In the soon-to-be-over year of 2023, China’s macroeconomy experienced a pattern of starting strong and ending weak. At the beginning of the year, we experienced an explosive rebound following the opening up after the pandemic, with the economy showing signs of rapid recovery in the first quarter. However, subsequently, weaker-than-expected prices suppressed the momentum of the macroeconomic recovery. Calculating at a growth rate of 5% for the whole year of 2023, the average growth rate over two years stands at 4%. Although this level is lower than the expected growth rate, under the immense downward pressure from both internal and external factors, the Chinese economy has shown significant resilience.
The low level of prices throughout the year was largely influenced by the pandemic. In the adjustment process of total supply and total demand, the pandemic had a prolonged lagging effect on total demand through debt, suppressing the growth rate of total demand. This is reflected in the rapid decline of the growth rate of retail sales surpassing historical levels. The Central Political Bureau meeting on July 24, 2023, clearly stated that the current phase of the economy is mainly characterized by insufficient domestic demand. This insufficiency is partly due to the slow progress of reforms aimed at expanding domestic demand since 2010 and partly due to the impact of the pandemic. In 2022, China adopted a large-scale expansionary fiscal policy, but due to repeated impacts of the pandemic, domestic demand was again impacted within the year, which constrained the expansionary fiscal policy in 2023 and fundamentally shifted the policy from cross-cycle to counter-cycle control. Regarding monetary policy, the key still lies in whether it can expand domestic demand.
In addition, external pressures were also a major reason for the slower-than-expected recovery pace in 2023. First, imported inflation at the beginning of the year suppressed the profits of industrial and enterprise sectors. Secondly, the global demand recession led to a continuous decline in our country’s export orders. Unlike the past three years during the pandemic, the challenge for exports in 2021-2022 was high sea freight prices and domestic energy constraints. The Federal Reserve’s continuous interest rate hikes brought two shocks to the global financial market. Firstly, the mid-year collapse of some small and medium-sized banks in the U.S. triggered a spread of financial panic to some extent. Secondly, the rapid rise of the U.S. dollar index and the yield of ten-year U.S. Treasury bonds presented unprecedented challenges to China’s monetary policy.
The recent Central Economic Work Conference set the direction for the overall economic work tasks for next year, with the risk clearance of the real estate market and its impact on the economy becoming a key topic. This was followed by the need to strengthen market confidence and improve price performance. It should be noted that market confidence and price performance are cyclical processes, which we have continuously emphasized this year. A decline in long-term expectations due to prolonged economic growth weakness will inevitably lead to weaker investment and consumption and increased savings. The conference proposed that “the scale of social financing and money supply should match the expected targets of economic growth and price levels,” marking a significant shift in the central bank’s monetary policy goals in recent years. Additionally, the conference emphasized the inclusion of non-economic policies in the consistency assessment of macro policies, indicating that expectations, in addition to economic data targets, are also a focus of work. This year, each policy stimulus has exhibited a pulsating pattern, improving economic data for 1-2 months before entering a downward trend, with expectations playing a crucial role. Furthermore, the overall tone of “seeking progress while maintaining stability, and promoting stability through progress, establish first and then break” reflects the strategy of seeking progress while maintaining economic stability and implementing reforms gradually. The conference also stressed the importance of expanding domestic demand to create a virtuous cycle of mutual promotion between consumption and investment. This move aims to increase the growth rate of total retail sales of consumer goods to stabilize and boost the economy. In terms of structural economic reforms, the conference focused on technological innovation and the effective use of state-owned assets. It also emphasized moderate reforms in the fiscal and tax systems to address current economic challenges and drive the economy towards a more robust and sustainable direction. Finally, the consistency of macro policies and active public opinion guidance are seen as key to addressing current economic challenges and boosting public confidence. The conference highlighted the importance of enhancing the consistency of macro policy directions and the necessity of strengthening economic propaganda and public opinion guidance, reflecting policymakers’ attention to stabilizing social sentiments and maintaining economic growth momentum.
Looking forward to 2024, the macroeconomy will face triple pressures from real estate risks, expectations, and the pace of the Federal Reserve’s rate hikes. From the current background, the economic growth rate in 2024 is likely to remain around 5%, which means a continued rise in the fiscal deficit rate, maintaining this year’s additional level of 3.8%. Observing the economic data from January to November already published, overall foreign trade is on a recovery path, the impact of macro-control on infrastructure is evident, and consumption is key to domestic demand. Looking back over the past three years, whether in 2021, 2022, or 2023, the key to real estate growth has always been whether the return of real estate sales was smooth. However, from the current situation, even if banks increase credit to real estate through mortgage loans, there are no suitable targets for mortgage, and the significant depreciation of asset prices has gradually reduced financial institutions’ willingness to use them as collateral. The deep adjustment of real estate prices has led to an overall contraction of credit in the economy, with the growth rate of M2 continuously exceeding that of M1, reaching a gap of 8.7 percentage points. High-powered money in the economy continues to decrease, corresponding to weak growth in stock asset prices and the Hang Seng Index. In 2023, despite the overall rise in capital market prices, China’s capital market experienced a continuous decline in the prices of high-liquidity assets. In addition, the collective downward trend in prices, including real estate and the CPI within the economy, indicates a lack of confidence. For investors, this overall weakness in monetary targets makes it impossible to achieve appreciation through internal asset allocation, with real estate, being the largest target, inevitably leading to a slow credit pattern. Furthermore, from a monetary perspective, the low growth rate of M1 indicates that residents and businesses are still keen on increasing savings. If the economic stimulus plan for 2024 still relies on issuing consumption vouchers, it will not work, as observed in some cities since early 2023, where this approach has not changed the weakening trend of M1, nor has it reflected a rebound effect, suggesting that the contraction in consumption is not just a concept of income and savings, but a result of insufficient long-term expectations of residents for the next 1-2 years.
From a causal analysis perspective, the weakening of residents’ expectations stems from a decrease in income, a reduction in employment opportunities, and a rapid contraction of high-powered money leading to a decline in the prices of RMB assets. This decline in asset prices, combined with debt issues, has absorbed a significant amount of liquidity in the economy. From this standpoint, the economy next year will still face immense pressure from debt issues, especially under the condition of tight fiscal balance and substantial depreciation of collateral held by local commercial banks, posing a significant challenge to the stabilization of the national economy. In the following text, we will make predictions in four directions: the turning point of real estate, the confidence in economic expansion, external pressures, and the market pressures on the domestic banking industry.
The Turning Point of Real Estate
The issue of real estate was a lingering problem of 2023. From the current data, although its share in GDP shows a rapid contraction trend, past problems still cause liquidity in the economy to be tense. As an important component of the market economy, supply, demand, and price are closely linked, thus raising the question of where the reasonable price of real estate actually lies. Since real estate issues gradually surfaced in 2022, the capital market has ceased injecting liquidity into it, leading to an increasing number of debt defaults, with Evergrande’s debt accumulating to a trillion scale. Observing from the balance sheets, most real estate companies have depleted cash flows, with their main assets being housing inventories. This means that there is no problem with supply; rather, it’s more about how to use price to guide the rise in demand. Since October, nationwide policies have relaxed restrictions on real estate prices, but data from November still shows a downward trend in real estate prices year-on-year and month-on-month, especially as the number of second-hand housing listings continues to rise, suppressing the speed of clearing new housing inventories. We have repeatedly emphasized in our reports this year that the drop in prices, resulting in an inversion, will inevitably lead to a surge in second-hand housing listings in first-tier cities. From the current data of some major cities, this scenario is still unfolding. In the backdrop of price cuts and a sluggish second-hand housing market, it’s difficult for the residential sector to show interest in new houses or even pre-sold houses, leading to the liquidity and sales returns of the overall real estate sector remaining at a low.
The sale of second-hand houses and the reduction of holdings by major shareholders in the financial market have put immense pressure on the overall asset prices in China. Whether these sellers will reinvest the liquidity into the production field after selling assets is a significant uncertainty, but one predictable scenario is that these assets will not translate into consumption power. If long-term expectations are difficult to recover and the funds invested in the production field continue to decrease, then the overall credit cycle will be broken. Here, we can use the volume and prices of second-hand housing listings as a type of data for economic growth points, as these data are relatively rich. Observing such data, real estate prices are expected to continue under downward pressure in the next six months. For homebuyers, the need for long-term loans to purchase homes is based on positive economic expectations. From the current data, even the fall in prices may not be enough to increase the willingness to buy. If prices continue to fall at the current rate, and residents still choose to wait and see, then this might lead to very pessimistic expectations. From the perspective of regulatory policies, if the current relaxed policies do not stimulate the market, then allowing the market’s price fluctuations to operate freely may be a relatively better choice.
There is a critical value P0 for real estate prices, the price at which early homebuyers are willing to continue paying their mortgages. We believe this is also a concern for the regulatory authorities who are hesitant to completely liberalize price fluctuations. Even before the pandemic, a drop in prices for a real estate project would trigger protests from early homebuyers, which often attracted media attention. Now with significant price drops, we believe there is still a protesting group, but their demands have been suppressed by the promise of project completion and have not surfaced, but this does not mean we can ignore them. When prices reach P0, where the current price is less than the price of the mortgage to be repaid, the willingness of early homebuyers to repay becomes a tricky issue. The position of this P0 can be estimated through simple calculations. Assuming the down payment ratio is 40%, when the price drop exceeds 40%, it will definitely trigger this balance. From the currently published data, the overall real estate market is at 80% of its price, which is not yet causing imbalance. However, with the continuous increase of second-hand housing, whether this pressure point will be triggered is questionable. Currently, with prices falling for 17 consecutive months, it is expected that by mid-2024, the market will hit bottom, with about a 7% drop space left from the moving average, still some distance from triggering the balance. However, for homebuyers, such prices are still unlikely to stimulate buying.
Under the framework of uncertainty analysis, if the rate of decline exceeds expectations, then a disastrous credit contraction will inevitably occur. Next, the work of policy should be based on a relatively certain expectation for real estate. A slow and rhythmic decline will provide policy space to reverse the downturn. From the current perspective, time is a critical element. This relative certainty will help alleviate the panic expectations of the residential sector in the four-dimensional space regarding uncertainty. If expectations cannot be improved, then facing such an uncertain future with pessimistic expectations, residents will continue to prioritize savings, tightening liquidity.
How to Resolve the Real Estate Problem?
The approach of active fiscal policy and prudent monetary policy has been maintained for three years. Looking back, fiscal policy has been very proactive in terms of special bonds, special refinancing bonds, comprehensive debt solutions, and additional budgets within the year, continuously expanding the overall toolkit without leading to debt evasion or default. The fiscal policy has been directed towards two goals: firstly, accelerating infrastructure construction, and secondly, maintaining the balance of local finances. From the current data, achieving a tight balance for local governments is not easy, and the active fiscal policies over the past three years have drained the available funds for accounts payable, forcing a further expansion of the policy toolkit. So, in such a context, will the fiscal policy in 2024 still have enough strength to support the real estate market? If real estate assets are purchased by issuing special government bonds, then returning to the original question, the equilibrium point of real estate prices is crucial. If done too early, before reaching the equilibrium point, fiscal liquidity will be completely lost, reflected as fixed assets on the balance sheet. An important issue is that fiscal liquidity is not cost-free; when liquidity is completely solidified, the overall deficit level will increase.
When we look forward to economic growth in 2024, the focal points of fiscal and monetary policy will fall on real estate prices. The Central Economic Work Conference’s emphasis on aligning the money supply with economic growth and price expectation targets focuses mainly on real estate expectations in the current economy. When the expectation of housing prices continues to fall, there will be no buyers using loans or other leveraged methods to purchase assets, which will naturally lead to a contraction in credit and directly affect the CPI, reflected as a decline in the price levels within the economy.
Currently, the Pledged Supplementary Lending (PSL) seems to be a more practical solution, which involves the central bank directly purchasing assets. This can be implemented in three ways:
1) Direct purchase of bonds and stocks of real estate companies: This method can stabilize stock market prices and protect small and medium investors, but making PSL profitable is challenging.
2) PSL as a re-lending tool: Purchasing real estate loans from commercial banks and securitizing these assets.
3) Direct purchase of physical assets such as new and second-hand houses.
Whether to adopt the PSL model and which specific method to choose mainly depends on the policy’s view of the transmission of emotional changes.
Regaining Confidence through Opening Up
Under the support of proactive and relaxed policies, let’s assume that by June next year, the economy’s debt issues will stabilize, leading to a phase of expanded production. This requires new directions and products for support. The Central Economic Work Conference has laid out the work for industrial technology for next year. Historically, products driven by technological advancement have been the most inspiring. Additionally, institutional factors play a role, particularly the development of the private economy, which has been a topic of much societal discussion. This year, the central government has continually emphasized the importance of the private economy in the national economy. However, there is still some uncertainty in breaking through various pressures to implement various preliminary documents. A significant breakthrough in corporate property rights governance in China is needed, with the real implementation of modern corporate governance systems, including independent directors, shareholder meetings, legal representatives, and executive teams. This will be a key issue at the next Third Plenary Session.
Following institutional issues is the question of whether there has been an increase in wealth levels. The weakness of the capital market this year has mainly been due to credit contraction, with market confidence warming up on the basis of the comprehensive debt solution. Looking at the present, we need to make some assumptions for the longer term. Suppose the economic growth rate remains between 4-5% over the next five years, with 2024 likely maintaining a level of around 5%, partly due to the low base in 2023. However, to maintain this level for the remaining four years is not just a matter of macro-control, it requires liberating thoughts. We need to review the efforts made since the reform and opening up in building a market economy, motivating everyone with an open market, and more importantly, encouraging creativity with market prices. A big environment for innovation and entrepreneurship firstly requires open thinking, followed by the opening of capital markets. A reasonable financial market and management model are urgently needed in China. What we do not need are mere slogans or the continuous snowballing of debt, which binds the future of young people. Under the framework of asymmetric equilibrium, these weary young people find it hard to possess the spirit of entrepreneurial innovation. Therefore, short-term confidence stems from policy solutions to debt problems, while long-term confidence must come from expanding openness.
Federal Reserve Rate Cuts
At the Federal Reserve’s interest rate meeting in December, Chairman Jerome Powell’s core discussion with reporters focused on two questions: 1) When will the Fed cut rates? 2) The judgment of the rate cut timing. Currently, after three pauses in Fed actions, market expectations have undergone significant changes. In the post-meeting press conference, Powell emphasized the balance of risks when asked about future economic recession risks and the risk of inflation rebounding. This means he brought forward the risk of economic recession, indicating that Powell will consider the overall economic progress and pointed out the prospect of rate cuts, signaling a potential prelude to economic recession, which had not been indicated before. Regarding price stickiness, Powell expressed some concern, especially since the core Personal Consumption Expenditures (PCE) remains at a high level. However, he confidently believes that the economy has not yet reflected the later effects of higher interest rates, suggesting that he does not see price stickiness as a major issue. Subsequently, the market anticipated three rate cuts, totaling 75 basis points.
Currently, we need to closely monitor whether inflation will fluctuate or if its decline will be too slow. As of now, the Fed has sold off a trillion in assets in the financial market, but the NASDAQ continues to rise, without signs of peaking or weakening. Based on this, we can consider several future scenarios. The first is that the speed of price declines exceeds expectations, possibly leading to an earlier start of rate cuts, beginning in the second quarter. Looking at the current level, it seems unlikely that the first quarter’s three data disclosures will bring the CPI close to 2%. The second scenario involves external input inflation, especially with energy prices stabilizing, and the U.S. economy gradually achieving a soft landing at a steady pace. In this context, starting to cut rates in the third quarter seems to be the best choice. The last scenario is continued economic overheating. If the Fed continues to sell assets while facing rising data in consumption, production, and investment, especially with the ongoing rise of the NASDAQ, this may force the Fed to restart rate hikes in the short term and accelerate the sale of financial assets. Currently, the second scenario seems more likely.
From a correlative perspective, the overall release of U.S. dollar liquidity is good news for the global capital market next year, especially beneficial for China’s capital market. The appreciation of the Renminbi provides considerable space for monetary and fiscal policy, meaning that next year’s policies can be more aggressive.
Challenges Facing the Financial Market
The pause in interest rate hikes and the expectations of rate cuts by the Federal Reserve have led to a steady rise in the Renminbi exchange rate and a gradual narrowing of external pressures, opening up space for monetary and fiscal policies. However, internally, there are still numerous challenges. The rapid contraction of high-powered money has led to a general decline in the prices of Renminbi assets, and the real estate sector, being a core target for assets and credit, continues to suppress overall liquidity. From the current perspective, the key to liquidity in the financial market lies in confidence, as evidenced by the divergence of high M2 supply and low demand.
For the banking industry, this economic environment presents both challenges and opportunities. Firstly, the steady rise of the Renminbi exchange rate and the gradual narrowing of external pressures may enhance the banking industry’s capabilities in foreign exchange transactions and demand for cross-border financial services. At the same time, the relaxation of monetary and fiscal policies provides banks with more liquidity and room for credit expansion. However, due to the rapid contraction of high-powered money and pressures in the real estate market, the banking industry faces the issues of declining asset quality and increasing risks of bad debts. Currently, a large number of small and medium-sized banks are facing this severe test.
Secondly, the resolution of local debt problems may have a significant impact on local banks. Local financial institutions are key in resolving local debts, whether through restructuring, mergers and acquisitions, or extensions, all of which require bank liquidity support. Whether debt resolution schemes will excessively absorb liquidity is a problem that needs to be faced next year.
Banks need to take measures to strengthen credit risk management and actively explore new sources of income, such as digital financial services and green finance. Moreover, confidence is key to financial market liquidity. In this regard, banks can enhance public and investor confidence through increased transparency and robust financial management. Especially under the conditions of high M2 supply and low demand, banks need to manage their balance sheets more cautiously to maintain stable and sustainable growth. Overall, the banking industry, in the current economic environment, faces challenges but also has opportunities for transformation and innovation. Actively applying market-based risk resolution principles is the best approach in facing these significant uncertainties.
Conclusion:
Looking forward to the entirety of 2024, the Chinese economy is expected to exhibit an overall stable demeanor. We can broadly categorize the outlook into two possibilities concerning how debt issues will evolve in the coming year. Firstly, if a comprehensive debt resolution plan emerges and is actively implemented at the beginning of the year, it will significantly improve both market confidence and the expectations of prospective homebuyers. More importantly, it will aid in restoring the economic cycle. Secondly, the central government may opt for a strategy of “buying time for space,” allowing risks to gradually surface as debts mature and addressing issues through market mechanisms. This approach of natural risk clearance is advantageous for avoiding short-term shocks but is extremely unfavorable for the quick recovery of confidence. On other levels of the macroeconomy, investment and consumption will be anchored by the debt issue. From an overall causal perspective, the resolution of debt issues remains fundamental. Additionally, exports and global trade, as well as the level of the Renminbi exchange rate, are closely linked. In 2023, China’s export pattern underwent significant changes, with exports to the Belt and Road and ASEAN regions rapidly increasing, while exports to Europe and America saw a certain decline. This pattern is expected to continue in 2024, especially as American consumption gradually cools down, and China’s trade will be taken over by developing countries, entering a new normal.
Throughout the year, in the face of significant challenges such as real estate and other debt issues, the proactive steps of monetary and fiscal policy may not be directly reflected on the economic surface. The resolution of debt issues is the foundation for the macroeconomy to soar again. Whether looking from a causal or correlative perspective, the pressure on economic growth next year will not be less than this year. At the same time, high-quality development is not just about a comprehensive breakthrough in the level of science and technology; it also requires open thinking as a prerequisite. When discussing the creation of a unified national market and breaking down market barriers, we must believe that the warm winds of reform and opening-up remain as gentle as ever.