KaiYuan Securities 2025 Macro Outlook: Five Major Pathways to Expand Domestic Demand

Core Viewpoints

1. Domestic Demand Insufficiency Issues

1. The downturn in real estate drags down the economy. The broad real estate sector's share of the economy has decreased from 34.7% in 2020 to around 28.0% in 2023. It is estimated that the drag of real estate on GDP in 2022 and 2023 is approximately -1.92% and -1.45%, respectively, and is expected to be -1.84% and -0.84% in 2024 and 2025. Regarding the wealth effect coefficient of housing prices, reviewing the 26 major real estate bubble bursts globally since 1970, the elasticity coefficient of the decline in housing prices to the decline in residents' consumption expenditure growth is: Y=0.1984*X. If we consider the National Bureau of Statistics' data indicating a 15.3% drop in second-hand housing prices in China from July 2021 to September 2024, this would drag down the growth rate of residents' consumption expenditure by 3.1%, averaging about 1.0% per year.

2. Low prices drag down corporate profits and residents' income. As of Q3 2024, the GDP deflator index has been negative year-on-year for six consecutive quarters, and the PPI has been in negative territory for 24 consecutive months. The core CPI has been weaker than seasonal trends for seven consecutive months; most industries on the corporate side are exchanging price for volume; residents are working longer hours with slower wage growth.

3. The overall leverage ratio is passively rising. The macro leverage ratio is accelerating upward, with nominal GDP in a declining range; the gap between residents' savings and loans is expanding rapidly; the activity of funds has dropped to historical lows.

2. Comparison of Historical Paths Out of Price Slump

Since the 1990s, there have been four instances in China where the GDP deflator index has been continuously negative, specifically from 1998-1999, 2009, 2015, and from 2023 to the present. By matching fixed asset investment, real estate investment, exports, and retail sales with the GDP deflator index, we can determine the dominant factors driving economic recovery based on their relationship with price trends. The review found that external demand recovery has played a significant role in past rounds of price recovery; real estate investment is a core factor in compensating for external demand gaps; when facing significant demand insufficiency issues, we will see substantial cuts in reserve requirements and interest rates from the central bank, along with a clear positive shift in fiscal policy.

3. China's Path Choices for Expanding Domestic Demand

1. Overseas Environment: The overseas interest rate cut cycle has begun and may continue into 2025. After the global elections in 2024, the international political environment may stabilize. Trump may prioritize fulfilling campaign promises such as tax cuts, immigration, and increasing energy supply to reduce inflation, while tariff issues may take a back seat. It is expected that exports will see a year-on-year decline in 2025, but may still experience slight positive growth.

2. Domestic Policy: In 2025, there is a high probability of expansive fiscal and monetary policies. There is considerable operational space for conventional monetary policy, with potential cuts in reserve requirements and interest rates exceeding those in 2024, and structural support for real estate and capital markets is expected to deepen. At the same time, the new monetary policy framework will focus on smoothing interest rate transmission, optimizing open market operations, and shifting regulatory tools from a focus on quantity to price The fiscal deficit rate may increase to 4%-5%, with the expansion of special bonds and ultra-long-term special government bonds, and fiscal funds further directed towards consumption, people's livelihood, and real estate; a one-time large-scale debt quota will be arranged. The broad fiscal deficit rate is expected to significantly increase to 9%-10%.

3. Pathways to expand domestic demand: Long-term optimism for consumption, ushering in a new era for consumption.

(1) After 2025, the real estate market is expected to stabilize, which is a prerequisite for the recovery of consumption. In overseas countries during financial crises/real estate clearances, the household debt repayment ratio converges to 11%-13%. In China, after the 924 monetary policy was intensified, this indicator has improved to 10.9%, indicating that it has broken through the effective boundary of real estate demand policies. Coupled with government monetization resettlement + storage contribution to incremental demand, it is expected that new home sales will decrease by 3% and second-hand home sales will increase by 5% in 2025.

(2) The stock wealth effect drives consumption. When the S&P 500's quarterly return exceeds 5%, 10%, and 15%, the corresponding increase in U.S. resident consumption growth is 0.3, 0.45, and 0.3 percentage points, respectively, which remains valid after excluding the impact of economic growth.

(3) Emphasizing people's livelihood and social security, and expanding the service industry is beneficial for increasing residents' income and solving employment issues. For the service industry: firstly, the remuneration rate for service industry workers is higher, and the expansion of the service industry is conducive to income distribution leaning more towards residents; secondly, the service industry has a clear advantage in absorbing employment; thirdly, the crowding-out effect of service consumption across periods is not significant.

(4) The effect of replacing old consumer goods with new ones is significant. The marginal pull effect is estimated to be about 2.5-3.2 times. If there are 300 billion consumer goods replacement subsidies in 2025, it will additionally drive consumption by over 400 billion yuan, with a retail sales growth rate of about 4.5%.

(5) The second urbanization is the urbanization of "population," mainly driving resident consumption, housing consumption, and public consumption (services). Assuming that the urbanization rate of registered and permanent residents narrows by 2-4 percentage points from 2024 to 2029, it will annually drive the economy by 524.2-1048.3 billion yuan, accounting for 0.4%-0.8% of the 2023 GDP.

4. Asset Allocation

1. Domestic asset allocation: stocks are better than bonds, with industry allocation first focusing on technology + cyclical sectors, followed by consumer-oriented domestic demand.

2. Overseas asset allocation: uncertainty is increasing. In the short term, U.S. stocks > U.S. dollar > gold > U.S. Treasury bonds > crude oil.

Main Text

1 Domestic Demand Insufficiency Issues

1.1. Causes: Four-dimensional analysis of the real estate drag on the economy

The three-year pandemic combined with the gradual decline of the real estate market has had multiple impacts on China's macroeconomic operation, supply-demand structure, and micro-subject expectations. From the input-output table, in 2020, the narrow definition of real estate (secondary industry housing construction + tertiary industry real estate) accounted for about 11.9% of GDP, estimated to decrease by 2.3 percentage points to 9.6% in 2023; the broad definition of real estate (narrow definition + related chains) has dropped from 34.7% in 2020 to less than 30% in 2023, estimated to account for about 28.0% of GDP in 2023 The positive aspect is that the expansion of new productive forces partially offsets the drag from the downturn in real estate. The coefficient of the construction industry's contribution to total output has declined from 3.4 times in 2012 to 3.0 times in 2020, while the new productive forces have remained stable at 3.3 times, demonstrating strong resilience.

We have detailed the direct and indirect impacts of real estate on the economy through four transmission chains: first, the drag on construction investment and the real estate commencement chain (steel, non-metallic mineral products, etc.); second, the decline in land acquisition fees, leading to reduced government funds that indirectly affect infrastructure; third, the downturn in demand for commercial housing, which drags down the tertiary industry related to real estate and post-cycle consumer goods; fourth, the downward trend in housing prices suppressing household consumption expenditure due to the wealth effect. Estimates show that the drag from real estate on GDP was approximately -1.92% in 2022 and -1.45% in 2023, with projections of -1.84% and -0.84% for 2024 and 2025, respectively. After 2025, there may be a stabilization in the real estate market. Specifically, the factors contributing to the drag from real estate change year by year, with construction investment and commercial housing sales being the main contributors in 2022 and 2023, while the drag from the wealth effect of housing prices significantly increases in 2024.

What is the specific coefficient of the wealth effect from housing prices? We further explore this from two dimensions: academic papers and global retrospective patterns. First, from 72 highly cited academic papers, most believe that the relationship between housing prices and consumption is time-varying, which can be preliminarily summarized into four stages: wealth effect → crowding-out effect → negative wealth effect → negative crowding-out effect. Huang Jing (2009) and Wang Kai (2019) argue that the wealth effect brought by rising housing prices has been declining year by year, with the former estimating China's wealth effect at about 0.08-0.12, lower than the 0.11-0.17 of OECD countries; the latter, based on TVP-VAR estimation, found it to be about 0.19-0.22 from 1998 to 2009, about 0.08-0.17 from 2010 to 2013, and 0.07 from 2014 to 2017. Therefore, academic papers indicate that the wealth effect of housing prices in China is about 0.07-0.12.

From a global perspective, since 1970, there have been 26 significant real estate bubble bursts in 18 countries. Based on the decline in housing prices during this period and the decrease in the growth rate of household consumption expenditure, we calculated the elasticity coefficient of the two: Y=0.1984*X, indicating that the wealth effect of housing prices during the real estate clearing phase is approximately 0.2. This level is slightly higher than estimates in academic literature. Considering that risk aversion can lead to asymmetry in the housing price effect (i.e., the wealth effect during the decline phase is greater than during the rise phase), 0.2 is also reasonable. Specifically for China, according to the National Bureau of Statistics, from July 2021 to September 2024, the price of second-hand houses in China is expected to decline by 15.3%, which will drag down the growth rate of household consumption expenditure by 3.1%, averaging about 1.0% per year.

1.2 Performance: Analysis of the Current Situation in Terms of Price and Balance Sheet

1.2.1 Continuous Decline in Price Indicators

First, from a superficial perspective, various price indicators are performing poorly: The GDP deflator has entered a downward channel year-on-year since 2022; from Q2 2023 to Q3 2024, the GDP deflator has been negative year-on-year for six consecutive quarters, the longest duration in nearly twenty years, with the largest year-on-year decline close to that of Q2 2009 after the financial crisis.

Specifically regarding CPI and PPI: PPI turned negative year-on-year from October 2022 and has been in negative territory for 24 consecutive months as of September 2024, with month-on-month figures being negative for nearly four consecutive months; core CPI has been weaker than seasonal trends in 9 out of the last 12 months from October 2023 to September 2024, and has been weaker than seasonal trends for nearly seven consecutive months.

Looking ahead, it is expected that the CPI year-on-year for the entire year of 2024 may be around 0.2%; in 2025, driven by policies to expand domestic demand, the CPI is expected to rise moderately. Assuming a seasonal equalization for month-on-month figures, regarding pork and crude oil prices, the supply of live pigs is expected to increase starting in November, and under the policy direction of Trump, traditional energy prices may face pressure. Assuming that pork and crude oil prices show a gradual downward trend in 2025, considering adjustments in pork and refined oil prices, it is expected that the CPI year-on-year in 2025 may be high at first and low later, with an average year-on-year of around 0.4% for the entire year In terms of PPI, it is difficult to see a significant increase in PPI year-on-year within the year, and it is expected that the PPI year-on-year in 2024 may be around -2%; the PPI in 2025 may rebound as the expansion of domestic demand policies takes effect. Assuming a seasonal hypothesis equal to that of 2015-2017, the PPI year-on-year in the second half of 2025 is expected to turn positive, with the full-year PPI year-on-year in 2025 expected to be around 0%.

1.2.2. Low prices drag down corporate profits and residents' income

(1) Corporate side: Profit growth rate declines, many industries exchange price for volume, and inefficient capacity needs to exit to achieve supply-demand balance. From January to October 2024, the cumulative year-on-year profit of industrial enterprises above designated size nationwide was -4.3%. Looking at the breakdown of profits (profit growth rate = industrial added value * PPI * profit margin year-on-year), the contribution of price (PPI) in 2024 continues to be negative, while the contribution of volume (industrial added value) is basically positive. As of October 2024, the negative growth range of PPI for upstream processing, midstream equipment, downstream consumption, and utilities has averaged 11.2, 20.0, 13.5, and 7.7 months, respectively, with the midstream duration being the longest and deepening.

By industry, the mining industry performs better in price than in volume; the upstream processing real estate chain sees both volume and price decline, while non-ferrous metals see both volume and price rise; the midstream equipment deeply exchanges price for volume, mainly in electrical machinery, automobiles, and computer communication electronics as new productive forces; the downstream slightly exchanges price for volume (papermaking, textiles, leather shoes, etc.), while textiles, agricultural products, and food see both volume and price decline.

Large-scale equipment updates boost manufacturing investment growth. From January to October, the cumulative year-on-year growth of manufacturing was 9.3%, and the cumulative year-on-year growth of equipment and tool purchases was 16.1%. By industry, the investment growth rates in non-ferrous metallurgy, chemical products, and textiles improved by 1.1, 1.1, and 0.6 percentage points compared to previous values, while food manufacturing, agricultural and sideline food processing, and metal products maintained relatively high growth rates. Looking ahead, the momentum for equipment updates is constrained by supply and demand relationships. From January to October 2024, the production and sales rate of industrial enterprises rebounded by 0.2 percentage points to 96.3%, indicating that the acceleration of "two new" will effectively boost demand and alleviate supply-demand imbalance issues. It is expected that manufacturing investment in 2025 will be slightly lower than in 2024 but will still maintain a medium to high growth rate of around 8%.

(2) On the resident side: Increased employment pressure, income "exchanging price for volume," and adjustments in multiple industries constrain resident consumption expenditure. First, both the total quantity and quality of employment are under pressure, with the number of college graduates in 2024 reaching a historical high of 11.79 million, and flexible employment exceeding 200 million, indicating that the quality of employment needs improvement. Historical data shows a good correlation between the unemployment rate and unemployment insurance fund expenditures, but since 2024, there has been a certain divergence between the two. Second, residents' working hours have lengthened, and hourly wages have slowed; in Q3 2024, the average weekly working hours for employed persons increased to 48.7 hours, while the growth rate of hourly wages dropped to 6.2%, slowing for two consecutive quarters. The lengthening of working hours and slowing of hourly wages depict a scenario of "exchanging price for volume" on the income side of residents. Third, adjustments and optimizations in certain industries, along with declining expectations for resident income and consumer confidence, further constrain their consumption expenditure. We have compiled microdata from ride-hailing, food delivery, healthcare, and civil servants to support this.

1.2.3 Performance at the Balance Sheet Level: Passive Rise in Leverage Ratio

Macroeconomic leverage ratio passively rises. Since 2022, the macro leverage ratio has begun to accelerate upward, while nominal GDP has been in a declining range during the same period. The reality of credit tightening and the divergence of the leverage ratio may be explained by the decline in nominal GDP. By sector, the leverage ratios of enterprises and government departments have increased during the aforementioned period, but corporate loans are showing a contraction trend, diverging from the leverage ratio trend. The leverage ratio of households has shown weak growth since Q3 2020, mainly due to the downturn in real estate leading to slow growth in household consumption loans.

Household and enterprise balance sheets need optimization. Since 2022, the gap between household deposits and loans has accelerated to widen. Affected by the decline in equity markets and real estate values, the wealth effect of assets has weakened, coupled with a decline in the growth rate of disposable income, putting pressure on household assets. The result is that households are tightening credit and transferring more assets to deposits, significantly increasing the household deposit-loan gap. For enterprises, the liquidity of funds has dropped to a historical low. In 2024, the growth rate of M1 fell to -7.4%, the lowest level in history, reflecting a significant weakening in the efficiency of fund utilization in enterprise operations. This aligns with the "reluctance to lend" behavior of enterprises, indicating insufficient demand and a need for improved confidence.

2 Comparison of Three Historical Paths Out of Price Slump

Since the 1990s, the phenomenon of negative GDP deflator in China has occurred four times, specifically in 1998-1999, 2009, 2015, and from 2023 to the present. The paths and dominant factors for the past three exits from price slumps have varied.

Prices are the result of supply and demand equilibrium, with the supply side mainly being domestic, and the demand side divided into exports and domestic demand. We use the GDP deflator as a representative indicator of prices, considering the turning point of its bottoming out as the turning point for price rebound. We match four major indicators: total fixed asset investment, real estate investment, exports, and retail sales with the GDP deflator. By analyzing the relationship between these indicators and price trends, as well as the sequence of turning points of these indicators and price rebound turning points, we can determine the possible dominant factors and causal relationships that drove prices out of the slump at that time. Among them, total investment tends to represent the supply side, real estate investment, due to its special attributes, tends to represent the demand of the real estate chain, while exports and retail sales represent overseas and domestic terminal demand (1) 1998-1999: Triple Pressure from Supply, Domestic and Foreign Demand. On the supply side, the issue of overcapacity caused by overheating investments in the early stage became apparent; on the demand side, the non-performing asset problem of state-owned banks suppressed domestic demand, while the Asian financial crisis suppressed external demand, leading to a negative GDP deflator index for seven consecutive quarters.

In response to this situation, China took targeted measures on both the supply and demand sides: on the supply side, China promoted the reform of state-owned enterprises and reduced capacity in certain industries. On the demand side, the central bank repeatedly lowered the reserve requirement ratio and interest rates; at the same time, the Ministry of Finance issued a one-time targeted special government bond of 270 billion yuan to the four major state-owned banks to replenish their capital, and increased the fiscal deficit to invest in infrastructure construction; promoted the marketization of the real estate sector; and actively negotiated bilateral trade agreements with Europe and the United States to boost external demand growth. During this period, the corresponding indicators reflected that total investment on the supply side decreased, while external demand on the demand side warmed up first, followed by improvements in consumption and real estate investment demand, leading to a rebound in prices, which in turn stimulated total investment.

(2) 2009: External Demand Dragging Total Demand. Under the impact of the global financial crisis, external demand weakened significantly, dragging down total demand, with the GDP deflator index being negative for two consecutive quarters.

In response to this situation, China mainly stimulated from the demand side: the central bank repeatedly lowered the reserve requirement ratio and interest rates; the government launched the "Four Trillion" plan, investing in infrastructure construction and real estate, and provided subsidies to promote consumption through the "Home Appliances to the Countryside" initiative; stimulated the real estate sector by lowering down payment ratios and loan interest rates; and with overseas economic stimulus, external demand quickly warmed up. During this period, the corresponding indicators reflected that on the demand side, domestic real estate investment and consumption warmed up successively, followed by a warming of external demand, leading to a rebound in prices. We tend to believe that the main driving force behind this round of price rebound was real estate and domestic and foreign terminal consumption.

(3) 2015: Dual Pressure from Supply and External Demand. On the supply side, there was overcapacity in domestic industries represented by the mid-to-upstream sectors; on the demand side, a significant decline in external demand dragged down total demand, and international commodity prices were sluggish. In 2015, except for Q3, the GDP deflator index was negative in the other three quarters.

In response to this situation, China launched structural reforms on the supply side and multiple measures to stimulate domestic demand: on the supply side, the "Three Reductions, One Decrease, One Supplement" supply-side structural reform was introduced to accelerate capacity reduction. On the demand side, the central bank implemented a certain degree of interest rate and reserve requirement ratio cuts; for real estate, monetary compensation for shantytown renovations was promoted to quickly stimulate domestic demand; in the later stages, external demand gradually recovered, contributing to total demand growth. During this period, the corresponding indicators reflected that on the supply side, total investment continued to decline; on the demand side, real estate investment drove a rebound in prices, and after the economic recovery, the rate of consumption growth decline slowed down, with subsequent export recovery providing additional momentum for price increases.

Reviewing the above three rounds of price recovery from a period of stagnation, the following three conclusions can be drawn:

1. As an export-oriented country, the slowdown in external demand has typically been the main reason for the past three rounds of price stagnation, while the recovery of external demand has also played a significant role in the price rebound in the past few rounds.

**2. Due to the strong endogenous nature of exports, when external demand remains persistently weak, real estate investment is the core factor driving domestic demand to compensate for the external demand gap, while total investment during this phase often moves in the opposite direction to price trends **

3. When facing a serious issue of insufficient demand, the demand side will see significant cuts in reserve requirements and interest rates from the central bank, along with a clear positive shift in fiscal policy.

3 Pathways for China to Expand Domestic Demand

3.1 Global Environment: The interest rate cut cycle begins, the political environment stabilizes, and China's policy space expands

Inflation in Europe and the United States has significantly decreased from its peak. As of October 2024, inflation in overseas countries has significantly decreased from its peak in 2022, and the downward trend in inflation is still ongoing. If we observe the more stable core inflation, the core CPI in the U.S. fell by 0.6 percentage points to 3.3% compared to the beginning of the year in October 2024, and the core HICP in the Eurozone also fell to 2.7%. The process of disinflation appears to be ongoing, with uncertainty only regarding the slope of the decline.

Looking further at the U.S., we believe that U.S. inflation has strong resilience, and the central tendency may rise, but the likelihood of a second major inflation is low. From the October U.S. CPI data, due to the strong resilience of demand in the U.S. economy, the Federal Reserve's 75bp rate cut had a noticeable boosting effect on interest-sensitive sectors of the economy, resulting in strong resilience in U.S. inflation and an upward shift in the central tendency. The Federal Reserve's 2% target may be difficult to achieve by 2025. However, considering the current stability of residents' inflation expectations, we believe the likelihood of a second major inflation similar to the 1970s is low.

As inflation levels trend downward, starting from mid-2024, the European Central Bank and the Federal Reserve began to cut interest rates in succession. The European Central Bank cut rates by 25bp in June, September, and October, while the Federal Reserve cut rates by 50bp in September and 25bp in November. Other developed country central banks, except for the Bank of Japan, have also entered a rate-cutting cycle.

From the recent economic data of major countries in Europe and the United States, economic growth is facing varying degrees of downward pressure, with the distinction being whether a smooth economic soft landing can be achieved (reducing inflation while avoiding economic recession). Therefore, although the pace of interest rate cuts by major central banks faces considerable uncertainty, the rate-cutting cycle may continue into 2025. First, let's look at the Federal Reserve. At the FOMC meeting in November, the Federal Reserve announced another rate cut of 25 basis points. Although Jerome Powell did not reveal much about the pace of future rate cuts, he stated that if the economy performs strongly or inflation does not continue to move towards 2%, future rate cuts will slow down, and vice versa; the pace of future rate cuts will still be determined based on changes in economic activity, but confidence in future inflation decline has weakened. (《The Federal Reserve's Subsequent Policy Faces Multiple Uncertainties - November FOMC Meeting Review》) In fact, due to the high variability of policy choices after Trump's election, the Federal Reserve can only respond passively. Currently, although there is some rebound pressure on inflation, considering that the current interest rate level in the United States is still relatively high, the direction of rate cuts will not change, but it will more affect the pace of future rate cuts.

Under the baseline scenario, we expect that rate cuts may pause in December 2024 or later, and in 2025, it is highly likely to shift to quarterly rate cuts, totaling 2-3 cuts, and the magnitude of the cuts may be less than expected. The September dot plot indicates that the Federal Reserve will cut rates to about 3.25% in 2025, but with Trump's election, his further tax cuts, increased tariffs, and immigration policies (which reduce labor supply) will provide clear support for U.S. inflation. Under the baseline scenario, the Federal Reserve may cut rates 2-3 times in 2025, and the magnitude of the cuts is likely to continue to narrow. Recently, Federal Reserve Chairman Powell also stated that there is no rush to cut rates and that there is time to understand the impact of Trump's policies. The CME market expects the Federal Reserve to cut rates by 75 basis points in 2025.

Next is the European Central Bank. At the monetary policy meeting in October, ECB President Christine Lagarde stated that the eurozone's economic performance was below expectations, with economic growth risks skewed to the downside. At the same time, the process of inflation decline is proceeding smoothly, with all indicators showing a downward trend. In subsequent remarks, she also stated that the direction of rate cuts by the ECB is clear, but the magnitude of the cuts needs to be approached with caution. Currently, the market expects the ECB to continue cutting rates, with the deposit rate expected to drop to about 2% by mid-2025. We believe that the overall magnitude of rate cuts by the ECB in 2025 may exceed that of the Federal Reserve, considering the negative economic impact that Trump's potential 10% tariffs on Europe may cause, the overall magnitude of rate cuts may exceed expectations.

With overseas central banks continuing to cut rates, the external economic environment faced by our country may marginally improve, especially as the flexibility of the RMB exchange rate is expected to recover, and the space for monetary policy will further expand. Since 2022, due to the misalignment of the economic cycles between China and the United States, under the rapid rate hikes by the Federal Reserve, the interest rate differential between China and the U.S. has gradually moved into deep inversion, with the bank's settlement rate remaining at a low level, putting significant pressure on the RMB exchange rate and partially limiting our monetary policy space However, as the economic growth rates in Europe and the United States decline and interest rates continue to fall, the interest rate differential between domestic and foreign countries is likely to narrow, which will help improve the exchange rate for settlement and alleviate the depreciation pressure on the RMB exchange rate, restoring the elasticity of the exchange rate. The pressure on the central bank to stabilize the exchange rate will decrease, and the policy space for loose monetary policy will further open up, creating a better monetary policy environment for stable economic growth and high-quality development. In the short term, the RMB exchange rate may fluctuate in the range of 7.2-7.25. If subsequent Sino-U.S. relations face significant pressure (such as the 60% tariff officially entering the Trump administration's agenda), we believe there is a certain possibility that the RMB exchange rate may break through the previous high of 7.3 and challenge the range of 7.4-7.5, with the timeline possibly in Q2-Q3 of 2025, thereby alleviating some pressure on our export industry.

More importantly, with the end of the 2024 global election year, the overseas political environment will also tend to stabilize, and the international political constraints faced by our country may also ease. In the U.S. presidential election held on November 5, Trump was successfully elected. Although he indicated during the earlier campaign that he would impose a 60% tariff on China, which could potentially impact our exports. However, we believe Trump may prioritize fulfilling his campaign promises of tax cuts, immigration reform, and increasing energy supply to reduce inflation. Since the Republican Party has simultaneously won the White House and control of both the House of Representatives and the Senate, and considering Trump's significantly enhanced control within the Republican Party compared to the past, there will be basically no obstacles to domestic governance, and domestic affairs will be his priority.

Therefore, the tariff issue may be relatively delayed, but not for long, and the impact may be quite noticeable in the short term. As mentioned earlier, the priority of tariffs may be relatively low; however, as an important policy to be fulfilled during Trump's previous term, the introduction of these tariffs will not be delayed for too long. We expect related impacts to emerge in Q2-Q3 of 2025, and the short-term impact will be relatively significant, especially some high-tech industries will suffer greater negative effects. According to estimates from LSE, if a 60% tariff is imposed comprehensively, it could lead to a reduction in GDP of 0.64% for the U.S. and 0.68% for China.

However, we believe that tariffs are a means rather than an ultimate goal. Referring to the first phase of the Sino-U.S. trade agreement, the final scope, extent, and impact of tariff imposition are highly uncertain. After experiencing the Sino-U.S. trade friction in 2018, especially against the backdrop of both sides having reached the first phase trade agreement, such a high tariff rate has many variables (which have negative impacts on the U.S. economy, stock market, inflation, etc.), and our country has significantly reduced the proportion of direct exports to the U.S. in recent years, so there may be relatively sufficient room for response. We tend to believe that there may be a second phase Sino-U.S. trade agreement by the end of 2025 to 2026.

Beyond tariffs, due to Trump's isolationist approach and the advocacy of the so-called America First policy, referencing the performance of his previous term, foreign policy will become more conservative.

In the baseline scenario, the relationship between the United States and its traditional allies (Europe, Japan, South Korea, etc.) will face certain pressures, and it is highly likely that the U.S. will withdraw from relevant international organizations (Paris Agreement, World Health Organization, etc.). The so-called IPEF (Indo-Pacific Economic Framework), AUKUS alliance, and QUAD (Quadrilateral Security Dialogue) launched during the Biden administration, which have a strong targeted nature, may collapse. For our country, relations with the EU, Japan, and South Korea may see marginal improvements, and related geopolitical and economic pressures may ease. U.S. aid to Ukraine may gradually decrease, and if Ukraine lacks U.S. assistance, the possibility of negotiations between Russia and Ukraine will greatly increase, making it likely that the Russia-Ukraine conflict will be resolved. Recently, Ukrainian President Zelensky stated that Ukraine must make every effort to end the conflict through diplomatic means next year, at which point the international geopolitical environment may stabilize, and prices of crude oil and other commodities, as well as shipping prices, may have limited upward movement.

Considering the performance of China-Europe relations during Trump's first term and the global geopolitical situation, although Sino-U.S. relations may face significant uncertainty and challenges, the overall international political environment faced by our country may improve, thereby creating a relatively stable external environment for our economic development. In fact, after Trump's election, China and Europe have negotiated the price commitment plan for the EU's tariffs on Chinese electric vehicles, and the Comprehensive Agreement on Investment between China and the EU, which was frozen in May 2021, may also be expected to reopen.

Exports are expected to decline year-on-year in 2025.

First, without considering the impact of tariffs, exports will cyclically decline. On one hand, based on recent export data from South Korea and Vietnam, as well as U.S. inventory and sales conditions, the global economic cycle has entered a downward phase; on the other hand, recent consumer and retail data from Europe and the U.S. indicate that overseas demand still possesses certain resilience, and 2025 will be in a phase of global liquidity easing, so the impact on exports will not be too significant. Secondly, potential tariffs may lead to a peak in exports followed by a decline. Whether the U.S. potential tariff policy can be implemented and the "rush to export" before the execution time window may weaken the negative impact of tariffs on exports in 2025, potentially raising early export amounts and lowering later export amounts. Finally, based on seasonal calculations from 2018-2019 and 2023-2024, we expect exports in 2025 to be around 0% year-on-year.

3.2 Domestic Policy: Expanding Fiscal and Monetary Policies to Stabilize Growth and Increase Prices

Since September 2024, policies have shifted. Currently, both fiscal and monetary policies have gained momentum compared to the first half of the year, but there is still room for improvement.

In 2025, there is a high probability of expanding fiscal and monetary policies. The operational space for conventional monetary policy is relatively large, and the extent of reserve requirement ratio cuts and interest rate reductions may exceed that of 2024. Monetary policy will focus on transitioning to price-based regulation, implementing new interest rate corridor controls, and secondary market government bond trading, providing more means and space to adjust long-term interest rates. At the same time, structural support for the real estate and capital markets is expected to deepen. The fiscal deficit ratio may increase to 4%-5%, with an expansion of ultra-long-term special government bonds, and fiscal funds further directed towards consumption, people's livelihoods, and real estate; a one-time large-scale debt issuance quota will be arranged. The broad fiscal deficit ratio is expected to grow significantly.

3.2.1 Monetary Policy: Creating a Loose Environment While Improving the New Regulatory Framework

Since 2019, nominal interest rates have been declining at an average rate of 30bps per year, reaching historical lows. However, the decline in real interest rates has not kept pace, and has only decreased by 26bps relative to early 2019, affecting the actual savings and consumption behaviors of the real sector. The core factor hindering the decline in real interest rates is the low level of inflation. In 2025, monetary policy may focus on raising price levels, making full use of policy space.

(1) Increase the intensity of monetary policy regulation, with raising price levels as an important consideration, continuing to cut reserve requirements and interest rates, and boosting nominal GDP.

(1) Since 2019, nominal interest rates have fallen to historical lows, but real interest rates remain high. The central bank has pointed out that "promoting a reasonable recovery in prices is an important consideration for grasping monetary policy." Combined with the statement made at the National People's Congress Standing Committee meeting on September 12, where "some attendees pointed out that the pressure of deflation in our country is increasing due to insufficient issuance of base currency...," further cuts in reserve requirements and interest rates are expected. Attention should be paid to the economic and price targets for 2025.

(2) It is expected that the reserve requirement ratio will be cut by at least 100bps in 2025, with interest rate reductions possibly exceeding those of 2024, and deposit rates will also decline.

(2) Loose monetary policy supports loose credit: Social financing and M2 are expected to steadily recover next year.

In an environment of loose monetary and fiscal policies, there are favorable conditions for a shift towards looser credit in 2025. The overall scale of government debt is relatively high, assuming an increase of about 4 trillion yuan in government bonds under the social financing criteria compared to 2024 (the increase includes 1 trillion yuan in ordinary government bonds, 1 trillion yuan in ultra-long-term special government bonds, 1 trillion yuan in special government bonds, and 0.5-0.6 trillion yuan in special bonds, assuming about 0.5 trillion yuan in debt replacement outside of social financing).

In terms of RMB loans, the first quarter may still see a strong start. The issuance of government bonds will drive matching financing, and the issuance pace of local bonds is expected to be advanced. The loosening of monetary and fiscal policies will drive a rebound in credit growth, and the liquidity of the real sector is expected to improve We predict that the growth rate of social financing stock will be more elastic in 2025, possibly rebounding to 9.3%; M2 year-on-year may rise to 8.4%.

(3) Framework Transformation: Emphasizing Price Over Quantity, Promoting the Transformation of Monetary Policy Regulation Framework

(1) Smooth Interest Rate Transmission. The 7-day reverse repurchase rate serves as the only policy interest rate, with a significant deviation between deposit and loan rates and the policy rate. By standardizing bank pricing, we can improve interest rate transmission. The central bank's third-quarter monetary policy implementation report suggests further smoothing of monetary policy transmission channels. Currently, the transmission efficiency in the money market and bond market is relatively high, but there is a significant deviation between deposit and loan rates and the policy rate, especially with loan rates "falling quickly" while deposit rates "remain stagnant." In the future, standardizing bank deposit and loan pricing will improve the transmission of policy rates. The adjustment of the deposit self-discipline mechanism introduced in November 2024 will make adjustments to the pricing of non-bank demand deposits, marking another important measure by the central bank following the prohibition of manual interest supplementation, which is expected to steepen the funding interest rate curve for terms under one year.

(2) Optimize Open Market Operations to Reduce Fluctuations in Funding Rates. In 2024, the central bank will narrow the interest rate corridor to guide funding rates to operate smoothly and shape a steep government bond yield curve; additionally, the central bank has introduced several new monetary control tools, such as buying and selling government bonds in the secondary market and reverse repurchase operations, which are expected to become routine operations in the future.

(3) Emphasizing Price Over Quantity, Promoting the Transformation of Monetary Policy Regulation Framework. Firstly, the central bank has announced adjustments to the M1 measure, incorporating personal demand deposits and customer reserve funds from non-bank payment institutions. The interpretative significance of the M1 indicator will become more scientific, while also smoothing out significant volatility in readings. Secondly, the current changes in financing structure have a greater impact on M2, and the reference value of M2 as a monetary quantity indicator may weaken. Tracking changes in domestic demand and the effects of fiscal policy can focus on the scale of social financing. The central bank believes that the correlation between money supply and economic variables has weakened, and in the future, more emphasis will be placed on the role of interest rate regulation. In terms of narrow liquidity, the central bank tends to use price indicators as a regulatory tool, with funding rates reflecting more information.

3.2.2. Fiscal: Broad Fiscal Expansion, Large-scale Debt Issuance, Funds Expected to Tilt Towards Consumption and Livelihood

1. Continue Expansionary Fiscal Policy, Deficit Rate May Increase. We believe that the Ministry of Finance's press conference on October 12 marks a turning point in the shift of fiscal expansion thinking. Unlike the traditional approach focused on tax cuts, fee reductions, and fiscal subsidies, the conference emphasized solving problems through borrowing and stated that "the central government still has considerable room for borrowing and increasing the deficit," which may hint at the possibility of raising the deficit scale in 2025 The current economy is facing pressure from insufficient domestic demand, and expanding fiscal stimulus is more effective. Supportive fiscal policies are relatively certain, and the scale of the deficit is likely to increase. In a neutral scenario, the deficit rate in 2025 may be 3.5%-4.0%, while in an optimistic scenario, it may be 4.0%-5.0%. We assume that the budget deficit rate in 2025 will be 4%, and assuming that the nominal GDP in 2024 is 4.3% and in 2025 is 6%, the broad deficit rate may be 9.4%/10.8%.

1. The direction of funds is the key to fiscal games

Dissection of fiscal funds: expansion and broadening of ultra-long-term special government bonds, arrangement of a one-time large-scale debt quota, and further directing fiscal funds towards consumption, people's livelihood, and real estate.

(1) The scale and direction of ultra-long-term special government bonds are key points in next year's fiscal game. Continuing to support "two 重" and "two 新", about 70% of ultra-long-term special government bonds in 2024 will be used for "two 重" and 30% for "two 新". It is expected that in 2025, ultra-long-term special government bonds will continue to support these two major categories, with possible structural adjustments, and increased funding directed towards consumption. There may be greater support for consumption vouchers, replacing old consumer goods with new ones, benefiting people's livelihood, and social security. Based on the above assumptions, it is estimated that the scale of ultra-long-term special government bonds will be around 1.5-2 trillion yuan. Key observations will be the Politburo meeting in December & the Central Economic Work Conference.

(2) On October 12, the Ministry of Finance's press conference indicated support for state-owned large banks to replenish core tier one capital, estimating that the scale of special government bonds may be around 1 trillion yuan.

(3) The direction of special bonds has relatively high certainty, and the scale may expand. The Ministry of Finance's press conference proposed to study and improve the management of the special bond direction list, increasing the areas used as project capital. The scope of special bonds in 2025 may include: 1. Conventional uses, traditional infrastructure and new infrastructure revenue projects, etc.; 2. Acquiring existing land and existing commercial housing, which is a new use proposed by the Ministry of Finance to support the healthy development of real estate. We estimate that the scale in 2025 may be 400-500 billion yuan; 3. Resolving existing debts. At the closing ceremony of the Standing Committee of the National People's Congress on November 8, the Ministry of Finance proposed to increase the debt limit for replacing local government hidden debts in a one-time manner, including a one-time replacement limit of 6 trillion yuan, and arranging 800 billion yuan annually from local special bonds for hidden debt replacement, totaling 10 trillion yuan in special bond quotas for debt resolution over the next five years. The quota for 2025 is 2.8 trillion yuan (2 trillion yuan refinancing bonds + 800 billion yuan new special bonds). We judge that the scale of local special bonds in 2025, excluding the 2 trillion yuan refinancing bonds, will be around 4.5 trillion yuan

1. The scale and form of the new debt resolution policy slightly exceeded expectations.

From 2024 to 2028, an additional 6+4 trillion yuan debt resolution quota will be introduced. First, 6 trillion yuan will be allocated for special bonds to replace hidden debts, implemented over three years; second, 800 billion yuan will be allocated annually from the new special bond quota for debt resolution over five consecutive years, totaling 4 trillion yuan. The former is more similar to the special refinancing bonds from 2020-2023, essentially replacing existing hidden debts, while the latter expands the use of regular special bond quotas. According to Minister Lan's introduction, by 2028, the total amount of hidden debts that local governments need to digest will be significantly reduced from 14.3 trillion yuan to 2.3 trillion yuan, with the average annual digestion amount decreasing from 2.86 trillion yuan to 460 billion yuan.

Special bonds are the main form of debt resolution. The repayment of regular special bonds relies on income from revenue-generating projects, while the interest payments on large-scale special bonds require certain cash flow from local government revenues. In the future, local governments need to actively expand revenue sources to ensure the stability of fiscal income.

The impact on the economy and equity assets is relatively positive, promoting the flow of local government resources towards the economy and people's livelihoods. The Ministry of Finance estimates that interest payment expenditures will be reduced by a total of 600 billion yuan, allowing local governments to allocate more resources to key livelihood areas, consumption, and investment. In terms of infrastructure investment, the resolved debts are aimed at hidden debts and corporate arrears from the Ministry of Finance's perspective between 2015 and 2018. The new quota for special bonds in 2025 will be based on the already allocated 800 billion yuan for debt resolution, which may partially weaken the crowding out of infrastructure funds, but the short-term impact may be neutral under strict control of increments; in addition, it will significantly improve the cash flow of construction/engineering companies closely cooperating with the government. In the bond market, short-term central bank funding support is key, while long-term returns to fundamentals. There may not be too much concern in the short term, as the central bank will provide support in the funding space to hedge against supply-side pressures, and the current funding environment is relatively loose. As of November 25, approximately 1.1 trillion yuan of special refinancing bonds have been issued across various regions, with smooth issuance progress.

Infrastructure: The crowding-out effect of debt resolution is expected to narrow in 2025. In the first half of 2024, the issuance and expenditure of special bonds will be slow, with some allocated for debt resolution, leading to poor performance in physical infrastructure work. Looking ahead, the comprehensive debt resolution "combination punch" announced on November 8 is expected to save local interest expenditures by 600 billion yuan over five years, which is likely to narrow the crowding-out effect of debt resolution on the three guarantees and infrastructure expenditures. It is expected that the growth rate of broad infrastructure in 2025 may be around 10% Water conservancy investment enters the second round of upward phase, expected to continue contributing incremental growth. The first round was from 2008 to 2012, benefiting from the four trillion investment and the central government's No. 1 document "The State Council's Decision on Accelerating Water Conservancy Reform and Development"; the second round began in recent years due to increased extreme weather events such as heavy rain and floods. The Politburo meeting in August 2023 studied and deployed flood prevention, disaster relief, and post-disaster recovery and reconstruction work. In November 2023, the issuance of additional national bonds included over 500 billion directed towards water conservancy, promoting a new round of water conservancy investment (e.g., Southwest hydropower) upward, with the proportion of water conservancy in infrastructure significantly increasing to 6.4% from January to September 2024.

4. Finance may increase tilt towards social security, livelihood, and consumption sectors

At the press conference of the 12th meeting of the Standing Committee of the 14th National People's Congress on November 8, the Minister of Finance stated, "Strengthen the investment guarantee in key areas such as technological innovation and people's livelihood." Combined with recent supportive policies in areas such as childbirth, migrant workers, and employment, we believe this may be another focus of fiscal work in 2025. Attention can be paid to the degree of fiscal budget funds tilting towards people's livelihood and the possibility of new incremental policies being introduced in the institutional system.

3.3. Path selection - Long-term optimism for consumption, consumption will welcome a new era

3.3.1. Consumption factor 1: A major premise for stabilizing consumption may lie in real estate

(1) Real estate shows initial signs of stabilization. From January to October, cumulative real estate investment year-on-year was -10.3%. In November, second-hand housing transactions continued to rise significantly, far exceeding historical highs, and new housing transactions continued to improve and were better than the same period in 2023. The inventory-to-sales ratio, as a leading indicator, has bottomed out and rebounded, indicating that the decline in second-hand housing prices is expected to gradually narrow. On October 17, the Ministry of Housing and Urban-Rural Development proposed to increase the credit scale of "white list" projects to 4 trillion by the end of the year, which may initially solve the issue of ensuring delivery of buildings. From overseas experience, the digestion of real estate bubbles corresponds to a shift in commodity housing transactions from new houses to second-hand houses, and it is expected that the decline in real estate investment will slightly narrow to -5% in 2025.

(2) The household debt repayment ratio has recovered to below the critical level: Household debt repayment ratio = household debt principal and interest payable in the current year / household disposable income. Reviewing the timing of financial crises and real estate clearances in overseas countries, the household debt repayment ratio converges to a level of 11%-13%. China also conforms to this pattern, with the household debt repayment ratio reaching 11.9% in Q3 2021, exceeding the critical level. After the monetary policy package on September 24, this indicator improved to 10.9% in Q3 2024, and it is expected that the growth rate of new housing sales will be -3% and the growth rate of second-hand housing sales will be +5% in 2025. If accompanied by certain income policies, the improvement will be even greater

(3) Government Monetization Resettlement + Incremental Demand from Storage Contribution. On October 17, the Ministry of Housing and Urban-Rural Development proposed to implement an additional 1 million sets of urban village and dilapidated housing renovations through monetization resettlement and other means. After three years of tackling issues from 2018 to 2020, the scale of shantytown renovations and the monetization ratio have significantly decreased. It is estimated that in 2023, monetization will be about 500,000 sets, thus the marginal increment to commercial housing sales is about 500,000 sets; special bond storage can refer to the years 2018-2022, where the average annual scale of shantytown renovation special bonds was about 400 billion yuan, and it is expected that this time the scale may be similar, around 400-500 billion yuan.

3.3.2. Consumption Factor 2: Emphasizing the Wealth Effect of a Slow Bull Market in the Stock Market

On September 24, the central bank introduced two groundbreaking innovative tools to support the capital market, with significant potential for scale, reflecting the central government's determination and strength in supporting the capital market; on September 26, the Politburo meeting proposed "to strive to boost the capital market and vigorously guide medium- and long-term funds into the market," and attention should be paid to the wealth effect brought by a slow bull market in the stock market.

From domestic research perspective: Zeng Jing (2012) empirically pointed out that "in the long term, the positive wealth effect coefficient of the stock market is about 0.12," and Ma Qiang (2016) calculated that "for every 1% increase in stock market prices, urban residents' daily consumption expenditure increases by 0.09%, indicating a positive wealth effect of 0.09"; historical patterns in the United States indicate that the wealth effect of stocks is quite significant: when the quarterly return of the S&P 500 exceeds 5%, 10%, and 15%, it corresponds to an increase in the growth rate of U.S. residents' consumption expenditure by 0.3, 0.45, and 0.3 percentage points, respectively. From a more rigorous perspective (excluding the impact of economic growth), this conclusion still holds; when the quarterly return of the S&P 500 exceeds 3%, the improvement in the growth rate of U.S. residents' consumption will be greater than the improvement in GDP growth rate. When the quarterly return of the S&P 500 exceeds 5%, 10%, and 15%, the former outperformed by 0.128, 0.129, and 0.167 percentage points, respectively.

3.3.3. Consumption Factor 3: Expansion of the service industry is beneficial for increasing residents' income and solving employment issues.

On July 30, the Politburo meeting first proposed "placing greater emphasis on consumption in expanding domestic demand," and "using service consumption as an important lever for expanding and upgrading consumption"; on August 3, the State Council recently issued the "Opinions on Promoting High-Quality Development of Service Consumption," indicating that service consumption is expected to become a key area of policy support for expanding domestic demand. The Politburo meeting emphasized "combining consumption promotion with improving people's livelihoods to increase income for low- and middle-income groups," "safeguarding the bottom line of people's livelihoods," and "strengthening assistance and support for low-income populations." At the fiscal press conference on October 12, it was proposed to increase support and security for key groups, expand financial aid for college students, and double the number of new national scholarship awards.

Previously, we proposed that "a new era of consumption centered on service consumption may be approaching," with the premise being whether effective income policies will be implemented subsequently and the narrowing of the negative wealth effect from real estate. First, the expansion of the service industry is beneficial for increasing residents' labor compensation. The nature of the industry determines that the income distribution of the tertiary sector (human capital) tends to favor residents more, while the income distribution of the secondary sector tends to favor capital. In 2020, the labor compensation rate in China's tertiary sector was 52.8%, significantly higher than the 40.7% in the secondary sector, with similar characteristics observed in U.S. data; second, the labor-intensive service industry has a clear advantage in absorbing employment, with the proportion of employed persons in the tertiary sector in China rising sharply from 27.5% in 2000 to 47.1% in 2022, significantly outperforming the secondary sector; third, commodity consumption is cyclical, while service consumption is sticky, resulting in a less pronounced intertemporal crowding-out effect. The 500 million yuan service consumption vouchers in Shanghai may be a small-scale pilot policy implemented in advance.

3.3.4. Consumption Factor 4: The effect of the old-for-new policy for consumer goods is significant.

This old-for-new policy began at the Central Economic Work Conference in December 2023, with the first phase from December 2023 to July 2024, corresponding to policy deployment and implementation; the second phase from July 2024 to the present, corresponding to policy intensification and accelerated effectiveness. On July 25, the National Development and Reform Commission and the Ministry of Finance coordinated the arrangement of ultra-long special government bond funds to support the two new initiatives, of which 150 billion yuan is used to strengthen support for the old-for-new consumer goods policy; by early August, all funds were allocated to localities, earlier than the original plan of the end of August; as of September 23, we have counted that all 31 provinces have implemented the "Ultra-Long Bond Strengthening Support Plan." High-frequency data shows that household appliance consumption surged in September and October, with automobiles taking over in November. The retail growth rates for household appliances, cultural and office supplies, furniture, and automobiles in October were 39.2%, 18.0%, 7.4%, and 3.7%, respectively, improving by 35.8, 19.9, 11.1, and 11.1 percentage points compared to July. Household appliances: According to data from the Ministry of Commerce, as of November 8, 20.257 million consumers purchased 30.458 million units of eight major categories of household appliances, driving sales of 137.79 billion yuan, with corresponding central government subsidies previously disclosed at approximately 26.27 billion yuan; Automobiles: As of November 18, applications for subsidies for scrapping and replacing cars nationwide have both exceeded 2 million, totaling over 4 million. It is important to note that the above figures represent overall stimulation rather than marginal stimulation and cannot be directly used to measure their impact on retail sales and GDP.

The marginal stimulation multiplier of the current consumer goods replacement policy is estimated to be about 2.5-3.2 times. The market typically estimates the overall stimulation of consumption policies, such as 5-7 times for household appliances and over 10 times for automobiles, but in reality, the consumption plans that were originally in place are not incremental. The marginal increment for the four major industries of household appliances, cultural products, furniture, and automobiles from August to September was about 80.7 billion yuan, while the central government issued 6.403 billion yuan in household appliance subsidies during the same period, with household appliances accounting for about 20%-25% of total subsidies. Thus, the marginal stimulation multiplier of central government funds = 80.7/(6.403/household appliance subsidy proportion) is approximately 2.5-3.2 times. It is estimated that the remaining fiscal funds for Q4 are about 120 billion yuan, which is expected to drive retail sales by 300-400 billion yuan, with a projected cumulative year-on-year increase in retail sales from January to December rising to 3.9%-4.1%. As the policy focus gradually shifts from investment to consumer livelihoods, it is expected that the ultra-long-term special government bonds in 2025 will expand to 2 trillion yuan. If 300 billion yuan of this is used for consumer goods replacement, it would represent an incremental funding increase of 150 billion yuan compared to 2024, with an additional stimulation of consumption of 375-480 billion yuan, and the retail sales growth rate in 2025 is expected to be around 4.5%.

3.3.5, Consumption Factor 5: New Second Urbanization Brings More Benefits to Consumption

On July 31, 2024, the State Council issued a notice on the "Five-Year Action Plan for Deepening the Implementation of People-Centered New Urbanization Strategy" (hereinafter referred to as the "Notice"), requiring that "after five years of effort, the urbanization rate of the resident population should be raised to nearly 70%."

In 2015, the economically active population in China peaked, and the urbanization rate began to slow down, compounded by the pandemic in 2020, continuous adjustments in the real estate market, and negative population growth, leading to a further decline in the urbanization rate. A global review shows that the slowdown in urbanization rates is concentrated around 70%-75%, and the timing of this slowdown is negatively correlated with the degree of aging (using the proportion of the population aged 65 and above as an indicator) In 2023, China's aging rate has reached 14.3%. We believe that "new urbanization" is not accelerating natural urbanization against the trend; its incremental meaning lies in promoting the "urbanization of the floating population." In 2023, the urbanization rate of the resident population and registered population in China has a gap of 17.9%, and this narrowing gap will significantly boost consumption growth.

The first urbanization is the urbanization of "land," mainly driving investment; the second urbanization is the urbanization of "population," mainly driving resident consumption, housing consumption, and public consumption (services), with a maximum potential space estimated at 8.8-9.9 trillion yuan. Assuming that the gap in urbanization rates between registered and resident populations narrows by 2-4 percentage points from 2024 to 2029, it could annually drive the economy by 524.2-1048.3 billion yuan, accounting for 0.4%-0.8% of the 2023 GDP.

(1) Resident consumption: From 2024 to 2029, it may annually drive 133.6-267.2 billion yuan. First, academic research indicates that converting to urban resident status may increase per capita consumption by 27%-30%. Wang Meiyan (2016) noted that "if migrant workers convert to urban resident status, per capita total consumption will increase significantly by 27%"; OECD (2017) empirically pointed out that rural populations working in cities and obtaining resident status may lead to nearly a 30% increase in consumption, driven mainly by higher income and longer education time.

Secondly, we have characterized three types of populations: urban, rural, and migrant workers: In 2023, China's urban population is 930 million, rural population is 480 million, migrant workers are 300 million, and out-of-town migrant workers are 180 million. In terms of income levels, the average salary of migrant workers and out-of-town migrant workers in 2023 is 55,000 yuan, which is close to the middle-income group (in reality, it has not reached this level, as disposable income is statistically counted by household, while migrant worker wages are counted individually); consumption tendencies are shown as "rural > urban > migrant workers," with consumption tendencies in rural and urban areas in 2023 being 83.8% and 63.7%, respectively, significantly higher than the 30.1% of migrant workers in 2015; in addition to the constraints of the "three major inequalities," migrant workers also actively save and meet their rural families' consumption expenditures through "transfer payments." It should be noted that migrant workers who go out are counted as part of the urban permanent population, while local migrant workers are counted as part of the rural permanent population. If households are considered as the unit of consumption decision-making, then the "real consumption tendency" of migrant workers + rural areas = (rural consumption + consumption of out-migrant workers) / (rural income + income of out-migrant workers). The estimate for 2023 is about 53%, which is not far from the 50% estimated by the National Research Center, and there is an improvement space of 11 percentage points compared to the 64% consumption tendency of urban residents.

Consumption expenditure = disposable income \ consumption tendency. After migrant workers convert to urban residents, income improvement is a slow variable and will have a significant contribution over a longer period, while consumption tendency may contribute more in the short term.* The "urbanization of the floating population" corresponds to an increase in consumption tendency from 53% to 64%, resulting in an incremental improvement in consumption tendency of 14.2*17.9%*51821*11% (i.e., total population * urbanization space of the floating population * average annual income * improvement space of consumption tendency) = 1.4 trillion yuan. The process of "urbanization of the floating population" has considerable uncertainty. Assuming that the 17.9 percentage points of space are fully released within 20-30 years, considering income growth, the potential space is about 2.6-3.7 trillion yuan, slightly lower than the consumption increase of 3.5-3.9 trillion yuan corresponding to a growth of 27%-30% according to academic literature. Similarly, it is estimated that from 2024 to 2029, it will drive annual resident consumption by 133.6-267.2 billion yuan.

(2) Housing demand: 2024-2029 or an annual increase of 266.5-533 billion yuan. The National Research Center believes that "if the per capita living area of migrant workers who move to cities increases to 30 square meters, it will drive an average annual investment of over 1 trillion yuan in housing (affordable housing) during the 14th Five-Year Plan period; each year, 5% of migrant workers moving to cities switching from renting to buying will drive 2.3 trillion yuan in housing consumption." This estimate may be somewhat overestimated. The "land urbanization" in our country is significantly faster than "population urbanization," and commercial housing faces considerable inventory destocking pressure, especially in third- and fourth-tier cities. Therefore, the first item’s impact on real estate investment can be ignored. Regarding housing consumption, we continue to use the two ratios of "5% switching from renting to buying each year" and "the per capita living area of migrant workers moving to cities increasing to 30 square meters." Considering that the adjustment of housing prices may not be over, and based on a price of 9,000 yuan/square meter, the maximum potential space can be calculated as 14.2*17.9%*30*9000*5% = 3.4 trillion yuan, which will drive housing consumption by 266.5-533 billion yuan from 2024 to 2029 (3) Public Consumption: 2024-2029 may drive an average of 124.1-248.2 billion yuan annually. In 2020, the research team of the Urban and Small Town Reform and Development Center estimated that an average migrant worker (incoming population) needs to increase government spending by about 110,000 yuan to settle in cities based on the settlement situation and urban government statistics from large and medium-sized cities in eastern regions such as Jinan, Yantai, and Taizhou, Zhejiang. The top three expenditure items are pension insurance financial subsidies, compulsory education for children accompanying migrants, and affordable housing, accounting for 35%-45%, 12-25%, and 12-18%, respectively. However, the research team also pointed out that "the public service expenditure for newly settled residents should be less than 110,000 yuan." The original report did not mention specific values, so we roughly assume the marginal cost is 10%, i.e., 11,000 yuan/person, thus the maximum potential space is 14.2*17.9%*11,000=2.8 trillion yuan, which may drive public consumption expenditure of 124.1-248.2 billion yuan annually from 2024 to 2029.

4 Asset Allocation Recommendations

4.1 Global Major Asset Classes: Significant Increase in Uncertainty

In the short term, US stocks > US dollar > gold > US bonds > crude oil

US Stocks: In 2024, due to the US economy basically achieving a soft landing, coupled with the continued enthusiasm in sectors like AI, US stocks are expected to record significant gains. Looking ahead in the short term, as there is no recession risk in the US economy and strong market expectations for Trump's tax cuts, US stocks may perform well, possibly oscillating upward. However, it should be noted that after Trump officially takes office in January 2025, his economic policies will have a high degree of uncertainty, which may put pressure on US stocks from the valuation side, and there may also be differentiation at the industry level, with volatility potentially amplifying;

US Dollar: In 2024, due to the relatively strong US economy, leading Europe and Japan, the US dollar index is expected to fluctuate widely above 100, without a trend-based decline. In the short term, given the resilience of the US economy, the dollar index may remain above 104. Furthermore, considering that Trump may impose tariffs globally, based on his previous term's experience, this could encourage global capital to flow back to the US, thereby boosting the dollar further;

Gold: In 2024, gold prices recorded an increase of about 40%, the largest increase in nearly a decade. On one hand, central bank purchases have significantly increased the demand for gold compared to the past; on the other hand, the Federal Reserve has entered a rate-cutting cycle, leading to a decrease in real interest rates. Coupled with the impact of global geopolitical situations, these factors have collectively driven the continuous rise in gold prices. In the short term, gold may face relative pressure due to the previous large increase in price. However, in the medium to long term, the factors driving the rise in gold prices are still present, and gold may continue to perform well; U.S. Treasury Bonds: The trend of U.S. Treasury bonds in 2024 is expected to be volatile, but the overall fluctuation range is somewhat narrowed compared to 2023. In the short term, due to the strong U.S. economy and market expectations that Trump may increase the U.S. fiscal deficit, the supply of U.S. Treasury bonds may increase, worsening the supply-demand structure in the bond market. The 10-year U.S. Treasury yield may range between 4.3% and 4.5%. Moving forward, due to the uncertainty surrounding Trump's tax reduction policies, as well as potential impacts from immigration expulsion and increased tariffs on the U.S. economy, the trend of U.S. Treasury bonds may remain volatile, with amplified fluctuations.

Crude Oil: In 2024, due to the resilience of the U.S. economy and OPEC's production cuts, crude oil prices are expected to show an M-shaped trend. We believe that crude oil prices may struggle to perform well in the future, as although OPEC is cutting production, Trump may increase crude oil extraction, and the Russia-Ukraine conflict may come to an end, leading to an increase in global crude oil supply, while demand may not show significant improvement.

4.2 Domestic Assets: Stocks outperform bonds, with sector allocation favoring technology + cyclical sectors first, then consumer-oriented domestic demand.

Equity assets are expected to perform better than bond assets, with bond yields likely to decline first and then rise. In terms of sector allocation, the focus will be on technology growth before shifting to cyclical sectors and consumer-oriented domestic demand.

Bonds: Interest rates may decline first and then rise. It is expected that fiscal stimulus will occur in two phases: the first phase will focus on debt reduction to address existing issues. During this period, the central bank is expected to release liquidity to lower overall financing costs, benefiting the bond market. The second phase will involve increasing incremental policies to stimulate the economy. At this point, the economy and credit may stabilize and rebound, which would be negative for the bond market.

Stocks: It is expected that in 2025, with loose fiscal and monetary policies, the effects of these policies will gradually transmit to broader credit, overall benefiting the stock market.

(1) Policies will first focus on real estate, debt reduction, and banks to address existing issues, stabilize expectations, and improve the balance sheets of households, enterprises, and governments, leading to corresponding valuation increases;

(2) Debt reduction will release fiscal funds and potential reconstruction demand from Trump's mediation of the Russia-Ukraine conflict, benefiting cyclical sectors such as banking, insurance, construction materials, chemicals, and non-ferrous metals;

(3) New productive forces will drive a new round of Total Factor Productivity (TFP) growth, combined with Trump's administration catalyzing themes of self-sufficiency, focusing on electronics, semiconductors, computers, and new energy;

(4) As loose fiscal policies transition from expectation to reality, there will be an emphasis on consumer spending, coupled with the stabilization of housing prices and the second urbanization boosting consumption demand, benefiting sectors such as automobiles, food and beverages, pharmaceuticals, and tourism, while export consumption in home appliances and furniture may be disrupted by increased tariffs.

Considering the policy stimulus and the fiscal policy boost on October 12, the GDP growth rate for 2024 has been revised upward to 5.0%. Looking ahead, the certainty of fiscal expansion in 2025 is strong, and it is expected to maintain a GDP growth rate of 5.0%, with inflation levels potentially rising further, improving nominal GDP growth to 5.3% As of November 22, three international financial institutions and 75 foreign institutions have made predictions regarding China's GDP growth rate for 2025, with a median of approximately 4.5%.

Authors of this article: He Ning (SAC certification number: S0790522110002), Chen Ce (SAC certification number: S0790524020002), Pan Weizhen (SAC certification number: S0790524040006), Source: He Ning Macro, Original title: "【Open Source Macro | In-depth】The Path Choices for China to Expand Domestic Demand - Macroeconomic Outlook for 2025", edited by Wallstreetcn

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