Will China’s Policy Shifts Finally Deliver for Investors in 2025?

Key points:

• Ineffective Policy Measures: China announced a series of policy measures to stabilize the economy, but their impact has been limited. The shift to a “moderately loose” monetary policy and plans for yuan depreciation aim to support growth, but weak consumer and business confidence, low credit demand, and global tariff risks have muted their effectiveness.
• Focus on Stability: Despite the lack of concrete actions, the government is prioritizing stability. The raised fiscal deficit to 4% of GDP signals a more aggressive stance, but the modest expansion may not be enough to address persistent domestic demand issues and deflation risks.
• Structural Challenges Remain: China faces deep structural challenges, including an aging population, high property inventory, and weak consumer sentiment. Restoring market confidence will require long-term reforms, particularly in healthcare, welfare, and the property market.
• Investment Strategy – Barbell Approach: Given the current environment, investors should focus on defensive sectors like consumer goods, healthcare, and utilities, while also exploring opportunities in autos, internet and green transformation for potential long-term gains.

In 2024, Chinese equities failed to stage a real rebound. Despite a brief rally in Chinese equities following the stimulus announced in September, two-thirds of the gains were erased by the end of November. This reflects the deep structural issues facing the economy. Recent weeks have seen a flurry of policy announcements, signaling intent to support the economy. However, the lack of clarity and concrete measures has muted their impact. Here, we review the recent announcements and economic data, and their implications for investors.

China's Policy Measures: Plenty of Announcements, Limited Impact

Shift to Moderately Loose Monetary Policy

China’s shift to ‘moderately loose’ policy was seen as a positive signal as it came after about 14 years of ‘prudent’ stance. China’s PBOC shifts to a “moderately loose” policy stance, ending its “prudent” stance held since 2011. This shift raised expectations for policy stimulus, similar to the ~200 basis points of rate cuts during the Global Financial Crisis. However, in a balance sheet recession, where consumer and business confidence is weak and credit demand is low, rate cuts have limited impact. Furthermore, China's current policy rates are much lower than they were post-GFC, restricting the potential for further cuts.

Yuan Depreciation to Support Exports

China announced plans to allow yuan devaluation next year to enhance export competitiveness, especially amid the heightened risk of tariffs from the new Trump administration. However, recent efforts to fix the onshore yuan stronger indicate caution against a freefall, which could undermine investor confidence, trigger capital outflows, and create challenges for businesses as import costs rise.

Beijing is likely to focus on keeping the yuan steady to safeguard financial stability and avert full-blown currency wars. That will be its best shot to recovery from its latest bout of headwinds. A more likely path for the yuan, therefore, will be a slow-burn devaluation, rather than a sudden devaluation.

Politburo Meeting Disappointment

The Politburo signaled a stronger stimulus to fill the hole in consumer demand. However, no concrete policy measures were announced, leaving markets disappointed.

Mixed Signals on Economic Data

While some data points, like higher PMIs, showed improvement, the slump in retail sales highlights the ineffectiveness of existing stimulus measures in reviving private demand. November's weak credit data further indicates low borrowing appetite despite stimulus efforts.

Fiscal Deficit Ceiling Raised

China has signaled a shift towards a more aggressive fiscal stance, with plans to raise the headline fiscal deficit to 4% of GDP in 2024. This marks a significant departure from its self-imposed 3% limit and the largest increase since 1994.

This suggests a more aggressive fiscal stance, but the modest expansion—only 1 percentage point of GDP—may be insufficient to address the widening domestic demand gap and persistent deflation.

Property Sector Stabilization

There are signs of stabilization in the property market, with price declines easing for the third consecutive month in November and year-on-year growth in home sales. However, the recovery remains fragile and uneven, particularly in smaller city markets with high inventory levels. While stimulus measures since September have had some impact, there are no signs of a sustainable turnaround in consumer sentiment or economic growth.

Bottom Line: China Facing a Balance Sheet Recession

China is currently facing a complex economic challenge, defined by a collapsing housing market, a sluggish stock market, and decreasing consumer activity. The decline in wealth, due to losses in real estate and equities, has led both businesses and consumers to focus on repairing their finances instead of spending or investing. These are typical signs of a balance sheet recession. As a result, traditional monetary policy tools, such as interest rate cuts or currency devaluation, have proven largely ineffective in addressing these challenges.

The general consensus is that, after making these significant announcements, Chinese policymakers are at a critical juncture where they must take decisive action to reignite growth. While the focus has largely been on monetary measures, there is an increasing need for strong fiscal intervention to revive consumption. However, structural challenges — including deflation risks, hidden local debts, high property inventories, and an aging population — mean that restoring market confidence will be a gradual process, offering only short-term tactical opportunities.

A more optimistic view of China could develop if structural reforms are enacted. The property sector, a major obstacle, requires attention, especially since it is unlikely to continue as a primary growth driver given demographic trends. In the consumer sector, high levels of precautionary savings and low consumer confidence need to be addressed, likely requiring increased spending on welfare, pensions, and healthcare to reinforce the social safety net.

Equities: A Barbell Strategy

Although there are ongoing concerns about the fundamental equity environment in China, the robust stimulus signals from Beijing are difficult for investors to overlook. In navigating the current economic landscape, a barbell strategy in equities may offer a balanced approach, capitalizing on both defensive and offensive opportunities.

Defensive Opportunities

• Consumer: In a balance sheet recession, consumer demand for essential goods remains stable, regardless of broader economic conditions. Consumers are also "trading down" to budget-friendly options, benefiting e-commerce, sportswear, and travel. Any signs of stimulus targeted to boost consumption could fuel further gains in consumer-oriented sectors.
  • Stocks to watch: Yum China, Kweichow Moutai, JD.com, Trip.com
• Auto Sector: China’s dominance in EVs and control of the battery supply chain offers export-driven growth potential.
  • Stocks to watch: BYD, Geely, NIO
• Utilities & Renewables: Utility demand is steady, while the green energy push offers long-term growth potential.
  • Stocks to watch: China Yangtze Power, Longi Green Energy, Sungrow Power Supply
• Healthcare: China's aging population supports sustained demand for healthcare services and pharmaceuticals.
  • Stocks to watch: Wuxi Biologics, Mindray, CSPC Pharmaceutical
• Telecom & Digital Infrastructure: Rising 5G adoption and cloud services expansion provide consistent cash flow.
  • Stocks to watch: China Mobile, China Telecom, Alibaba Cloud
• Internet Sector: Regulatory easing allows internet companies to boost margins, pay dividends, and buy back shares.
  • Stocks to watch: Tencent, Alibaba, Meituan
• State-Owned Enterprises (SOEs): Backed by government support, SOEs offer stability amid market downturns. However, increased focus on reviving the private sector is a key risk.
  • Stocks to watch: China Railway Construction, ICBC, Sinopec

Offensive Opportunities

• Property & Real Estate: While resolving the property-sector crisis can take a long time, any efforts towards helping developers complete projects, reduce housing inventory, and boost households’ purchasing power by lowering borrowing costs could trigger gains in this undervalued part of the Chinese market.
  • Stocks to watch: China Overseas Land, Country Garden Services
• Export-Oriented Companies: Yuan depreciation enhances China's export competitiveness, boosting exporters.
  • Stocks to watch: Xiaomi, Haier Smart Home, Lenovo
• Infrastructure & Construction: Fiscal stimulus and higher infrastructure spending drive growth in construction and heavy equipment.
  • Stocks to watch: CRRC Corporation, Anhui Conch Cement, Zoomlion

Chinese Yuan: Weakness to Linger

The outlook for the yuan suggests potential weakness ahead, primarily driven by the strength of the U.S. dollar. Factors such as U.S. exceptionalism and a slower pace of rate cuts by the Federal Reserve in 2025 contribute to this dynamic. The rate differential between US and China, coupled with tariff risks and China's accommodative policies, is expected to exert further downward pressure on the yuan. Additionally, the authorities may not be inclined to maintain a strong grip on the currency amidst these pressures.

The anticipated weakness in the yuan is likely to have spillover effects on the Australian dollar (AUD). With the Reserve Bank of Australia (RBA) having recently pivoted to a less hawkish stance, the AUD could face additional pressure. Other commodity currencies like the New Zealand dollar (NZD) may also be impacted.