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The 24th �۶���Ƶ Greater China Conference (GCC), held in Shanghai from January 8-12, 2024, attracted a significant number of clients and participants. This is clearly a reflection of the great interest surrounding China and its economic outlook. How far has the burst of the real estate bubble gone? Will China be able to maintain its 5% GDP growth rate in 2024 and beyond? And what is the outlook for Chinese assets?

In this brief note, I share eight key highlights from the conference, including reflections on many insightful discussions I had with clients from central banks, sovereign wealth funds and other institutional investors.

1. Larry Summers on the secular stagnation
The most prominent external keynote speaker was former US Treasury Secretary Lawrence H. (“Larry”) Summers. In addition to providing views on the global economy and next monetary steps of the US Federal Reserve (Fed), he also shared his perspective on China.

The best way to describe his view is as follows: the secular stagnation has moved East! Summers has been an advocate of the secular stagnation story affecting the global economy for a long time, and China is now facing the same problem. The People’s Republic has a high (private household) saving rate; in the past, these excess savings were channeled into exports and infrastructure, thus fueling the country’s spectacular growth.

These two growth drivers were supported by two factors: first, an unprecedented period of hyper-globalization with the Western world almost completely open to Chinese exports; and second, the need to catch up on infrastructure development as the country is moving up from a very low level of per capita income. Both these drivers have lost steam: The era of hyper-globalization ended with growing protectionism (particularly against Chinese goods) and “friendly onshoring” by Western corporates, and infrastructure spending has reached its limits.

The weakening of these two growth drivers has essentially reduced what economists call the “absorption capacity” of the economy. This is a profound and long-term problem that many analysts believe will require the implementation of structural economic reforms.

2. Domestic consumption and green transition as growth drivers
Dr. Zhu Min, former Deputy Governor of the People’s Bank of China, shared insights on Chinese real estate and economic growth drivers. Dr. Min expects the real estate problem to affect China “for years to come”, which goes back to the previous point about the “absorption capacity”. There is a lot of supply but not sufficient demand in the real estate sector. The problem will be resolved when this excess supply will finally be re-absorbed.

Two future key growth drivers will be domestic consumption and the green transition. Domestic consumption is being hampered by the higher household saving rate. A key question is why Chinese consumers are unwilling to increase consumption after years of harsh lockdowns.

On one hand, there is the usual problem of the weak welfare state – pensions, health and education – which keeps the saving rate of Chinese households higher than what it should normally be. This is a structural problem, and the policy response should be a rapid expansion of the welfare system to lower the saving rate and boost spending.

On the other hand, the problems in the real estate sector and rising youth unemployment make households more risk averse. This is a classic liquidity trap, and it is a challenge to move away from this situation. An improvement in the real estate sector and a rise in (youth) employment are required to increase the willingness of individuals to spend.

In terms of the green transition, it is impressive to see how the adoption of electric vehicles (EVs) has spread across China, and there is no doubt that China is well-positioned to become a future leader in this key economic sector. China is also building a “new clean energy sector”, which requires massive investments. This is one of the bright spots in the lower absorption capacity issue discussed above.

Another bright spot is the scaling up in value chains (e.g., in the semiconductor sector) driven by geopolitical tensions: An impressive 50% of private investments are currently in this sector.

Will these “new” drivers of growth be strong enough to keep the GDP growth rate at around 5%? Min’s answer was yes and no. It will take time to see whether this will be enough. What is certain is China faces new obstacles in taking advantage of these growth drivers: a) Geopolitics: e.g., given the low Chinese per capita income, the EV sector needs exports to reach a sufficient scale – however, protectionism is on the rise, and in Europe, the debate on how to block the “invasion” of cheap Chinese cars has already started; b) moving up in the technology value chains still requires access to Western technology – at least in an initial phase – but this has become a national security concern in the West with obvious implications for China.

3. Structural versus cyclical factors
Why has the Chinese economic recovery been weaker than expected following the lifting of Covid restrictions?

There are both structural and cyclical factors at play (i.e., cyclical real estate and structural geopolitics), but the fundamental factor is that the balance sheets of households, corporates and the public sector are stretched. This has important implications for the policy response. What is needed is a multi-faceted policy response centered around three areas.

First, fiscal expansion to alleviate the balance sheet situation of households and corporates and structural fiscal policies; second, monetary policy to support structural changes (i.e., channel liquidity into the growth sectors discussed above); and third, policy support for digitization (moving up technology value chains) and the energy transition.

Are these policies being implemented? Based on discussions with public officials, the answer is not clear. Chinese officials are clearly aware of where the problems are, but many acknowledge that a coherent and robust policy approach to tackle them has yet to emerge.

There are two issues at play. First, a lack of predictability that prevents public officials from taking action, and second, the tradeoff between certain goals, i.e., common prosperity or more equality and growth. For decades, the focus of Chinese leadership was on growth, but this is no longer the case. Another question is about who is really in charge? Over the past few years, there has been a centralization of power at the top, and some ministries, agencies or institutions have been sidelined. A good example is the perception that the central bank has lost some influence: in the past, the macroeconomic and financial stability has largely been the result of cautious central bank policies.

4. Monetary and foreign exchange policy
According to many experts, monetary policy in China – currently facing deflation – should be more expansionary with more rate cuts (but no quantitative easing). Last year, the People’s Bank of China (PBOC) implemented only moderate rate cuts, while inflation decreased by much more. Consequently, real interest rates have increased.

The main reasons why the PBOC abstained from further rate cuts is that the central bank did not want to further increase the interest-rate differential with the United States in the context of sharply declining capital inflows and the risk of increased capital outflows. China is indeed making use of capital controls, which provides some comfort for the stability of the Chinese renminbi (RMB); however, the memories of 2015, when the central bank spent a staggering 1 trillion USD in reserves to defend the RMB, are still vivid.

The stability of the RMB is a central pillar of the Chinese policy framework, and the central bank is likely to wait for the Fed to cut rates before it feels comfortable to cut more aggressively. Chinese officials never discuss a devaluation of the RMB in spite of economic challenges such as lower growth, deflation or the bursting of the real estate bubble. There are fears that such a move might cause a spiral of a weaker RMB, inflation and capital outflows that could ultimately further destabilize the economy. Furthermore, there is also a political angle: China is (still) keen to boost the international use of the RMB, and a managed devaluation of the RMB would not play well in this regard.

5. How much do geopolitics matter?
The impact of the new geopolitical environment for China is significant. National security has become a key government policy, which interferes with the structural policies required to rebalance the economy.

The Chinese economic miracle of the last decades took place in a very different external environment. It did not happen by promoting specific strategic sectors, but rather by creating a generally business-friendly environment. Coupled with a domestic environment that is no longer entirely supportive of the private sector, the changed external environment is perceived as an impediment to the continuation of the Chinese success story.

This view is not only shared by investors, but also by several officials. On the domestic front, the protection of copyrights, maintaining the openness of the country and creating a growth-supportive environment are all fundamental.

Will we see an improvement in the geopolitical situation for China? Preventing a decline in bilateral US-Chinese relations would already be perceived as a positive outcome in 2024. A worsening of the situation would open the door to increased controls of foreign direct investments in China by Western companies (beyond sensitive sectors) and the introduction of limitations to investors’ portfolio flows into China.

Many Chinese would welcome a reelection of former US President Donald Trump because he is perceived as someone you can make a deal with. However, Chinese officials are also well aware of the bipartisan US antagonism toward China. Regarding Taiwan, the general consensus (before the Taiwanese presidential elections in mid-January) was that China will not take any aggressive unilateral action. However, the risk of sanctions (e.g., against the PBOC similarly to what happened to the Central Bank of the Russian Federation over the Ukraine conflict) is on the table. The perception is that this risk is currently not priced in.

6. Is China following the Japanese route?
The similarities between China today and Japan at the end of the 1980s are significant: an export-led growth model and a massive real estate bubble burst. Some observers expect China to experience a prolonged period of below-potential growth similar to Japan in the 1990s.

However, there are several important differences between the two countries that matter. First, when the real estate bubble burst in Japan, its per capita income was similar to that of the US. In comparison, China’s per capita income is still only one quarter of US levels. Second, Japan was at full employment, while China has still room for a further labor supply expansion – i.e., the youth unemployment rate is high. Third, China has capital controls in place and can keep the massive amount of national savings in the country (financial repression). The parallels between China and Japan will remain a topic of conversation with investors going forward.

7. Muted foreign capital inflows
Currently, the PBOC does not see capital flowing back into the country. The attitude of institutional investors is heterogenous with different sensitivities. Based on conversations with sovereign institutions, including central banks and sovereign wealth funds, we can distinguish between three different positions.

First, investors driven by geopolitical concerns and sanction risk; they pulled out of China and are unlikely to return any time soon. This applies mainly to investors in the US, Canada and selected European countries. Second, investors such as many pension funds from Europe and Asia, who are not concerned about geopolitics but want to see more clear evidence of a stabilization in the Chinese real estate sector and the economy. Third, investors with a long-term view, who want to have exposure to China as one of the largest economies in the world, and who are taking advantage of current opportunities in Chinese assets. These are predominantly Middle Eastern and selected Asian sovereign wealth funds plus selected central banks that are still building up exposure to RMB fixed income.

8. Mixed outlook for Chinese assets
Most investors are currently bearish on China. As such, we need some positive developments – i.e., a real estate stabilization, more fiscal and monetary policy action, as well as a decrease in geopolitical tensions – to see significant improvements in investors’ appetite and a resumption of foreign capital inflows.

However, given the unanimously bearish consensus, even just moderate improvements might suffice to revive Chinese risky assets; this is why we see some investors making a move into Chinese equities. We should also not forget that the question is not whether China will fall into recession, but rather whether it will be able to maintain a GDP growth rate of 5% in 2024 and beyond; this is a higher rate than that of all advanced economies and many emerging markets.

With regards to RMB fixed income, there is little correlation with Western fixed income markets, which still provides diversification benefits. However, foreign-exchange risk is perceived as high. Should the Fed cut rates in 2024, the PBOC will likely follow suit. The RMB yield curve is currently flat. Yet, in case of a stronger recovery, we could see an increase in short-term interest rates.