Former advisor to China's central bank calls for more govt investment
Yu Yongding stands by expansionary fiscal stance, argues investment -- not consumption -- is the true long-term engine of the economy
China released its Q1 foreign trade figures yesterday, with exports rising by 6.9% (a 13.5% increase in March alone) and imports falling by 6%. Many media outlets have described the export surge in March as a final push before the full impact of Trump's tariffs sets in.
The anticipated decline in exports over the next few months, or even years ahead, will undoubtedly affect China, traditionally an export-driven economy.
Against this backdrop, the China Macroeconomy Forum (CMF) at Renmin University of China hosted an online seminar on April 9th, discussing the necessity and feasibility of China's 5% annual economic growth target. Six scholars shared their thoughts during the session.
Yu Yongding, former senior economist at the Chinese Academy of Social Sciences and former monetary policy adviser on the People's Bank of China's Monetary Policy Committee, reaffirmed his stance on expansionary policies in the online seminar, advocating for increased government investment.
He then presented several critiques: First, he challenged the argument that a decline in growth is inevitable. Second, he criticized the viewpoint that expansionary policies are not suitable due to overcapacity. Third, he opposed the notion that fiscal balance should be prioritized without considering the sustainability of public finances. He argued that greater focus should be placed on the long-term sustainability of fiscal policies. Fourth, he questioned the idea that "investment-driven growth is unsustainable," noting that growth driven by consumption is economically unsound. He then discussed the dynamic interaction between investment and consumption, ultimately criticizing the theory of infrastructure saturation.
Furthermore, Yu analyzed the impact of current tariff rates and how to mitigate their effects, ultimately concluding that strengthening infrastructure investment remains crucial. He emphasized that to achieve the 5% GDP growth target, China should capitalize on its significant room for borrowing and increasing deficits by 2025. Additionally, he emphasized the need for central government financial support to alleviate the fiscal shortfalls faced by local governments.
The following is a translation of the transcript published on CMF's official Wechat account. Please note that the English translation has not been reviewed by the speaker.
I. The Necessity of Achieving the 5% Growth Target
1. Stabilizing expectations
Since 2010, China's GDP growth rate has been on a downward trend. Since 2016, the country's economic trajectory has been described as "L-shaped," yet the bottom of this "L" has not yet been clearly defined. It is essential to reach that bottom soon. After achieving a 5.2% growth rate in 2024, meeting the 5% target in 2025 will strengthen market and public confidence in China's economic rebound. Increased confidence will stimulate consumer spending and investment, creating a positive feedback loop for economic growth.
2. Achieving relatively full employment
Through field surveys, I've found that the employment situation is far more severe than I initially thought, especially for people between the ages of 35 and 40. This group faces significant challenges in finding new jobs once they become unemployed. Although the elasticity of job creation has decreased and there are many reasons leading to unemployment, economic growth remains the foundation for solving unemployment. Achieving a 5% or higher economic growth rate is essential for ensuring relatively full employment. Employment is not just an economic issue but a social one, making the 5% target not just an economic goal but a serious political task.
3. Overcoming the "Hysteresis Effect"
The "hysteresis effect" in economics refers to a situation where, after an economic shock, the system does not return to its original equilibrium, even after the shock fades, but instead stays at a new, lower level. To overcome this, the government must implement strong counter-cyclical measures as soon as possible to restore the economy to its previous state and prevent declines in growth and rising unemployment from becoming permanent. For example, once a research team is disbanded, it's difficult to reorganize, and long-term unemployment can lead to the permanent loss of skills. The longer the economic slowdown lasts, the more damaging the hysteresis effect becomes, and the harder it will be to return to a higher growth rate. Achieving 5% growth in 2025 would mean that China's economy has already bottomed out and started to recover in 2024, reinforcing the recovery process. Otherwise, this "recovery" would have to start over.
4.Ensuring the achievement of the centennial goal
At the 5th Plenary Session of the 19th CPC Central Committee in October 2020, the goal was set for China to reach the level of a moderately developed country in terms of per capita GDP by 2035, indirectly doubling the per capita GDP from 2020. To meet this target, the National Development and Reform Commission (NDRC) has calculated that the average annual GDP growth from 2021 to 2035 should be 4.95%, with an average of 5.01% during the 14th Five-Year Plan period. Many economists believe that, given the pattern of higher growth at the beginning and slower growth later, China's GDP should at least reach 5% in 2025.
5.Ensuring National Security
When setting the economic growth target, it's crucial to consider the geopolitical landscape. Currently, China is in intense competition with the United States. To ensure national security, it is essential to narrow the GDP gap with the U.S. A smaller GDP gap will provide stronger security for China's national safety.
II. The Feasibility of Achieving the 5% Growth Target
1. In 2024, China's GDP growth reached 5%, while key indicators like the GDP deflator, CPI, and PPI were negative or close to zero. Historically, when China's economy achieved growth rates of 13.1% in 1994 and 9.8% in 2008, inflation was much higher, at 24.1% and 5.9%, respectively. High inflation typically limits further growth, but in the current low-inflation environment, there is significant potential to achieve higher growth. From this perspective, it's entirely feasible for China to increase its economic growth beyond 5%.
2. China still has substantial room for fiscal and monetary policy adjustments. The 2025 fiscal deficit is projected to be 4% of GDP, with a deficit of 5.66 trillion yuan. The total new government debt will amount to 11.86 trillion yuan, including national debt, ultra-long special treasury bonds, special treasury bonds, and local government bonds. The broad fiscal deficit-to-GDP ratio will be around 8%.
According to Finance Minister Lan Fo'an, China's total government debt was 85 trillion yuan in 2024, with government debt to GDP at 67.5%, which is lower than that of many other major economies. For example, Japan's debt-to-GDP ratio is 249.7%, while Italy's is 134.6%, and the U.S. stands at 118.7%. China's 10-year government bond yield remains low, between 1.5% and 1.8%.
China's monetary policy also has room for easing. The weighted average reserve requirement ratio for financial institutions is 6.6%, while many Western countries, including the U.S., have a ratio of 0%. This indicates that China still has significant room to reduce the reserve requirement if necessary. The central bank’s policy interest rates, such as the open market operations (OMO) and medium-term lending facility (MLF), are currently set at 1.5% and 2%, respectively, indicating further room for adjustment.
On December 9, 2024, China's top leadership signaled a shift towards more proactive macroeconomic policies, emphasizing active fiscal measures, moderately loose monetary policies, and strengthened counter-cyclical adjustments. This shift marks a significant and necessary change in government policy, based on over a decade of practical experience and lessons learned. Past policy shortcomings have been identified and addressing them will strengthen the implementation of the new counter-cyclical adjustment strategy.
III. Five Misconceptions About Macroeconomic Policy
1. The "inevitable" slowing of economic growth
It's often assumed that once per capita income reaches a certain level, economic growth will inevitably slow down. While this idea has some basis, it shouldn't serve as the guiding principle for economic policy. Take Argentina as an example: in 1964, its per capita GDP was $1,000, rising to $8,000 by the late 1990s, then dropping to just over $2,000 in 2002, and climbing again to $8,236 in 2008. This case shows that it's difficult to pinpoint exactly when Argentina's economy entered a specific growth phase based on per capita income alone. So, while factors like an aging population, diminishing returns, environmental costs, delayed reforms and geopolitical issues can explain part of the slowdown, predicting the exact rate of decline is impossible.
Long-term factors don't fully explain short-term changes. For example, in 2011, China's economy grew at 9.6%, while in 2015, it slowed to 7%. Yet, the working-age population in 2015 was higher than in 2011. Although aging is a concern, China's biggest challenge today is unemployment, not labor shortages.
Many long-term factors cancel each other out. For instance, urbanization and technological advancements, such as big data and AI, can offset the negative effects of an aging population on economic growth.
Economic growth should be analyzed on a case-by-case basis. Each change in growth rate, whether in a specific year or quarter, has a direct, identifiable cause. For instance, the better-than-expected growth in the fourth quarter of 2024 can be directly attributed to increases in investment, consumption, and net exports, driven by government adjustments to macroeconomic policies and stronger counter-cyclical measures. This improvement had nothing to do with slow-moving variables like aging. In the short term, economic growth largely depends on policy. In other words, it's within our control.
Economic growth is full of uncertainties, as Franklin once said: "In this world, nothing can be said to be certain, except death and taxes." If we insist that growth can only reach a certain level—say, no higher than 5%—and plan accordingly, we may find that growth will indeed be capped at 5%.
2.The primary task of China's macroeconomic regulation: eliminating "overcapacity"
At the macroeconomic level, there are only two types of imbalances: one where total demand exceeds total supply, leading to inflation and an overheating economy; and another where total demand is less than total supply, resulting in deflation and an economic slowdown. Though there is a third situation, "stagflation," China has never experienced this condition.
For policymakers, the approach is clear: if economic growth is high and inflation is severe, contractionary policies are adopted; if economic growth continues to decline and deflationary pressures become evident, expansionary policies are implemented. In the pre-Keynesian era, when macroeconomic policy tools were nonexistent, an economic crisis meant an overall "overproduction." However, in the more mature post-Keynesian era, macroeconomic regulation targets the economy as a whole, without considering industry-specific structures (as if there were only one product).
If we continue to use the concept of "overcapacity" at the macroeconomic level, it equates to insufficient effective demand. Eliminating "overcapacity" is essentially about stimulating effective demand. Macroeconomic policies can only increase or decrease current total demand (including consumption, investment, and net exports) and cannot change the current capacity determined by previous investments.
If "overcapacity" is identified and investment is reduced, the issue will only worsen. Strictly speaking, "overcapacity" is not a macroeconomic issue but rather an industrial and product-level one. Excess capacity exists at the level of industries and products, and "eliminating overcapacity" is not a macroeconomic policy goal. The policy toolbox does not contain tools to eliminate overcapacity in specific industries (such as steel) or products (like rebar, cement, or electrolytic aluminum).
Excess capacity should be addressed through market pricing mechanisms, supported by national industrial policies. When determining macroeconomic policy direction, policymakers should focus only on inflation rates, economic growth, and unemployment rates. Industry-specific excess capacity should not interfere with the overall direction of macroeconomic policy. Related to this, the concept of "structural monetary policy" and distinguishing between regular revenue and expenditure in the general public budget versus those aimed at stimulating economic growth (or controlling inflation) are areas that merit further study.
3. Maintaining fiscal balance as much as possible
Due to historical factors, the Chinese government has always emphasized maintaining fiscal balance. However, when discussing fiscal policy, the focus should be on sustainability rather than balance. By definition, expansionary fiscal policy leads to fiscal imbalance. The key to sustainability is ensuring that economic growth exceeds the interest rate. In theory, as long as a country's economic growth is higher than the interest rate, its fiscal situation remains sustainable.
In 1997, Japan's national debt-to-GDP ratio was 91.2%, and the combined deficit of central and local governments was 5.4% of GDP. At the time, Prime Minister Ryutaro Hashimoto stated that if Japan continued its current deficit spending, "there is no doubt that Japan's economy will collapse in the next century." To quickly restore fiscal balance and reduce the debt-to-GDP ratio, Japan implemented fiscal tightening policies, aiming to reduce the deficit each year and eventually achieve a surplus until the debt ratio fell below 60%. However, the fiscal tightening led to a severe economic recession in 1997. As economic growth slowed, Japan's debt-to-GDP ratio rose instead of falling, and by 2023, it had reached 255%. Although Japan's economic situation is still challenging, its fiscal and economic systems have not collapsed.
In 2000, based on Japan's failed fiscal "reconstruction" efforts, we developed a framework to assess China's fiscal sustainability: the maximum sustainable debt-to-GDP ratio equals the fiscal deficit rate divided by economic growth. For instance, if the deficit rate is 5% and economic growth is 5%, the maximum sustainable debt-to-GDP ratio would be 100%. If economic growth approaches 0%, even a low initial debt-to-GDP ratio will lead to an "infinite" ratio. Therefore, any debt reduction policy must support economic growth, or it will result in a higher debt-to-GDP ratio rather than a lower one.
Many people underscore the Maastricht Treaty's fiscal rules—3% of GDP for the government deficit and 60% of GDP for government debt. However, these rules have no strict theoretical basis. They were set based on the assumption that European economic growth would be 5%, so 3% divided by 5% equals 60%. The 60% limit likely arose out of concern that Southern European countries would overspend if allowed to join the EU.
China's Finance Minister stated in a press conference on November 8, 2024, that there is still considerable room for borrowing and increasing the fiscal deficit. In fact, by the end of 2023, China's total government debt was 85 trillion yuan, including 30 trillion yuan in national debt, 40.7 trillion yuan in local government debt, and 14.3 trillion yuan in hidden debts. The government debt-to-GDP ratio is 67.5%, far lower than that of most developed nations and even many developing ones. Additionally, China is a high-saving country with over $3 trillion in net international investment assets and 292 trillion yuan in net assets in the government sector (as of 2022). Despite China’s GDP growth rate being around 5% in recent years, it remains much higher than that of other major economies. Not only that, China has managed to maintain high economic growth while keeping the fiscal deficit within a relatively stable range (around 3%-5%). Few countries in the world have such a large "borrowing capacity" and room for fiscal expansion as China. So, if we aim for a 5% GDP growth target, why wait until 2025 to fully utilize this space?
4. Shifting China's economic growth from investment-driven to consumption-driven
Scholars like Paul Krugman have emphasized that China's growth model is heavily driven by investment, and they argue that this is a flawed approach. They believe that if China continues to rely on investment for growth, the economic growth rate will not only fail to improve but will continue to decline. Many domestic scholars agree that China should shift from an investment-driven model to one driven by consumption.
From the perspective of economic growth theory, there is no such thing as a purely "consumption-driven" growth model. Economic growth is primarily driven by capital accumulation, effective labor input, and technological progress. Technological progress, in fact, relies on investment. China's rapid accumulation of capital has been a key factor in its rise as the world's leading manufacturing power and its strong international competitiveness. This viewpoint is supported both by Marxist political economy and traditional Western economic theory. Consumption only stimulates growth when there is insufficient effective demand.
Economic growth models show that the key drivers of growth are investment, labor input, and technological progress—not consumption. Therefore, it's important to distinguish the roles of consumption in driving both short-term and long-term economic growth. In the short term, when effective demand is lacking, consumption can stimulate economic growth and should not be overlooked. However, in the long term, consumption is not the main driver of economic growth unless it is closely linked to improvements in human capital. Additionally, the relationship between consumption and investment should not be viewed as contradictory. The ultimate goal of production is consumption, but investment and consumption are not in conflict. The choice between the two is essentially a trade-off between current consumption and future consumption.
Different nations, cultures, systems, and generations have varying time preferences. East Asian countries generally have higher savings rates, and the "East Asian miracle" is closely related to this strong savings preference. A wealth of empirical studies shows that, over the long term, there is a positive correlation between consumption and investment: without investment, there is no economic growth, and without growth, there is no increase in consumption.
One significant challenge China faces is a large income gap, with the Gini coefficient ranging from 0.45 to 0.46, indicating a high level of inequality. This issue needs greater attention, and policies should focus on addressing it. Specifically, speeding up efforts to support vulnerable groups will also help stimulate consumption.
I want to emphasize that there is no such thing as a purely "consumption-driven" growth model. This is not to underestimate the role of consumption in driving economic growth. In recent years, the growth rate of consumption has lagged behind GDP growth, preventing GDP growth from rising further. A key task for current macroeconomic policy is to boost consumption growth.
The issue is that when discussing the relationship between consumption and income growth, we often fall into a circular argument: for consumption to grow, income must grow, and for income to grow, consumption must increase. So, what is the starting point for growth? Consumption is a function of income, income expectations, and assets. If income doesn't grow, consumption is unlikely to grow. But how do we kickstart income growth?
The logical starting point for stimulating consumption growth must come from a third factor that is neither reliant on consumption nor income. I believe this factor is infrastructure investment, which doesn't depend on either consumption or income. Infrastructure investment funded by the government can immediately generate income. This income boost leads to increased consumption, which in turn drives further income growth. Through the positive cycle of income-consumption-income, the multiplier effect will result in both consumption and income increasing significantly.
Of course, increasing disposable income, direct government payments, tax reductions, and reforming the social security system can also serve as starting points for launching this income-consumption cycle. These policies are logically sound. However, I believe that their effectiveness, costs, and speed of implementation are not as favorable as infrastructure investment. More importantly, infrastructure investment not only stimulates consumption growth but also improves China's growth potential, laying a stronger foundation for faster consumption growth in the future.
How can we combine infrastructure investment with efforts to stimulate consumption? My proposal is as follows:
a. Increase the growth rate of infrastructure investment to boost household income, which in turn will increase consumption.
b. Invest in infrastructure to meet future consumption needs:
"People-centered" new urbanization projects (such as underground pipelines, sponge cities, ramps for elderly, residential insulation, mass transit systems).
Prepare for an aging society by investing in various types of elderly care facilities (based on Japan's experience), professional caregiver training, and wage subsidies.
Hospital construction.
Childcare facilities.
c. Consumer subsidies (for electric vehicles, household appliances, elderly care robots) – while ensuring alignment with industrial policies.
d. Regulate and support the development of extracurricular services (like interest-based skill training) to promote service-oriented consumption (which is more about supply than demand).
e. Increase relevant fiscal expenditure to raise disposable income for specific groups:
Increase coverage and standards for urban and rural pension schemes and social welfare.
Maternity subsidies.
Childcare subsidies.
f. Tax reform to adjust income distribution patterns, reduce wealth gaps, and increase overall consumption in society.
g. Stabilize the real estate and stock markets.
h. Create a conducive environment for corporate innovation (as the saying goes, "supply creates demand" — high-quality animated films will naturally attract viewers).
5. China's infrastructure investment is saturated and its efficiency is too low
The key to infrastructure investment lies in its social benefits, not short-term commercial returns. Take high-speed rail as an example: while it still operates at a loss, its social benefits are significant and undeniable. Western countries, by overemphasizing commercial returns, have often overlooked the broader social value of infrastructure investment, which has affected their economic growth. In China, infrastructure is not saturated, and we should not solely focus on high commercial returns. Instead, the focus should be on social returns and their broader societal impact. Of course, measuring these social benefits is complex and requires extensive research.
State and state-owned enterprise investments in infrastructure are essential for the development of related industries. For example, China has invested over 730 billion yuan in 5G infrastructure. By July 2024, the total number of 5G base stations reached 4.04 million, and the number of 5G mobile users had reached 966 million. The main investors in this infrastructure are China Mobile, China Unicom, and China Telecom, with some internet companies and equipment manufacturers also involved. The government has provided some support as well. Without base station construction, companies like Alibaba, Tencent, and Huawei could not have developed. Without substantial power generation capacity, where would the computational power for big data come from? And how could start-up companies thrive?
On December 12, 2024, the Central Economic Work Conference called for "increasing the efficiency of investment." This includes, as for me, not only commercial returns but also broader economic and social benefits. The three major telecom operators involved in building base stations are doing quite well financially. However, other projects, such as high-speed rail, have faced significant losses before 2023, according to China Railway Group's financial reports. Still, the economic and social benefits of high-speed rail are enormous. For example, building lighthouses might not bring commercial returns, but their social value is clear. The construction of the high-speed rail network has reshaped China's economy and social life, with its social benefits being immeasurable. However, the operational profits of high-speed rail may not be high.
China's infrastructure investment and construction capacity are institutional advantages. During periods of insufficient total demand, this advantage should be leveraged to its fullest. What should infrastructure investment focus on? Based on incomplete information from relevant departments, infrastructure investment should target the following areas:
a. People-centered new urbanization: This includes upgrading urban infrastructure, such as improving safety in city pipelines (gas, heating, sewage systems), renovating old residential areas, comprehensive upgrades in urban villages, and enhancing urban transportation facilities.
b. Green energy projects, such as the Yarlung Tsangpo Grand Canyon hydropower station.
c. Building transportation and information networks connecting cities by land, sea, and air.
d. Massive equipment upgrades related to industrial policy, supporting high-tech development driven by enterprises (replacing old with new should be part of this).
e. Addressing gaps in industrial systems and supply chains.
f. Elderly care facilities and professional training, related to an aging population.
g. Welfare arrangements for vulnerable groups.
2025 will be a year of unprecedented challenges for China's economy. If Trump continues his aggressive policies towards China, the country's economic growth will suffer even more than in 2008, as external demand plummets. In such extraordinary times, extraordinary measures are needed. We should consider introducing a large-scale stimulus plan similar to the 4 trillion yuan package. The "Western Development Strategy" should be a key option. Since its implementation in 1999, the strategy has achieved significant progress, greatly improving infrastructure, protecting the ecological environment, developing emerging strategic industries, and advancing the new land-sea corridor in the West. The development potential of regions like the Pearl River Delta and Yangtze River Delta has already been largely tapped. The question is whether the government can further push forward the "Western Development Strategy," focusing on large-scale infrastructure investment along the Hexi Corridor towards Central Asia, creating a new economic corridor. The Western Development Strategy not only has major economic implications but also significant geopolitical importance.
IV. How China Can Achieve 5% GDP Growth in 2025
First, let's consider the possibility of net export growth in 2025. According to customs data released last year, China's trade surplus reached 7.06 trillion yuan, growing by 22.1% year-on-year, although other numbers show discrepancies. Given the ongoing tariff war with Trump and shifts in the global economy, most investment institutions predict negative net export growth for China in 2025. When analyzing the impact of Trump’s tariffs on Chinese exports, factors such as the share of exports in GDP, the proportion of Chinese exports to the U.S., the share of domestic value added in exports, price elasticity, and tariff pass-through must be taken into account.
Based on these factors, most studies estimate that if Trump imposes a 60% tariff on Chinese goods, China's GDP could shrink by around 1 percentage point, with a higher reduction in growth. Naturally, the impact would vary with the addition of another 34% tariff on top of the current 20% rates. Most predictions suggest negative net export growth in 2025. For simplification, I’ll make two optimistic assumptions: net export growth will be zero, and final consumption growth will reach 5%. Given their respective shares of GDP at the end of 2024, we can estimate that they will contribute 2.8 percentage points to GDP growth. In this case, to achieve the 5% growth target, capital formation would need to contribute 2.2 percentage points. Based on the share of capital formation in GDP at the end of 2024, capital formation would need to grow by 5.4% in 2025.
Since we lack detailed data on fixed capital formation, I’ll use this concept as a proxy for capital formation. The manufacturing sector performed well last year with a growth rate of 9.2%, so let's assume it will maintain that rate this year. Real estate investment declined by over 10% last year, but let’s assume it will recover to -5% in 2025, starting to stabilize but still showing negative. To achieve the required 5.4% growth in capital formation and a 2.2 percentage point contribution to GDP growth, infrastructure investment would need to grow by 5.7%.
However, if final consumption growth falls short of 5% and instead reaches 4%, infrastructure investment would need to grow by 10.5%. Given the unfavorable export conditions China faces in 2025 and the difficulty in significantly boosting final consumption growth, achieving 5% GDP growth will require double-digit growth in infrastructure investment. It's clear that achieving 5% growth in 2025 is quite challenging, but with effort, it remains possible.
I want to emphasize once again that the most effective way to achieve the 5% growth target is still to significantly increase the growth rate of infrastructure investment and use it as the primary driver of economic growth. As outlined in the Chinese government work report, it's crucial to align with national development strategies and people’s needs, maximizing the role of government investment in supply, coordinating fiscal and financial policies, enhancing project reserves and resource guarantees, accelerating the implementation of key projects, and ensuring the successful completion of major projects in the 14th Five-Year Plan. The policy direction has been set, and the main task now is to select the right infrastructure projects and implement them as soon as possible.
While this year's fiscal policy has been quite expansionary, to counter the negative impact of Trump's tariff policies and achieve the 5% growth target, fiscal policy may still need to be further strengthened, with the scale and intensity of infrastructure investment being expanded accordingly. However, the exact scale of investment will need to be determined by the relevant authorities.
To achieve the 5% growth target through increased infrastructure investment, the issue of local government funding shortages must be addressed. Local governments have long been responsible for infrastructure investment, but it has been difficult for them to get the necessary financial support from the central government. They must rely on their own resources to solve this funding issue. For example, in 2021, the central government's contribution to infrastructure investment was only 0.1%, while local government contributions were 10%, and over 50% of funding came from financing platforms. As a result, local government debt has become increasingly problematic. The central government needs to increase its contribution. In the previous 4 trillion yuan investment plan, the central government contributed 1.18 trillion yuan, but this contribution has gradually decreased since. While this approach helped reduce the fiscal burden on the central government and maintain budget balance, it has hindered local development and China's long-term economic growth.
The Ministry of Finance strictly manages local government debt and has set clear standards for debt ratios (debt/local government fiscal capacity). For instance, according to a January 2022 regulation, debt risks are categorized into different levels, such as red, orange, and yellow zones. Generally, local government debt should not exceed 200%. However, most counties and cities in China struggle to meet this standard, significantly limiting their investment capacity. While it is necessary to strengthen debt risk control, it's important to avoid discouraging local governments from making investments.
V. The Impact of Trump’s Tariffs on the RMB Exchange Rate
Since 2015, China has experienced a capital account deficit in several years, while maintaining a large surplus in the current account. However, in many years, the capital account deficit has outweighed the current account surplus, putting pressure on the Chinese yuan. In 2024, there was a net outflow in securities investment, other investments (including external debt repayments), and direct investments under the capital and financial accounts.
Looking to 2025, there are a few key points: First, the adjustment of foreign investment reducing holdings in Chinese assets that started in 2024 is largely finished. Coupled with China's impressive performance in high-tech industries and the recent revaluation of the U.S. stock market, securities investment may shift from a net outflow to a net inflow. Second, the pressure for Chinese companies to repay USD-denominated bonds (mainly in real estate and finance) may ease, though the scale of currency purchases by residents remains uncertain. Third, for many years, Chinese companies have used direct foreign investments to bypass U.S. tariff barriers. With the recent U.S. tariffs on countries that serve as intermediaries for Chinese exports, the wave of Chinese companies expanding abroad may gradually slow down.
Trump’s tariffs will seriously impact China's exports, leading to a significant reduction in the current account surplus. At the same time, China’s capital account deficit in 2025 may decrease compared to the previous year. Overall, China may still have a balance of payments deficit in 2025, but the deficit is not expected to show a significant change from the previous year. The future movement of the RMB exchange rate is difficult to predict. While there will likely be downward pressure on the yuan, the chance of a sharp crash is very small. On the other hand, if the U.S. mishandles the situation, there is a possibility of a significant depreciation of the U.S. dollar. In general, the RMB to USD exchange rate should remain relatively stable, and any depreciation would likely stay within manageable levels. Moreover, given China’s large foreign exchange reserves, the central bank has the capacity to intervene in the foreign exchange market. While I generally advocate for minimal intervention, in special circumstances, necessary interventions are acceptable.
What is concerning is that the trade war could extend to China’s overseas assets. As of 2024, U.S. net foreign debt had reached 77% of GDP, totaling $26 trillion, with this trend continuing to escalate. The U.S. fiscal deficit is also growing, pushing its net foreign debt-to-GDP ratio toward 100%. The U.S. is increasingly pursuing the "weaponization of the dollar." Back in December 2013, Martin Wolf warned that if a conflict arose between China and the U.S., there is a high likelihood the U.S. could seize China’s overseas assets. While this would have a huge impact on the U.S., the damage to China would be even greater. The freezing of $300 billion in Russian foreign exchange reserves by the U.S. in February 2022 serves as an example. As U.S.-China trade tensions rise, there is growing concern about whether the trade war will affect China’s overseas assets.
To mitigate the impact of external shocks, we must further expand fiscal and monetary policies to stimulate domestic demand. In the medium to long term, we should accelerate the adjustment of our development strategy, shifting from a model focused on "big circulation" and embracing globalization to a more resilient and self-reliant "dual circulation" strategy, with an emphasis on internal circulation. We face a tough task in adjusting industrial chains and transforming our development strategy, but despite the high costs, we must speed up this transition.
Recently, the U.S. has discussed the so-called "Mar-a-Lago Accord," which plans to exchange U.S. dollar bonds held by foreign creditors for 100-year zero-interest bonds. This constitutes a clear act of default, posing a huge threat to China's dollar-denominated assets. We must prepare for this possibility to minimize future losses.