggregate financing.”

Beijing shifted its official monetary policy setting to “moderately loose” at the end of 2024.

The move was interpreted at the time as a sign of major loosening, given the phrase was last employed in the aftermath of the Global Financial Crisis, during Wen Jiabao’s implementation of a mammoth four trillion yuan stimulus plan.

In 2025, however, the Chinese central bank dialled back on interest rate and reserve ratio cuts, despite the treacherous waters created by Trump’s tariff war and worsening trade relations with the US.

Last year, the central bank implemented only a single reduction to its main policy rate - the seven-day reverse repo rate, with a cut of just 10 basis points in May.

This stands in contrast to two cuts applied to the policy rate in 2024, bringing it down by a total of 30 basis points.

The Chinese central bank was also highly restrained in its use of reductions to the required reserve ratio.

The reserve ratio refers to the volume of deposits that commercial lenders are required to stow with the central bank, constraining their ability to create new loans.

In 2025, the central bank reduced the required reserve ratio on just a single occasion, with a 50 basis point cut that coincided with the adjustment to the policy rate made in May

This reduction also fell short of the central bank’s loosening measures in 2024, which saw two cuts to the reserve ratio that collectively brought it down by 100 basis points.

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Interest rate restraint anticipated in 2026

In the wake of the central bank’s latest work meeting, leading Chinese economists now expect it to show further restraint on key aspects of monetary policy this year, at odds with the official stance of “moderate loosening.”

Wang Qing (王青), chief macro-economist at Golden Credit Rating, forecasts that the Chinese central bank will cut interest rates twice in 2026, bringing them down by 20 - 30 basis points.

Li Xunlei (李迅雷), chief economist at Zhongtai Securities, is even more conservative, expecting a reduction of just 10 - 20 basis points.

This means the Chinese central bank’s interest rate cuts in 2026 could fall short of the 30 basis point reduction in 2024 - before Beijing decided to make the bold move of shifting its official monetary policy setting to “moderately loose,” and prior to the start of Trump’s second term in office.

With regard to the required reserve ratio, Wang Qing expects the central bank to make at least one or two cuts, bringing it down by 50 - 100 basis points, while Li forecasts a full year reduction in the required reserve ratio of 25 - 50 basis points.

Once again, the central bank could also fall short of its loosening measures in 2024, when it reduced the required reserve ratio by 100 basis points.

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Why all the restraint?

China’s top policymakers and economists have long contended that the biggest challenge facing the national economy is insufficient domestic demand.

Many impute this issue to the damage to balance sheets caused by China’s property slump and the economic disruptions of the Covid pandemic.

The decline in home prices has made Chinese households and businesses more inclined to pay off their debts, as opposed to piling them higher.

As a consequence, unwarranted cuts to interest rates may do little to raise their propensity to borrow and spend. This was evidenced by ailing growth in renminbi lending towards the end of last year.

Rate cuts could also deprive the central bank of policy ammunition it may want ready at hand in future, should the challenges that beset the Chinese economy further intensify.

Copious fiscal spending is Beijing’s other macroeconomic option for keeping China’s economy afloat in the face of uncertainty.

In order to support such spending, the Chinese central bank stepped up liquidity injections last year, while simultaneously showing restraint on interest rates.

It achieved this via a range of other instruments that are part and parcel of its monetary policy toolkit, serving to complement adjustments to the policy rate and the reserve ratio.

The Chinese central bank made net injections of 591.6 billion yuan during the period from January to November last year, via open market operations that included the medium-term lending facility (MLF), the standing lending facility (SLF) and pledged supplementary lending (PSL).

This marked a stark reversal from net withdrawals of 3.09 trillion yuan for the same period in 2024.

Wang Qing expects such injections to continue in 2026, with the central bank making greater use of MLFs as well as outright reserve repos to inject medium-term liquidity, in tandem with open market purchases of Chinese treasuries to inject long-term liquidity.

“At present [the central bank] has a rich variety of quantitative policy tools, and is not constrained by the limitations on required reserve cuts,” he said to Securities Daily.

“This will maintain ample market liquidity, ensure that the government can issue bonds effectively, and guide financial institutions to expand the intensity of lending.

“This too is a key point of effort for strengthening counter-cyclical adjustments.”

2026 is set to be a critical period for the Chinese economy, as the inaugural year of the 15th Five Year Plan (FYP) that will guide Beijing’s policy decisions until the end of the decade.

Renowned economist Li Xunlei (李迅雷) expects Beijing to keep its GDP growth target at around 5%, in order to strike a positive note for China at the outset of the new FYP.

Li - who is chief economist at Zhongtai Securities - has made five bold predictions for China’s macroeconomic performance this year in light of these growth ambitions, including:

1. China’s broad deficit rising to 8.5% on the back of more expansionary fiscal spending.

2. A heavy focus on growth in domestic demand, including further subsidisation of consumption and the rebound of investment levels.

3. The ongoing growth of Chinese exports despite Trump’s tariff war.

4. The weakening of deflationary pressure as domestic demand improves.

5. The extension of China’s housing slump into a fifth year, prompting Beijing to take more concerted action to prop up the market.

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Fiscal deficit to expand as monetary policy remains constrained

Li sees China keeping its foot firmly on the pedal of expansive fiscal policy in 2026,

The 2025 Central Economic Work Conference held in December called for “maintaining the fiscal deficit, overall debt scope and total expenditures as is necessary” in 2026.

As a consequence, Li is “quite optimistic about the broad fiscal deficit” this year.

Chinese economists draw a sharp distinction between narrow and broad fiscal deficits.

The narrow fiscal deficit excludes debt incurred via the issuance of special purpose bonds and other government bonds, that are used to fund projects which are officially deemed to be sources of fiscal revenue.

Li expects the “narrow” deficit ratio to hold steady at 4% this year - after Beijing lifted it above the 3% threshold for the first time on record in 2025.

He further expects the new special purpose bond quota to increase from 4.4 trillion yuan to 4.8 trillion yuan, and ultra-long-term treasuries to remain at least on par with 2025 at 1.8 trillion yuan.

As a consequence, he expects China’s broad fiscal deficit to rise from 11.86 trillion yuan in 2025 to around 12.45 trillion yuan in 2026.

This will cause China’s broad fiscal deficit ratio to lift from 8.4% to 8.5%.

Li expects the Chinese central bank to remain far more conservative when it comes to monetary policy, however.

He forecasts a full year reduction in the required reserve ratio of 25 - 50 basis points, while the seven-day reverse repo rate (the Chinese central bank’s main policy rate) is on track to fall by only 10 - 20 basis points.

He also forecasts a slowdown in Chinese credit growth as a consequence.

Year-on-year growth in aggregate social financing (a broad measure of credit creation across the Chinese economy) is expected to slow from 8.4%in 2025 to 8.0% in 2026, and growth in the M2 money supply to drop from 7.8% to 7.1%.

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Beijing fixated on growth in domestic demand

China’s top policymakers consider “inadequate” domestic demand to be the nation’s chief macroeconomic challenge.

As a consequence, expansive fiscal policy in 2026 will focus heavily on addressing this issue, with an especial emphasis on growth in consumption.

The Central Economic Work Conference held in December made “upholding the leading role of domestic demand and establishing a great domestic market” the to priority missions for 2026.

“Expanding domestic demand will be a key path for achieving a GDP growth target of around 5% in 2026,” Li writes.

He expects Beijing to continue to implement its “cash-for-clunkers” (以旧换新) policy to subsidise consumption of durable goods such as EVs and household appliances, given the successes it’s achieved since its introduction in 2024.

Beijing is set to maintain or increase the volume of funding for the subsidy scheme via the issuance of ultra-long-term treasury bonds, which provided 300 billion yuan in support for cash-for-clunkers in 2025.

Li believes the Chinese government could expand the scheme to include food and beverages, tourism and other forms of services consumption.

Beijing could also provide cash subsidies to support family formation and child care, as well as disadvantaged demographic groups.

On the investment front, Li forecasts that infrastructure spending will see YoY growth bounce back to 8% in 2026, from -1% in 2025.

The focus of infrastructure spending will be key projects under the 15th Five Year Plan, including hydraulic, energy transition and grid development projects.

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Export growth set to continue

While Beijing strives to boost domestic demand, Li also expects China’s exports to continue to grow, on the back of the cost advantages enjoyed by its manufacturing sector.

China posted a surprisingly strong export performance in 2025, despite the Liberation Day tariff war launched by Washington at the start of April.

Real YoY growth in Chinese exports for the period from January to November came in at 9.0%, thanks in part to transfer exports and surprise improvements to global trade conditions.

Li forecasts that Chinese exports will “remain resilient” in 2026, posting YoY growth of 3.4% in US-dollar denominated terms.

“Even if global trade growth eases, due to cost advantages, China’s share of export orders is expected to further increase,” Li writes.

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Deflationary pressure on track to wane

China remains distinct amongst the world’s major economies in its struggle with deflationary pressure, just as central banks in other parts of the world remain cautious about rate cuts due to persistent inflation.

Li expects this deflationary pressure to ease moderately in 2026, as China sees “marked improvements” to supply-demand imbalances, thanks to the aforementioned fiscal spending drive.

He expects China’s PPI and CPI to see rebounds in YoY growth terms, with PPI growth rising from -2.6% in 2025 to -1.2% in 2026, and CPI growth to rise from 0.0% to 0.5%.

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China’s property slump set to persist

Chinese pundits have long imputed weak domestic demand to the balance sheet damage caused by the slump in property prices, making households and businesses far less willing to spend.

Li refers to China’s ongoing property slump as a “direct drag” on economic growth that will continue into 2026.

He expects it to moderate significantly, however, with top policymakers introducing fresh measures to stymie further declines.

Li sees real estate investment in China posting a year-on-year decline of -11% - as compared to a drop of -16% in 2025 - to still leave a major dent in economic output.

He also forecasts a 5% YoY decline in commercial housing sales in terms of floorspace.

In order to address these issues, Li anticipates robust policy measures from Beijing, in order to “prevent the weakness in real estate from spreading to other areas of the economy.”

After previously signalling the possibility of staging its biggest monetary stimulus since the Global Financial Crisis, China’s central bank decided to hold off on exorbitant cuts to interest rates in 2025.

Chinese businesses and households have proven reluctant to take out loans despite a downward trend in borrowing costs, as their balance sheets continue to recover from the lingering impacts of the Covid pandemic and a multi-year property slump.

Despite the absence of major reductions to its official interest rate, the Chinese central bank has nonetheless stepped up injections of liquidity into the financial system this year, in order to coordinate with Beijing’s debt-fuelled fiscal stimulus plans.

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Chinese central bank holds back on rate cuts

Beijing made the landmark announcement that it would “implement moderately loose monetary policy” (实施适度宽松的货币政策) at the Central Economic Work Conference held in December 2024 - an event that serves as a key platform for the unveiling of policy plans for the upcoming year.

In spite of its ostensibly restrained phrasing, the statement was viewed as a signal that the Chinese central bank would dramatically loosen monetary policy in 2025.

This is because the last time that Beijing trotted out the phrase “moderately loose monetary policy” was 14 years prior, when the Chinese central government was busy implementing its four trillion yuan stimulus plan to deal with the fallout of the Global Financial Crisis (GFC).

The announcement by the Central Economic Work Conference triggered a rush for Chinese treasury bonds at the end of last year, with the 10-year yield dropping 88 basis points in 2024, for its largest annual decline in a decade.

Since the start of 2025, however, the Chinese central bank has remained highly restrained in its monetary policy adjustments, despite the turmoil created by Trump’s tariff wars, as well as the economy’s ongoing struggle with ailing domestic demand.

This year the central bank has only implemented a single reduction to its main policy rate - the seven-day reverse repo rate, with a cut of just 10 basis points in May.

This stands in contrast to two cuts applied to the policy rate in 2024, bringing it down by a total of 30 basis points.

The Chinese central bank has also been restrained in its use of reductions to the required reserve ratio. The reserve ratio refers to the volume of deposits that commercial lenders are required to stow with the central bank, constraining their ability to create new loans.

In 2025, the central bank reduced the required reserve ratio on just a single occasion, with a 50 basis point cut that coincided with the adjustment to the policy rate made in May

This reduction also fell short of loosening measures in 2024, which saw two cuts to the reserve ratio that collectively brought it down by 100 basis points.

In the wake of this restraint from the central bank, the yield on 10-year Chinese Treasury bonds rose by 16 basis points in 2025, instead of falling as would customarily be the case during an episode of significant monetary loosening.

Guan Tao, chief economist from Bank of China’s investment banking wing, points out that the rise in yields was also likely due to “the rush to buy [Treasuries] at the end of last year exhausting the benefits of monetary easing.”

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Chinese households and businesses still loathe to borrow

It’s very likely that the Chinese central bank held off on further interest rate cuts due to concerns that such measures would fail to boost economic activity and end up being the macroeconomic equivalent of “pushing on a string,” as Keynes phrased it.

This is because Chinese households and businesses are still suffering from the lingering impacts of both the Covid pandemic and a protracted slump in the property sector, causing widespread injury to balance sheets.

These impacts have prompted domestic pundits and policymakers to point to inadequate domestic demand as the biggest challenge currently faced by the Chinese economy.

As a consequence, market actors may still prove reluctant to borrow and spend - irrespective of how much the cost and availability of credit improves.

The latest raft of data from the Chinese central bank would appear to vindicate this perspective.

In November, renminbi loans increased by 390 billion yuan, for a contraction of 188.3 billion yuan compared to the same period last year, as well as the fifth consecutive month that new loans have fallen short of the previous corresponding period.

Medium and long-term loans to enterprises increased by 170 billion yuan, 40 billion yuan less than the print for the same period in 2024.

Central bank data further indicates that household loans fell 206.3 billion yuan in November, for their second consecutive month of decline.

This tepid level of lending arrived despite the fact that Chinese regulators have used administrative measures to reduce the real cost of borrowing beyond the central bank’s cuts to the policy rate.

As of September this year, interest rates for new corporate loans and personal home loans have fallen by around 40 and 25 basis points respectively in year-on-year terms - far greater than the decline in the seven-day reverse repo rate.

As a consequence, Beijing has leaned more heavily on fiscal instead of monetary policy measures to keep GDP growth steady in 2025, with the objecttive of hitting the full year target of a 5% increase.

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Central bank injects liquidity to complement fiscal spending

The Chinese central bank has no doubt exercised restraint in the use of two of its main monetary policy tools - adjustments to interest rates and adjustments to the required reserve ratio, relative to the expectations created by last year’s Central Economic Work Conference.

It has, however, stepped up liquidity injections via a range of other instruments that are part and parcel of China’s monetary policy toolkit.

The Chinese central bank made net injections of 591.6 billion yuan during the period from January to November, via open market operations tools including the medium-term lending facility (MLF), the standing lending facility (SLF) and pledged supplementary lending (PSL).

Guan Tao point out that this marks a stark reversal from net withdrawals of 3.09 trillion yuan for the same period last year.

As of the end of November, China’s broad M2 money supply had risen 8.0% year-on-year terms, for an acceleration of 0.9 percentage points compared to the same period last year.

Despite lacklustre loan growth, aggregate social financing (a broad measure of credit extension across the Chinese economy) had increased 8.5% in year-on-year terms, for an acceleration of 0.7 percentage points.

The liquidity injection and monetary expansion coordinated with an expansion in debt-fuelled fiscal spending, designed to compensate for ailing demand from households and private businesses, as well as the trade tensions casting a cloud over exports.

In March, China set its official deficit ratio at a record high of 4% of GDP - one percentage point higher than the year previously. The decision marked the first time that Beijing has opted to lift China’s deficit ratio beyond the Maastricht Treaty threshold of 3%.

In 2025, Beijing increased its issuance of ultra-long-term treasury bonds to 1.3 trillion yuan, from 1 trillion yuan in 2024, while local government bond issues surpassed the 10 trillion yuan (US$1.41 trillion) threshold for the first time on record.

This rise in debt-fuelled fiscal spending has made government bonds a main pillar of credit growth in China in 2025, with corporate bond issues also playing an increasingly important role.

“Government bonds are still the core support for growth in social financing,” said Yang Chang (杨畅), chief analysts at the policy unit of Zhongtai Securities, to China Business Herald.

“Ultra-long-term treasury bonds and special purpose government bonds have effectively driven the expansion in social credit.”

As Trump’s tariff war fails to make a significant dent in the export powerhouse of the Chinese industrial machine, Western economists have stepped up their calls for Beijing to revalue the renminbi.

Economists such as Brad Setser have long asserted that the renminbi is massively undervalued, leading to huge trade imbalances and China’s accumulation of a massive current account surplus.

Leading economists within China have also joined the chorus of calls from abroad advocating for appreciation of the nation’s official currency.

Lian Ping (连平) - director of the China Chief Economists Forum, wants the Chinese central bank to implement a strategic appreciation of the renminbi appreciation during the course of the 15th Five Year Plan, set to run from 2026 to 2030.

“During the 15th Five Year Plan, we should allow the renminbi to appreciate against the US dollar in a moderate and orderly manner, driven by supply and demand on the market,” Lian writes in a recent opinion piece, “A Strategy of Renminbi Appreciation Should Be Implemented During the 15th Five Year Plan” (“连平：“十五五”时期应实施人民币升值战略”).

“This will be of the utmost importance for medium and long-term strategies including the expansion of wealth, invigorating consumption, scientific and technological innovation and the internationalisation of the renminbi.”

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Is the renminbi undervalued?

In 2005, China made the momentous decision to remove the renminbi’s peg to the US dollar, permitting its value to fluctuate within a narrow band as part of a longer-term transition towards full free market floating.

Ten years later, however, the Chinese central bank shocked international markets by announcing a succession of three devaluations starting on 11 August 2015 that would eventually shave the renminbi’s value by 3%.

Lian says the move marked the start of a decade of steady depreciation that would cumulatively reach 15% by the start of the first half of 2025.

He argues that this depreciation trend runs contrary to the rapid shift in the economic fundamentals of both China and the US over the past ten years - particularly given the concurrent increase in the scale of China’s economy and the quality and scope of its output of goods and services.

“During this period, China’s economic growth was markedly higher than that of the US, and the current account ran up multiple consecutive years of very high surpluses,” he writes.

“Balance of payments fundamentals were stable, and foreign reserves were ample.

“In comparison, the US current accounts deficit further expanded, its fiscal deficit has continually expanded, and government debt has repeatedly tapped new highs.

“We can see that during this time, the depreciation trend of the renminbi has not at all been a reflection of economic fundamentals, but instead an excessive reaction to short-term market sentiment and one-sided expectations compounded by external shocks.”

Lian further points to the stark divergence in inflationary trends between China and the US since Covid as evidence that the renminbi is at present undervalued.

The US - like many other OECD nations - needed to hike interest rates shortly following the onset of the Covid to deal with a painful spike in inflation, which pundits blamed on either supply chain shocks or copious fiscal spending designed to keep the economy afloat through the worst of the pandemic.

China - by sharp contrast - faced no such inflationary dilemma. It instead now finds itself grappling with deflationary pressure, which many impute to the shortfall in domestic demand created by its property slump.

This diverging inflationary trend has led to an increasing shift in the purchasing power of the two nations’ currencies.

“From the perspective of purchasing power, the exchange rate fluctuations between the currencies of two different nations should largely offset the differences in their inflation rates,” Lian writes.

“Following the pandemic, the price of US goods has risen considerably, while prices for goods in China have been relatively stable.

“This, in turn, proves that the renminbi is undervalued, and thus possesses intrinsic appreciation pressure relative to the US dollar.”

Lian cites research indicating that the renminbi was likely undervalued relative to the US dollar by anywhere from 6 - 15% during the period from 2022 - 2024.

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Renminbi appreciation pressure set to further accrue

Lian sees pressure for the renminbi to appreciate against the US dollar continuing to rise in future, as China’s economic growth outpaces the US, Chinese household wealth further expands and rates of inflation further diverge.

He expects China’s pursuit of tech-driven industrial dominance as the key support for appreciation of the renminbi, by increasing demand for the Chinese currency abroad and piling the nation’s current account surplus even higher.

“The ongoing current account surplus will form a support for appreciation of the renminbi via supply and demand on forex markets,” Lian writes.

“China possesses the most complete industrial system in the world, the quality of its labour force continues to improve, while industrial robots and other forms of smart automation are spreading with increased speed.

“Over the next five years, the development of new quality forces of production will drive growth in the export of high-end manufactures, thus further supporting renminbi appreciation via market supply and demand relations.”

Lian also expects the problems of the US economy as supporting the appreciation of the renminbi, by putting downwards pressure on the dollar and undermining its incumbent hegemonic position

He points firstly to the adverse impact of the Trump administration on the credibility of the US as a responsible economic power - highlighting the president’s efforts to pressure the US Federal Reserve to reduce interest rates, thus compromising its integrity as an independent central bank.

The Liberation Day tariffs have also weakened the US dollar’s status as a dependable medium of settlement and exchange for the international community. This has exacerbated concerns created by Washington’s prior use of financial sanctions against geopolitical adversaries - an expedient that Chinese pundits are wont to refer to as “weaponisation of the dollar.”

Lian further points to the ongoing expansion of US federal government debt - which breached a historic high of US$38 trillion in October of this year, as “markedly weakening US dollar forecasts.”

The upshot of all these challenges could be “global de-dollarisation” and the emergence of a multi-polar international monetary system, giving greater play and support to peer currencies such as the renminbi.

“De-dollarisation has evolved into a trend of coordination across multiple sectors, currencies and systems, which will further weaken US dollar hegemony and strengthen pressure on the US dollar to depreciate,” Lian writes.

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The benefits for China of a rising renminbi

Lian sees the appreciation of the renminbi as having benefits for the Chinese economy across four key areas:

1. Achieving China’s goal of becoming a developed economy by 2035

2. Transforming China into the world’s leading market for consumption and imports.

3. Accelerating China’s scientific and technological innovation.

4. Driving the internationalisation of the renminbi.

China intent on developed economy status by 2025

Beijing has set the goal of China becoming a “mid-tier developed nation” in terms of per-capita GDP by 2035.

This requires per capita GDP to reach at least US$20,000, which in turn entails achieving average per annum growth of between 4 - 5% for the next decade, given China’s per capita GDP stood at US$13,445 in 2024.

The Chinese central government has recently stressed the role of rising asset prices in raising average levels of affluence in China, as part of efforts to step up domestic consumption via “wealth effects.”

Lian argues that appreciation of the renminbi will also enable China to leverage such wealth effects to achieve its 2035 goal of achieving developed nation status, by enhancing the ability of everyday Chinese to invest in global markets.

“If the renminbi moderately appreciates, then the overseas investments and global asset allocation ability [of Chinese households] will markedly increase,” he writes.

“Improvements to asset-based income will drive improvements to living standards, as well as further optimisation of the scale and structure of their wealth.”

China as world’s largest consumer market

Lian says there is still a 10 - 30 percentage point gap between Chinese household consumption as a share of GDP compared to developed economies, with services consumption at especially low levels.

Since the Covid pandemic, China’s domestic consumption growth has further weakened, with many imputing the issue to balance sheet damage caused by the housing slump.

In 2021, China had become the world’s second largest consumer market, with domestic consumption of US$6.83 trillion - equal to 92.12% of US consumption, which stood at US$7.41 trillion that year.

By 2024, however, China’s consumption had only lifted to US$6.85 trillion - by that 80.18% of US consumption at US$8.54 trillion for the same year.

Lian sees appreciation of the renminbi as one of the solutions to boosting consumption and thus expanding China’s weak domestic demand - considered by policymakers to be one of the biggest challenges currency facing the economy,

“A moderate appreciation of the renminbi can be a key lever for unleashing the enormous consumption potential of China’s massive population of 1.4 billion,” he writes.

“[It] will lead to increased purchasing power and optimized consumption patterns, propelling China’s consumer market to continuously approach and ultimately surpass that of the US.”

This will also burnish China’s lustre as an market for imports, helping to reduce the mounting trade imbalances that are one of the most celebrated causes of complaint for overseas critics of Beijing’s economic policies.

“Allowing the renminbi to moderately appreciate will enable China to more rapidly rise to become the world’s largest import market, helping to deal with the problem of excessively large trade surpluses, and easing up international economic relations,” Lian writes.

Accelerating China’s tech ascendance

Lian argues that appreciation of the renminbi can serve as a “strategic lever” for driving China’s scientific and technological innovation.

It will firstly reduce the cost of hi-tech imports in areas where China is still highly dependent on foreign products - including semi-conductors, jet engines and high-end research reagents.

These costs remain considerable, given that in 2024 China’s imports of hi-tech products accounted for around 30% of its total imports.

“A moderate appreciation of the renminbi will considerably reduce the prices of imported technology and equipment,” Lian writes.

Lian further points out that the appreciation of the renminbi will raise the relative value of domestic financial assets, making foreign capital more inclined to flow into the Chinese market to help drive the growth of domestic tech enterprises.

Internationalisation of the renminbi

A final strategic goal for Beijing that renminbi appreciation can advance is the internationalisation of the renminbi.

The 15th Five Year Plan is set to see China “drive renminbi internationalisation, raise the openness of the capital account, and establish a sovereign and controllable renminbi cross-border payments and settlement system.”

Lian contends that in order for the renminbi to become a credible competitor to the US dollar and the euro, it’s critical for it to undergo appreciation in order shore up its status as a store of value - one of the three key functions of any monetary medium, alongside serving as a medium of exchange and a unit of account.

“Any money which suffers from long-term weakness cannot possibly become an international currency that is widely accepted by the global community,” he writes.

“In the near-future, moderate appreciation of the renminbi will continue to drive its internationalisation.”

Xi Jinping convened the all-important end-of-year economic work meeting of the Communist Party’s Politburo on 8 December.

The event serves to send critical signals on the direction of China’s fiscal and monetary policy in 2026.

Domestic economists now expect a dramatic increase in Chinese government debt to drive growth in fiscal spending next year.

This will be complemented on the monetary policy front by multiple cuts to both interest rates and the required reserve ratio.

“[We] will continue to implement even more active fiscal policy and moderately loose monetary policy,” the Politburo said in an official statement.

“[We] will expand the intensity of counter-cyclical and cross-cyclical adjustments, and pragmatically increase the effectiveness of macro-economic regulation.”

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Fiscal policy in 2026

This year’s economic work meeting continued to stress the need for “even more active fiscal policy” to safeguard China’s economic growth, amidst the choppy waters created by ongoing Cold War tensions between Beijing and Washington.

Beijing remains highly concerned about two economic challenges in particular.

The first is the long-standing problem of inadequate domestic demand in the wake of China’s property slump - an issue viewed by policymakers as arguably the greatest dilemma facing the national economy.

The second is the impact of external growth threats resulting from the trade dispute with the US, and potentially other nations that have run up mounting current account deficits with China, by purchasing more goods than they sell to the Chinese market.

Beijing consider expansionary fiscal spending to be the best short-term solution for both of these economic challenges.

Chinese economists see it pickup up the slack of any fall in exports resulting from the protectionist measures of other countries, while Beijing also hopes that the right policy design will drive growth in household consumption.

As a consequence, domestic analysts anticipate a sharp increase in Chinese government debt next year, with an expansion in the issuance of ultra-long-term special government bonds by the central government, as well as special purpose bonds by local governments.

Zhang Aoping (张奥平) - a special economic advisor to Tsinghua University and state-owned media, expects total bond issues by the Chinese government to hit at least seven trillion yuan (approx. US$1 trillion) next year.

He firstly expects the issuance of ultra-long-term special bonds by the Chinese central government to increase from 1.3 trillion yuan this year to around 2 trillion yuan in 2026.

This represents a doubling compared to the issuance of 1 trillion yuan in ultra-long-term special government bonds by Beijing in 2024.

In a recent opinion piece on the economic work meeting (“张奥平：128政治局会议，释放2026年八大关键信号”), Zhang writes that fiscal spending by the central government will hone in particular on two main policy areas.

These policy areas are:

• The “Two Keys” (“两重”) - a reference to “implementation of key state strategies” and “security capability in key areas,” and

• The “Two New’s (两新)” - a reference to “cash-for-clunkers” consumption subsidies and and subsidies for upgrades to capital equipment.

The focus of the “Two Keys” will lie in urban renewal schemes, alongside programs to accommodate the ongoing urbanisation of China’s rural migrant workers.

Beijing has already indicated that the 15th Five Year Plan (2026 - 2030) will “deeply drive people-focused forms of new urbanisation,” as well as “drive the urbanisation of rural migrant populations in a scientific and orderly manner.”

According to figures released by the National Development and Reform Commission (NDRC) at the end of December, Beijing used 700 billion yuan and 800 billion yuan in funds raised from ultra-long-term special bonds in 2024 and 2025 respectively for urban renewal and upgrade programs around China.

With regard to the “Two New’s”, Beijing is set to expand its consumer subsidy program to include services consumption by Chinese citizens, while simultaneously broadening the scope of subsidies for capital equipment upgrades.

Zhang also foresees an increase in local government debt in 2026, particularly given it’s the inaugural year of the 15th Five Year Plan, as well as the vital role that China’s regional authorities play in fiscal spending.

He expects the issuance of special purpose bonds by local governments to increase from 4.4 trillion yuan this year to around 5 trillion yuan in 2026.

Key areas of spending are set to include rolling over the debts for state investment projects and making payments in arrears to small businesses, which is expected to help to pour liquidity into China’s regional economies.

Special-purpose bonds will also be used to support the growth of investment in China’s more economically important provinces.

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Monetary Policy in 2026

The latest Politburo meeting called for the continued implementation of “moderately loose monetary policy” (适度宽松的货币政策) in 2026.

This specific phrase was resurrected by Beijing at the end of 2024 - a move which was viewed as a sign of significant monetary easing, given it was last employed by China’s top policymakers in the aftermath of the Global Financial Crisis.

Beijing has been restrained when it comes to interest rate cuts in 2025, however, as quarterly GDP prints successively pointed to China handily reaching its full-year growth target of 5%, and calls mounted abroad for appreciation of the renminbi to deal with trade imbalance.

The Chinese central bank has only reduced its key policy rate - the seven-day reverse repo rate - on one occasion, trimming it from 1.5% to 1.4% in May. This in turn supported a reduction in China’s benchmark loan prime rate (LPR) from 3.1% to 3%.

China’s macroeconomic system is distinguished by the coordination of fiscal and monetary policy, with the central bank and the Ministry of Finance both operating under the unified leadership of the State Council.

This stands in sharp contrast to the world’s other major economies, where central banks possess at least nominal independence from the executive branch, to prevent the misuse of monetary policy by elected officials during campaign season.

For this reason, Zhang also expects the Chinese central bank to “focus on coordination with fiscal expansion,” as well as work to dissolve the hidden or risk-fraught debt burden of local governments.

In 2026, he sees the Chinese central bank implementing one to two cuts to interest rates, as well as one to two cuts to the required reserve ratio.

“The goal is to stabilise growth and fight deflation,” Zhang writes.

Zhang also sees the central bank continuing to implement the other distinguishing feature of China’s monetary policy system - the use of credit guidance to direct funds to priority sectors of the economy.

This is reflected by the Politburo’s call for “the implementation of even more active macroeconomic policy” in tandem with “strengthening of the foresight, targeting and coordination of policy.”

“Structured monetary policy could continue to expand, with a focus on supporting the ‘Five Great Chapters’ of finance,” Zhang writes.

The “Five Great Chapters of Finance” that Zhang refers to were first proposed by China’s Central Financial Work Conference in December 2023.

They encompass the economic priority areas of:

• Science and technology financing.

• Green finance.

• Financial inclusion.

• Aged care financing, and

• Digital finance.

A leading Chinese economist argues that China will eventually succumb to a calamitous debt crisis, if Beijing continues to resort to short-term stimulus measures to satisfy long-term growth imperatives.

Liu Xiaoshu (刘晓曙), director of the China Chief Economist Forum and chief economist at Bank of Qingdao, has taken aim at deficit doves in a recent opinion piece, arguing that the incessant use of fiscal stimulus will create far more perils than benefits over the long-haul.

He instead advocates for long-term structural adjustments to the Chinese economy via more restrained macroeconomic measures, as the most effective solution for achieving sustainable growth.

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Deficit hawks and doves battle over fiscal stimulus

China’s policy circles are host to a plethora of deficit doves, clamouring for Beijing to take on more debt to fuel the fiscal spending they believe is needed to keep the economy on track.

They’ve helped to drive China’s official deficit ratio for 2025 to 4% - the highest level on record, as well as a full percentage point above the threshold set in 2024.

Lian Ping (连平), an academic at East China Normal University, expects Beijing to keep both fiscal and monetary policy loose for the next decade, in order to satisfy the core development goal of China achieving “middle-developed nation” levels of per capita income by 2035.

Strident deficit hawks are out in force as well, however, with Liu Xiaoshu ranking prominently amongst them.

He’s launched a broadside against long-term fiscal stimulus in a recent opinion piece entitled: “The short–term sum is not equal to long-term gains - a sober reflection on economic stimulus” (“短期的加总不等于长期，对经济刺激的冷思考”).

“There’s a widespread misconception that continuously boosting the economy through short-term stimulus measures will achieve long-term prosperity,” he writes.

“If you’re skeptical about this, just look at today’s academics and industry professionals.

“When the economy dips, they immediately call for government stimulus policies, offering their advice and pontificating.

“When the economy improves, they attribute it to their own efforts, believing that stimulus is indeed necessary. Once the stimulus wears off and the economy declines again, new calls for stimulus begin.”

Liu argues that their views are misguided, on the grounds that the relationship between short and long-term policy impacts are highly complex, and cannot be reduced to just a simple process of linear addition.

“In the eyes [of deficit doves], since stimulus is effective in the short-term, why shouldn’t we keep stimulating. Shouldn’t this be capable of long-term effectiveness?

“Short-term gains do not equate to long-term gains, and continuously relying on short-term stimulus to drive economic growth cannot achieve true long-term prosperity.

“Only by abandoning excessive dependence on short-term stimulus and focusing on long-term structural reforms and development can a solid foundation be laid for sustainable economic growth.”

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The perils of fiscal stimulus

Liu points to two dangers in particular when it comes to using short-term stimulus measures to continually prime the Chinese economy over lengthy time frames: market distortion and an eventual debt crisis.

Market distortions - zombie companies and household consumption

A key concern for Liu is that short-term stimulus measures will disrupt the price signalling function of the market, as well as its ability to effectively perform resource allocation.

Businesses and consumers could become excessively dependent upon large-scale fiscal spending and loose monetary policy, which will warp their decision-making processes.

Excess fiscal subsidies can also perpetuate the existence of “zombie companies” that squander limited resources and undermine China’s economic productivity.

Liu argues that it would be better to leave such companies to perish via a natural process of Schumpeterian competition, allowing new and more innovative enterprises to emerge in their wake.

While China’s current goal is to boost consumption at present via wealth effects - via government intervention and credit support in the stock and property markets - Liu believes that this can also be highly perilous if macroeconomic policy is deployed too loosely.

“The wealth illusion created by monetary stimulus may lead to excessive or premature consumption, causing consumers to overdraw on future purchasing power and a decline in the savings rate,” he writes.

“When stimulus policies are withdrawn, consumers may face debt pressure, reducing consumption and negatively impacting economic growth.”

Short-term stimulus means long-term debt risk

The more acute threat to China’s economy from indefinite fiscal stimulus lies, however, in the risk-fraught debt burden that the government will amass over the long-term.

Liu cites the problems generally raised by deficit hawks in the West, chief amongst them a sharp rise in future interest payments, putting an ever-increasing burden on China’s fiscal health.

“Over-reliance on debt financing for short-term stimulus leads to a continuous accumulation of government debt and a gradual increase in debt risk,” Liu writes.

“Once the debt reaches a certain level, the government needs to use a large volume of funds for interest payments, squeezing out fiscal spending on other public services and social welfare.

“Excessively high debt levels can trigger market concerns about the government’s debt repayment capability, leading to decreased investor confidence and increased government financing costs, further exacerbating the debt burden and creating a vicious cycle.”

Liu believes that taken to its logical conclusion, this process could have catastrophic consequences for the Chinese economy.

“Ultimately, this could trigger a debt crisis, causing long-term and severe economic damage,” he warns.

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The lessons of Japanese and European history

Liu points to the malaise which has consumed the Japanese economy for several decades as an object lesson for China on the perils of excessive fiscal stimulus.

“Japan’s ‘Thirty Lost Years’ profoundly illustrates that short-term stimulus cannot bring about long-term prosperity,” he writes.

“In the early 1990s, after the bursting of Japan’s real estate and stock market bubbles, the government implemented massive fiscal stimulus and monetary easing policies in an attempt to revive the economy.

“However, a large amount of money was invested in inefficient public works and zombie companies, failing to promote technological innovation and industrial upgrading.”

The results were dismal for Japan, leading to a prolonged period of economic stagnation, as well as a ballooning of the nation’s public debt.

Liu also points to the more recent European debt crisis of the previous decade as more firm proof of the perils of debt-fuelled fiscal spending.

“Nations such as Greece have long relied on fiscal deficits and external borrowing to maintain economic growth, implementing various short-term stimulus measures,” he writes.

“However, this model has failed to address issues such as economic structural imbalances and insufficient competitiveness.

“This ultimately led to the outbreak of the European debt crisis, plunging their economies into a prolonged recession, creating extremely difficult fiscal situations, and making the road to recovery both long and arduous.”

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Structural adjustment seen as China’s economic panacea

Liu believes China should focus more on achieving long-term structural adjustments, in order to achieve the sustained growth needed to propel it into the ranks of the world’s developed economies.

His argument is that the factors of production that serve as the inputs of the economy can only be adjusted over the long-term, giving the example of a factory rapidly increasing overtime and its procurement of raw materials, yet taking far longer to construct new facilities.

“Short-term behavior is limited by existing resources and constraints, while long-term behavior has more room for adjustment and flexibility,” he writes.

“Consequently, true long-term prosperity cannot be achieved without deep-seated structural reforms.”

While inveighing against short-term macroeconomic measures as a source of long-term debt risk, Liu nonetheless advocates the judicious use of certain fiscal measures that can “enhance the endogenous growth momentum of the economy.”

He calls for reducing corporate taxes and simplifying administrative approvals to “stimulate corporate vitality and creativity,” as well as measures that encourage R&D investment and technological progress.

Liu also calls for driving greater improvements to China’s human capital, by further stepping up investment in education and vocational training. Only then will China be able to create the supply of high-quality labour needed to support future growth, just as its society faces adverse demographic shifts.

Beijing has given marching orders to China’s commercial banks, to extend “special loans” to financially distressed government entities running late on their payments to regional businesses.

While the goal is to give a boost to China’s regional economies with an influx of funds destined for smaller companies, concerns abound that the move could worsen the problem of bad loans in the all-important state-owned banking system.

The episode serves as an outstanding example of how the Chinese state continues to actively intervene in the credit-debt relations of the national economy, while fostering the growth of a market-based system and private enterprise.

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Local government debt seen as economic peril

It’s no secret within China that local governments have long carried a burden of heavy debt that is a keen source of anxiety for the nation’s financial regulators.

This debt burden has arisen as a result of an unbalanced fiscal system, which forces regional authorities to bear a disproportionate share of government expenditures, while leaving them deprived of sufficient access to tax-based revenues.

Chinese economists have long urged Beijing to address the issue, on the grounds that these mounting debts could become a trigger for systemic risk in the financial sector.

Key concerns have included the use of land sales by regional authorities as a revenue source - incentivising the formation of regional property bubbles - as well as the use of local government financing vehicles (LGFV) to covertly amass hidden debts

A related dilemma has been the widespread failure of financially distressed state-owned entities to make payments on schedule, to regional businesses whose goods and services they’ve procured.

This is believed to have put a major brake on economic activity around China, by depriving small and medium-sized enterprises of the funds they urgently need to keep their businesses ticking.

The need for these funds has been especially keen for Chinese businesses in the wake of the havoc created by the Covid pandemic, as well as the trade uncertainties that continue to fester between Beijing and Washington.

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Chinese banks told to make special loans to state entities

China’s financial authorities are now making haste to address the issue, in a bid to keep economic activity on an even keel as the end of the year fast approaches.

They’ve ordered the Chinese banking system to extend special loans to state-owned enterprises and government platforms in financial distress, in order to clear the late payments they owe to small-and medium-sized businesses.

China’s policymakers hope the move will help give a boost to regional economies, by providing smaller private companies with an infusion of funds, while also helping to lift market expectations and stabilise corporate lending.

They also hope to alleviate the financial pressures on defaulting state-owned entities, still struggling with the burden of their unpaid debts.

State-owned news outlet Jiemian reports that Chinese banks have created a special category of loan for clearing overdue payments, with the issuance of such loans surging abruptly since the start of the second half.

The “special loans for clearing overdue payments” (清欠专项贷款) refer specifically to loans made by Chinese banks to “state-owned enterprises, public institutions and government financing platforms,” for the purpose of discharging overdue payments owed to small and medium-sized businesses.

According to the report entitled “The Concentrated Deployment of Special Loans for Clearing Late Payments - What, Why and the Impacts” (清欠专项贷款密集落地：是什么，为什么，有何影响？), Hunan province, Shandong province, Guangxi province, Fujian province and the Ningxia autonomous zone have already made use of the special loans to help out beleaguered government companies, with both state-owned and joint-stock banks compelled to take part.

Chinese financial commentator Xia Xinyu (夏心愉) points out that a key area of focus has been government companies in the healthcare system, with one leading municipal hospital in northeastern China recently obtaining a loan of nearly 10 million yuan from a joint-stock bank.

In order to facilitate the lending process, Chinese authorities have also ordered parties in the financial sector to provide credit guarantees to some of these distressed state-owned entities seeking special loans.

Given that public institutions and state-owned enterprises are considered high-quality borrowers - irrespective of their financial straits - the guarantees have helped to bring the rates for the special loans to very low levels.

They’re reported to currently stand at around the one-year loan prime rate (LPR) minus 40 basis points - or around 2.6%.

Xia Xinyu highlights the heavy hand of the Chinese government in driving the banks to step up the provision of special loans, as opposed to extend them of their own volition for reasons of commercial interest.

“This isn’t at all the result of spontaneous action by the banks,” Xia writes in a recent commentary.

“It’s the result of concern on the part of regulators for the real economy, and driving banks to raise their awareness and engage in further hard work.”

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Beijing anticipates economic boost from forced lending

China’s policymakers made it an official priority to clear the overdue debts of state-owned entities at the start of the year, in the hope of providing a boost to the economy amidst the uncertainty created by Trump’s second term as president.

The State Council held an executive meeting on March 28 to approve the “Action Plan for Accelerating the Clearing of Overdue Payments to Enterprises” (加快加力清理拖欠企业账款行动方案).

A month later, a meeting of the Politburo held on April 25 continued to emphasize “accelerating the resolution of the problem of the overdue payments owed by local government enterprises.”

In addition to banking-sector measures, local governments are also using special-purpose bonds to to make overdue payments.

According to data compiled by Jiemian, the total amount of special-purpose bonds used to repay overdue payments across 10 Chinese provinces was close to 200 billion yuan as of the end of September.

“Clearing overdue payments to enterprises is an important tool for boosting market expectations, promoting the development of the private economy, clearing out the ‘arteries’ of the economic cycle, and maintaining the government’s credibility,” Chinese officials in Jilin province said during a recent video conference.

Wen Bin (温彬), chief economist at China Minsheng Bank, said that one of the biggest benefits from a macroeconomic perspective is the injection of fresh vitality into the provision of credit to Chinese businesses.

“Currently, the drag on corporate loans from hidden debt resolution is gradually easing,” Wen said.

“Policies targeting local government financing vehicles (LGFVs) and public institutions for debt repayment are driving the conversion of commercial credit to bank credit.

“Quasi-fiscal forces such as policy-based financial instruments are poised for deployment.

“This, coupled with seasonal factors, has resulted in significantly better corporate medium- and long-term loan issuance in August compared to July.”

Data from the Chinese central bank indicates that corporate and public institution loans increased by 590 billion yuan in August, for a rise of 530 billion yuan month-on-month.

Short-term loans increased by 70 billion yuan - for an increase of 620 billion yuan month-on-month; while medium- and long-term loans increased by 470 billion yuan, for an increase of 730 billion yuan month-on-month.

While the special loans may inject fresh life into Chinese corporate credit activity, the perennial concern, of course, is that they also have the effect of perpetuating or worsening the burden of bad debts for the state-owned banks - still the mainstay of China’s financial system.

This is an issue that regulators are acutely aware of, given the nation’s recent financial history.

The severe under-performance of state-owned enterprises following the start of the reform era at the end of the 1970s led to a massive proliferation of bad loans throughout the eighties and nineties.

This mountain of non-performing loans threatened to capsize the Chinese banking system completely by the turn of the 21st century, forcing Premier Zhu Rongji to adopt bold measures to avert disaster.

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Fixing the local government finance platforms

In addition to giving regional economies a cash boost, Beijing is also heavily focused on addressing the issue of local government finance vehicles (LGFVs) - the state-owned investment companies established by local governments that are a key source of covert debt accumulation.

A major concern with the LGFVs has been their ability to amass opaque, off-balance sheet debt, hidden from the prying eyes of China’s financial regulators.

For this reason, Chinese regulators are implementing a “list-based management system” for the LGFVs, in a bid to transform them into “market-oriented state-owned enterprises” - as opposed to expedient tools for debt raising by local governments.

This essentially means that LGFVs are included on special lists that restrict them from accessing new bank loans to resolve their overdue debts.

LGFVs can exit the lists, if regulators believe they have adequately dealt with the problem of their hidden debts, at which point they will have greater access to lending by banks.

The approach appears to be working. At a press conference held by the State Council Information Office on September 12, Finance Minister Lan Fo’an (蓝佛安) stated over 60% of LGFV platforms had exited the list as of the end of the second half, and that over 60% of their hidden debts had also been cleared.

In this briefing for Friday, 21 November, 2025:

• The top mission for finance during the 15th Five Year Plan will be funding Chinese tech innovation, opines Guo Tianyong (郭田勇), chair of the China Banking Sector Research Institute, at the Central University of Finance and Economics in Beijing.

• Gold’s displacement of the greenback heralds the beginning of Bretton Woods 3.0, says Zhang Ming (张明), deputy chair of the Chinese Academy of Social Sciences, deputy chair of the National Institution for Finance & Development.

• China’s ailing credit growth is a long-term trend, but M2-M1 gap gives hope, according to Wen Bin (温彬), chief economist at China Minsheng Bank.

• China should increase the manufacturing sector’s share of its economy, argues Zhang Yu (张瑜), researcher from the International Monetary Research Institute of Renmin University.

• The key to boosting Chinese consumption lies in tax reforms, writes Luo Zhiheng (罗志恒), director of the China Chief Economists Forum.

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The top mission for finance during the 15th Five Year Plan will be funding China’s tech innovation.

Thus opines Guo Tianyong (郭田勇), chair of the China Banking Sector Research Institute, at the Central University of Finance and Economics in Beijing.

“During the 15th Five Year Plan, the financial sector will bear the critical mission of accelerating the establishment of a great financial superpower,” Guo writes in his recent opinion piece, “Considerations on the Financial Agenda for the 15th Five Year Plan” (郭田勇：“十五五”金融规划的思考).

To this end, Guo sees China continuing to focus on the “Five Great Chapters” (五篇大文章) of its financial policy blueprint, which include:

• Science and tech financing.

• Green financing.

• Inclusive financing.

• Aged care financing.

• Digital financing.

Guo believes that out of the “Five Great Chapters,” financing of China’s tech undertakings will assume prominence of place, amidst China’s efforts to achieve “independence and self-strengthening” in scientific and technological terms.

“Financing of science and technology ranks first out of the Five Great Chapters,” Guo writes.

“It plays a leading role in supporting innovation-driven development.

“During the 15th Five-Year Plan, continued efforts should be made to increase financial investment in science and technology innovation and improve the entire chain of financial support from basic research to commercialisation.”

In 2024, the Chinese central bank lead the release of the “Work Plan on Firmly and Effectively Undertaking the Great Chapter of Science and Technology Financing” (关于扎实做好科技金融大文章的工作方案).

In terms of monetary policy, the Chinese central bank has since raised the quota for its re-loans to support scientific and technological innovation, as well as pushed for commercial banks to increase lending to tech SMEs.

On the bond market, China has also seen the launch of a “science and technology” board to expedite debt financing by tech companies, as well as launched related risk mitigation tools to make banks more willing to lend.

Nearly 300 companies have since issued around 600 billion yuan in science and tech innovation bonds (科技创新债券).

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Gold’s displacement of the greenback heralds start of Bretton Woods 3.0

Zhang Ming (张明), deputy chair of the Chinese Academy of Social Sciences, deputy chair of the National Institution for Finance & Development, believes that the rising share of gold in the reserves of the world’s central banks heralds profound changes to the international monetary system.

He points out that since the second half of 2025, gold has exceeded US Treasuries as a share of global reserves for the first time in nearly two decades.

While gold’s share was higher prior to 1996, during the period from 1996 until the first half of 2025, US treasuries trumped bullion.

In 2016, US treasuries reached a peak of one third of global reserves, from a low of 10% in 1980.

By mid-2025 they had fallen to 25%, while gold’s had climbed beyond the quarter threshold, after languishing at around 10% from 2008 to 2016.

In his essay “A Portent of Changes to the International Monetary System” (国际货币体系变化的先兆?), Zhang argues that this development presages a shift to a multi-polar global currency system.

“Given that the evolution of the international monetary system is a slow and gradual process, the US dollar will remain the most important international reserve currency for some time to come, despite a potential decline in its international status,” Zhang writes.

“However, other international currencies such as the euro, renminbi, yen, and pound sterling will play increasingly important roles, with the renminbi undoubtedly possessing the greatest potential.

“Furthermore, gold, and even commodities like crude oil and non-ferrous metals, will also occupy a place in international reserves.”

Zhang predict that the future international monetary system is “increasingly likely to become a hybrid of Robert Mundell’s three islands of global financial stability and Zoltan Pozsar’s “Bretton Woods 3.0.”

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China’s ailing credit growth is a long-term trend, but M2-M1 gap give hope

Wen Bin (温彬), chief economist at China Minsheng Bank, says that lacklustre credit figures are a cause for concern when it comes to domestic demand from Chinese households and enterprises.

“Reduced loan demand and slower credit growth are long-term trends, given a shifting economic and financial structure and large credit base,” Wen writes in his recent opinion piece "How to View the October Financial Data” (温彬：如何看待10月金融数据)

“Relative to interest rates, loan rates have been running at low levels for a considerable period, indicating that the overall supply of credit resources is ample, and the financing needs of the real economy have been met to a high degree.”

Renminbi loans increased by 220 billion yuan in October - 280 billion yuan less than the same period last year, indicating a continued decline in credit growth.

The credit growth rate for October was 6.5%, 0.1 percentage points slower than the previous month.

From January to October, renminbi loans increased by 14.97 trillion yuan, a decrease of 1.55 trillion yuan compared to the same period last year.

New social financing in October reached 815 billion yuan, for a growth rate of 8.5%, down 0.2 percentage points month-on-month but 0.7 percentage points higher than the same period last year.

Wen further points that household loan growth is still ailing, despite Beijing’s much-vaunted campaign to step up domestic consumption, via improved financial access and improvements to the social safety net.

Household loans decreased by 360.4 billion yuan in October, a decline of 520.4 billion yuan compared to the same period last year.

Short-term household loans decreased by 286.6 billion yuan - for a decline of 335.6 billion yuan; while medium- and long-term household loans decreased by 70 billion yuan, 180 billion yuan less than the print for the same period last year.

“This indicates that overall household credit has yet to be stabilized,” Wen writes.

Wen does highlight some cause for optimism in the October data - in particular structural changes that show the Chinese central bank’s push to raise lending to private businesses and the manufacturing sector is proving effective.

At the end of October, the outstanding balance of inclusive micro and small enterprise loans was 35.77 trillion yuan - for a year-on-year increase of 11.6%.

The outstanding balance of medium- and long-term loans to the manufacturing sector was 14.97 trillion yuan, for a year-on-year increase of 7.9%.

“Both of these loan growth rates were higher than the overall loan growth rate during the same period,” Wen writes.

Wen further points out that the gap between China’s M2-M1 money supply has widened - a development generally considered to be positive for domestic demand, as it shows a rising share of demand deposits.

“The M2-M1 gap expanded to 2% month-on-month, but remained at the second lowest point since April 2021.

“The trend of funds being converted into demand deposits continued, reflecting positive signals such as increased activity in corporate production and operations, and a gradual recovery in personal investment and consumption demand.”

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China should increase the manufacturing sector’s share of the Chinese economy

Beijing has indicated that the 15th Five Year Plan (2026 - 2030) will see China “maintain manufacturing as a rational share” of the national economy.

In 2024, China’s manufacturing sector comprised 24.9% of GDP, begging the question of whether Beijing should view this as a “rational share” moving forward.

Zhang Yu (张瑜), researcher from the International Monetary Research Institute of Renmin University, argues that determining the rational size of the manufacturing sector should use a new metric that takes into account its size relative to both GDP as well as global manufacturing.

In the opinion piece “A Brief Reflection on the Rational Ratio for the Manufacturing Sector” (浅思“制造业合理比重”) she advocates using a ratio that consists of the following:

The manufacturing’s share of national economic output x manufacturing’s share of the global economy/ the national share of the global economy.

Zhang argues that based on this metric, China still has room to raise the scale of the manufacturing sector, given an ongoing decline in manufacturing as a share of the global economy.

Manufacturing as a share of global economic output has steadily declined for more than half a century, from 25% in 1970 to 15.1% in 2024.

Zhang concludes that even if China has a disproportionate share of global manufacturing, this does not translate into a disproportionate share of global GDP.

The Renmin University economist further argues China’s share of global manufacturing is not conspicuously high by recent historical standards set by the world’s other major economies.

“In 2024, China’s share of the global manufacturing sector was 27.7%,” she writes.

“Since 1970, the US was above 27% from 1981 to 1985 as a share of global manufacturing, and Japan was over 20% from 1993 - 1995.

“This it to say that [China’s] share may still have room for increase.”

The key to boosting Chinese consumption lies in tax reforms.

Thus argues Luo Zhiheng (罗志恒), director of the China Chief Economists Forum.

This is because tax reforms can achieve pivotal shifts to wealth distribution, as well as raise the revenues needed for improvements to the social safety net, both of which will dim the urgent need felt by Chinese citizens to be thrifty and frugal.

Given Beijing’s current preoccupation with boosting domestic demand via gains to consumption, Luo anticipates tax reforms to be a major theme during the upcoming 15th Five Year Plan (2026 - 2030).

“Taxation, based on the political power of the state, influences the distribution of national income, and raises revenue to ensure people’s needs for public services such as healthcare, education, and aged care,” Luo writes in the opinion piece “Taxation Energises the 15th Five Year Plan - Six Thoughts and Recommendations on Better Employing the Role of Taxation” (“罗志恒：税收赋能“十五五”——更好发挥税收职能的六点思考与建议”)

“In the past, continuously optimized tax systems and tax and fee reduction policies have reduced business operating costs, promoted technological innovation, and boosted consumption, playing a vital role in high-quality development.

“In the future, tax system reform and policy optimization will play an even more active role.”

Luo highlights the 15th Five-Year Plan’s heavy preoccupation with consumption.

“[It] will focus more on expanding domestic demand and invigorating consumption.

“The Recommendations [on the 15th Five Year Plan] firstly make a clear call for markedly increasing the household consumption ratio, a mission which requires the creation of a ‘great domestic market.’

“Great domestic demand can both absorb industrial capacity, drive a smooth shift from old to new drivers, as well as gradually reduce dependence on external demand and further strengthen economic resilience.”

China’s export levels have held up remarkably well in 2025, despite the tremendous headwinds unleashed by the Liberation Day tariffs announced by the Trump administration at the start of April.

Luo Zhiheng (罗志恒), director of the China Chief Economist Forum, argues that the resilience of China’s export growth can be imputed to two main factors.

The first is the ongoing geographic diversification of China’s export markets - towards less reliance upon the US and its OECD allies, and greater focus on the emerging economies of the global south.

The second is China’s ascendant role as a supplier of intermediate goods and capital equipment to other emerging economies, that are pursuing similar trajectories of catch-up development. Chief amongst such markets are the nations of Latin America as well as the member states of ASEAN.

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Emerging markets soak up China’s exports

China’s total exports saw year-on-year growth of 6.1% for the first three quarters of 2025, marking their highest print for the past three years.

The figure is especially remarkable given that it arrives in the thick of mounting trade tensions between Beijing and Washington, and an ongoing succession of tit-for-tat tariff measures that have played out across the past six months.

In recent opinion piece (“罗志恒：压力下的突围——中国出口韧性从何而来，能否持续?”) Luo points out that the growth patterns for exports to different parts of the world provide a clear account of how China managed to keep its trade levels in fine fettle, even after the Trump administration launched its shock tariff measures.

China’s exports to the US dropped by 16.9% for the first three quarters, undermining its overall export growth to the tune of 2.4 percentage points.

This plunge in sales to the US also belies the claim often touted by observers, that a rush to buy Chinese goods before the tariffs did their worst has helped to buoy export levels.

Exports to two of China’s main trading partners - Russia and South Korea, also posted declines during this period, of 11.3% and 0.3% respectively.

In sharp contrast, exports to a slew of other regions - including both advanced economies and emerging markets, saw impressive increases in the first three quarters of 2025.

These gains collectively served to more than compensate for the post-Liberation Day decline in China’s exports to the US.

China’s exports to Africa, ASEAN and India all posted robust year-on-year growth that was well above the two-digit threshold, coming in at 28.3%, 14.7% and 12.9% respectively.

Exports to the advanced economies of the EU, UK and Canada also saw strong gains of 8.2% and 8.7% and 5.1% respectively, while exports to Latin America rose 6.9%.

All of this was enough to boost China’s overall export growth by approximately 6.3 percentage points.

The figures are part of a longer pattern of geographic diversification of China’s key export markets for almost a decade.

Since Trump’s first term in office as president, Beijing appears to have made a concerted effort to reduce its dependence upon the US and its OECD allies when it comes to export destinations.

During the period from 2017 - 2024, the US and EU share of China’s exports fell from 35.4% to 29.1%.

Luo believes that it is unlikely for advanced economies to restore their share of China’s export total in future, given efforts to diversify the geographic demand pattern.

He does forecast sharp growth in exports to advanced economies of hi-tech goods where China is ecking out a mounting competitive advantage - including electric vehicles (EVs), mechanical equipment, key components, as well as semi-conductors.

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China as capital supplier to emerging economies

Much ado has been made about China’s emergence as an exporter of high-end tech products, most notably EVs, smart phones and household appliances.

Another trend which is arguably just as critical for the global economy, yet far less remarked upon, is China’s ascendant role as an exporter of intermediate goods and capital goods to the emerging economies of the global south.

These are goods and equipment that are used for the production of other goods. They play an essential role in the growth of any developing nation which is adopting the time-tested economic strategy of low-cost, export-driven industrialisation.

Luo argues that demand from emerging economies - chief amongst them ASEAN and Latin America - has already made intermediate goods and capital goods the “main force” driving growth in China’s overall exports.

For the first three quarters of 2025, intermediate goods exports saw year-on-year growth of 10.2%, contributing 4.7 percentage points to growth in overall exports.

Exports of capital goods posted growth of 6.9%, driving 1.4 percentage points in total export growth.

Luo notes that this rapid growth in exports of intermediate goods and capital goods is primarily the result of the relocation of key segments of industrial supply chains to parts of the world beyond China’s borders.

It’s also been driven by the efforts of Chinese enterprises to expand abroad, to capitalise upon the resulting dependence in other emerging economies upon key materials and equipment that are still produced in China.

During the period from 2017 - 2024, China’s exports of intermediate goods to ASEAN and Latin America posted average per annum growth of 11.6% and 11.8% respectively.

This new role for China has also helped to accelerate the geographic shift in its export markets away from advanced economies.

“Emerging economies such as ASEAN and Mexico are seeing rapid growth in imports from China, and ASEAN has already replaced the EU and US to become China’s number one export market,” Luo writes.

“During the period from 2017 to 2024, aside from 2023, China’s exports maintained rapid growth to ASEAN, with five years seeing export growth of over 10%.”

Looking to the future, Luo expects this trend to continue, as the economies of ASEAN and Latin America continue to climb towards higher segments of the global manufacturing chain.

This will result in greater demand for key intermediate goods and capital goods made in China, helping to buoy its export levels across the medium-term.

The top economist at one of China’s big state-owned banks says Trump’s second term in office is having a transformative impact on the global monetary system, by despoiling the credibility of the US dollar as reserve currency.

Guan Tao (管涛), chief economist at Bank of China’s investment banking wing, has called for Beijing to take advantage of the “rare opportunity” this creates, to drive further internationalisation of the Chinese renminbi and augment China’s global financial clout.

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Liberation Day seen reshaping global monetary order

Guan writes that Trump’s tariffs are having as momentous an impact on the global monetary system as Nixon’s depegging of the dollar from gold in 1971 - a move which spelt the downfall of the Bretton Woods system that had been in place since the end of the Second World War.

“America’s bullying, unilateral economic and trade policies have not only shocked the global trade system, they have also accelerated the re-forging of the international monetary order,” Guan writes in a recent opinions piece (“管涛：国际货币体系重置中的机遇与挑战”).

“The reciprocal tariff policy is comparable to the Nixon shock of 1971, when the Nixon administration announced the removal of the gold peg and levied a 10% import tax.

“This paved the way for the collapse of the Bretton Woods system.”

Guan points out that since the launch of Trump’s Liberation Day tariffs at the start of April, the US dollar has seen its share of global foreign reserves post an abrupt decline to a new 30-year low.

Data from the IMF indicates that as of the end of the second quarter, the US dollar’s share of forex reserves publicly disclosed by the world’s monetary authorities had fallen to 56.32% from 57.79% at the end of the first quarter, for a 1.47 percentage point decline.

Guan also highlights a plunge in purchases of US-dollar assets by government investors in the wake of Liberation Day, based on figures from the US treasury department’s Treasury International Capital (TIC) report.

“In the second quarter of 2025, official foreign investors excluding international organisations made US$510 million in net purchases of US financial assets, including treasuries, agency bonds, corporate bonds and stocks, for a drop of 94.4% from the previous quarter,” he writes.

Dollar imperilled by Trump’s Fed attacks

China stands apart from most other major economies in practising the unified coordination of fiscal and monetary policy, by making the country’s central bank subordinate to the Chinese government’s top ruling body - the State Council.

Standard practice in advanced economies is for monetary and fiscal policy to be subject to rigorous separation. The independence of the central bank is supposed to be strictly maintained, in order to shield it from the influence of elected officials who could abuse the control of monetary policy to prime the economy during campaign seasons.

Despite China itself lacking an independent central bank, Guan Tao has joined other Chinese commentators in arguing that Trump’s attacks on the Federal Reserve pose a threat to the prestige of the dollar.

In September, Wang Qing (王青), chief macro-analyst at Golden Credit Rating, highlighted “the intensity of [Trump’s] attacks on the Fed’s independence” as a factor behind the rise in bullion prices.

Beijing’s top policymakers were concerned about Trump’s attacks on the Fed’s independence, and the possibility he could resort to coercive measures to unstopper monetary policy, which could have a dire impact on China’s copious troves of dollar-denominated assets.

Guan Tao says this situation creates a credibility issue for US monetary policy that is bound to further weaken the greenback’s standing.

He goes so far as to argue that Trump’s attacks on the Fed’s independence could make the current shift in the global monetary order even more momentous than the collapse of the Bretton Woods system at the start of the 1970s.

“This latest development goes a step further, as the credibility of the dollar - the independence of the Federal Reserve itself, also faces a grave threat.”

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The dollar’s decline paves the way for the renminbi’s rise

In Guan’s view, the international monetary system is characterised by network effects, path dependency and legacy inertia, given that global investors only reluctantly shed their habitual trading practices.

For this reason, major changes in the global monetary system depend just as much upon the decline of incumbent powers as they do upon the emergence of catch-up competitors.

Guan thus sees Trump’s second term in office as creating a golden opportunity to rig the global financial system in China’s favour.

“The USA’s self-destructive, beggar-thy-neighbor trade policies are collapsing American exceptionalism and widening the cracks in the dollar’s credibility,” he writes.

“This provides a rare opportunity for the rise of other currencies.”

Guan advocates that Beijing take advantage of this rare opportunity to drive greater internationalisation of the renminbi - a move he considers an integral part of China’s ambitions to transform itself into a “financial superpower.”

“A strong currency ranks first among the six key core elements of a financial superpower,” Guan writes

“The renminbi achieving international status commensurate with China’s economic influence and steadily advancing its internationalisation are essential aspects of China’s accelerated development into a financial superpower.”

He outlines a raft of measures needed to enhance the offshore appeal of the renminbi, including:

• Further driving the systemic opening-up of China’s financial sector.

• Accelerating the “post-border opening-up” of domestic rules, regulations, standards and regulatory procedures, with the goal of making them consistent with international practices.

• Further accelerating the development of China’s domestic financial market.

• Strengthening the “functional carriers” for cross-border renminbi investment and financing.

• Further accelerating innovations in cross-border renminbi financial products, systems, and technologies, to better serve the high-quality development of the “Belt and Road” initiative and the “going abroad” strategy of Chinese enterprises.

• Further enhancing the competitiveness and influence of Shanghai as an international financial center.

• Further consolidating and elevating Hong Kong’s status as an international financial center.

One of China’s leading economists says the 15th Five Year Plan (2026 - 2030) will see Beijing dramatically step up debt-fuelled fiscal expenditures, in a bid to satisfy ambitious long-term growth targets.

Lian Ping (连平), director of the China Chief Economists Forum, expects Beijing to raise the deficit-to-GDP ratio to north of 4% during the period of the new five-year plan, as well as issue 1.5 trillion yuan in ultra-long-term special government bonds annually.

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China targets developed economy status by 2035

The Communist Party just revealed critical details on the 15th Five Year Plan, at the Fourth Plenary Session of its Central Committee held from 20 - 23 October in Beijing.

The Plan - as well as the Plenary Session - is a holdover from China’s command economy past, serving as a critical blueprint for the Communist Party’s development policies for each five-year period.

A key target reiterated by the 15th plan is the longer term goal of China achieving “mid-tier developed” nation status in terms of per capita GDP by 2035.

In a recent opinions piece (“连平：“十五五”财政政策将怎样积极有为”), Lian argues that in order to achieve this goal, China will need to maintain real GDP growth of at least 4.5% per annum during the period from 2026 to 2030 covered by the 15th Five Year Plan.

China will face major headwinds to growth during this period, including steady population declines, further adjustments to the property market, a transition in its growth model, as well as continued global uncertainties.

Consequently, Lian argues that “fiscal policy should become more active…and create a vigorous driver of aggregate demand.”

He highlights the need for expanding the scale of China’s government expenditures, as well as the more innovative usage of policy tools.

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Inadequate consumption still China’s biggest challenge

Lian argues that the biggest challenge faced by China’s economy at present remains inadequate domestic demand.

For this reason, the 15th Five Year Plan calls for “upholding the strategic key point of expanding domestic demand.”

Lian highlights in particular the weakness of household consumption, due to the impacts of the property slump on personal wealth, as well as concerns over the quality of the social safety net.

“This is reflected by households having a low willingness to consume, due to expectations of payment pressures when it comes to education and healthcare,” he writes.

Given that weak consumption is viewed as the root cause of China’s inadequate domestic demand, Lian argues that fiscal expenditures should focus on improvements to the social welfare system, as well as transfer payments that seeks to redress wealth inequities.

“Fiscal policy should adopt measures that ‘invest in the people’ - via improvements to the social welfare system, in order to stabilise household expectations,” he writes.

“Fiscal policy should be a core tool for the reallocation [of wealth,] with targeted policies such as taxation and transfer payments able to effectively adjust gaps in wealth distribution, and shrink the gulf between the cities and the countryside.”

Fiscal policy as Cold War economic tool

Despite the occasional thawing of tensions between China and the US, Beijing’s political leaders anticipate the continuation of Cold War tensions between the world’s two remaining superpowers for the indefinite future.

In its recommendations on the 15th Five Year Plan, the Fourth Plenum referred specifically to an “increase in factors that are uncertain and difficult to predict” during the period from 2026 to 2030.

The Plenum issued a rallying cry for China to “dare to struggle, be adept at struggle, and have the courage to face the grand test of strong winds and urgent waves - or even raging storms.”

Lian believes this rhetoric points to the use of more active fiscal policy to offset the economic impact of any shock downturns in Sino-US relations.

“This strategic decision requires that fiscal policy not only keep an eye on current economic performance, but must also possess strategic foresight,” he writes.

“As a foundation and key pillar for state governance, fiscal policy is a firewall for withstanding risk, as well as a ballast stone for stabilising expectations.”

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Specific recommendations for China’s fiscal policy

Lian offers a series of four key recommendations for Chinese fiscal policy during the period of the 15th Five Year Plan.

The new normal of a 4.0% deficit ratio

Lian expects the deficit to remain high, as growth in fiscal revenues slows and inelastic expenditures increase.

He forecasts a normalised deficit ratio of 3.8% - 4.0% - or even as high as 4.2% in the event of shock contingencies.

“This provides the necessary support to macroeconomic stability and avoids the disorderly accumulation of debt risk, “ Lian writes.

Such a change will mark a sharp contrast from precedent, with Beijing having formerly sought to keep its deficit-to-GDP ratio beneath the EU Maastricht Treaty threshold of 3%.

Transfer payments and strategic missions

Lian expects China to issue 1.5 trillion yuan (USD$322.24 billion) in ultra-long-term special bonds during each year of the 15th Five Year Plan, with funds to be directed toward scientific and technological innovation, national security, and improvements to China’s social safety net.

Key focal points will include spending on both childcare and aged care, as well as transfer payments to rural villages and underdeveloped areas, in a bid to boost household consumption.

Deepening of fiscal system reforms

China’s existing fiscal system was established by Premier Zhu Rongji in the mid-1990s, and currently suffers from the problem of imbalances when it comes to central and local revenues and expenditures.

The issue has forced cash-strapped local governments to turn to methods such as land sales and local government financing vehicles (LGFV) to raise money, contributing to both overheating property markets and widespread regional debt risk.

Lian says China should make strides in addressing this problem during the 15th Five Year Plan, by increasing the central government’s share of expenditures, as well as tax reforms conferring a greater share of revenue to local governments.

Rooting out local government debt risk

Local government debt risk is a matter closely related to the reform of China’s fiscal system.

Chinese pundits consider the deficiencies of the three-decade old fiscal system to be the root cause for the accumulation of risk-fraught debt by China’s local authorities.

Lian expects China to enter the “assault phase” for the dissolution of this debt risk during the 15th Five Year Plan.

“The mentality of policymakers will be active stabilisation, and treating both the symptoms and causes,” he writes. “They will firmly guard the bottom line against the onset of systemic risk.”

He foresees a three-part process of:

1. Dissolution of outstanding debts, and the inclusion of hidden debts in government balance sheets, in a bid to reduce debt cost and risks. Lian expects China to see the issuance of around 4.5 - 5 trillion in new local government special bonds each year, with some of these proceeds used to support the rollover of existing debts. He also expects the Chinese government to use debt restructuring, term extensions, rate reductions and repayment using central fiscal revenues to deal with the matter.

2. Strict control of new risk. This will require addressing the issue of local government finance vehicles that regional governments have long used as covert channels for raising debt.

3. Improvements to long-term funding mechanisms - the focus here will be on reforming fiscal relations between the central and local governments.