Tianfeng's Song Xuetao looks ahead to 2025: Reform implementation, real estate transformation, consumption hedging against exports

Reform, transformation, and volatility are the three keywords for China's economy next year.

Keyword 1: Year of Reform Implementation

Although consumer stimulus, growth targets, and deficit rates are topics of market concern, in the long run, reform is the underlying logic of policy. Since the end of July, the introduction of various policies has revolved around this logic of reform.

The keyword for reform in August is fair competition. On August 1, the "Regulations on Fair Competition Review" were officially launched, imposing numerous restrictions on local governments regarding market entry and exit (such as franchise rights), free flow of factors (such as restrictions on foreign goods entering local markets), and corporate production costs (such as tax incentives, differentiated fiscal rewards, or subsidy preferences). This aims to break local governments' regional protectionism and unfair investment attraction, encouraging local governments to compete fairly within a market-oriented framework and seek differentiated development based on resource endowment advantages.

The keyword for reform in September is policy coordination. The package of incremental policies introduced at the end of September is characterized by policy coordination and targeting. For example, the People's Bank of China, the China Securities Regulatory Commission, and the Financial Regulatory Administration played a coordinated role in stabilizing the stock market (two capital market financial instruments) and the real estate market (reducing existing mortgage rates), which is also a positive change brought about by reform.

The keyword for reform in October is debt reduction and risk prevention. The press conference held by the Ministry of Finance on October 12 focused on debt reduction and preventing local government debt risks, ensuring the bottom line for the "three guarantees" (guaranteeing wages, basic livelihoods, and operational expenditures). The fundamental purpose of debt reduction is to free local governments, allowing them to accelerate transformation, which is also an important part of reform.

The keyword for reform in November is marketization of factors. The cancellation of export tax rebates for certain goods will, on one hand, shift the tax burden to foreign consumers, keeping tax revenue domestic, which helps alleviate current fiscal pressure. On the other hand, it also helps to clear excess capacity from inefficient enterprises, changing the inefficient competitive landscape reliant on export tax rebates. The relaxation of household registration conditions in Guangzhou is also a push for reform in the marketization of factors.

2025 will be the first complete year for the comprehensive deepening of reform implemented by the 20th Central Committee's Third Plenary Session. The draft "Private Economy Promotion Law" has been submitted for review by the Standing Committee of the National People's Congress, and reforms in the fiscal and tax system (such as the downward adjustment and postponement of consumption tax), marketization of factors (such as land index trading platforms and exploring compensated exit from homestead land), and the coordination of responsibilities in the livelihood sector (housing, elderly care, education, healthcare) will also be important focal points for reform policies next year.

The early-year reserve requirement ratio and interest rate cuts have brought liquidity easing, and the expectations of reform policies will boost market sentiment, creating a trading window driven by both capital and sentiment.

Keyword 2: Real Estate and Prices Emerging from the Transformation Period

Recently, Xinhua News Agency has published a series of articles providing insights into next year's economic policies. The first article mainly focuses on the economic sector, stating that "the figures for high economic growth are not unattainable, but there is no need to excessively pursue short-term high growth at the expense of growth quality and future growth potential." It mentions that "a growth target of around 5%, whether slightly above or below, is acceptable," implying that next year's economic growth target may still be around 5% In 2024, the real estate industry's drag on the economy will still be significant. After deducting land acquisition costs, real estate investment is expected to drag GDP growth down by about 1 percentage point. However, this impact is mainly confined to the real estate sector itself, and its influence on other industries, especially manufacturing, is diminishing. For example, in the steel industry, the production growth rate of section steel and strip steel used for manufacturing is significantly higher than that of rebar and wire rod used for real estate.

In 2025, the negative growth rate of real estate investment and sales may narrow, especially in sales. The sales area of new homes has declined for three consecutive years, and while second-hand housing prices are adjusting and inventory is being digested, they are also squeezing new home sales. This is reflected in the rapidly increasing proportion of second-hand home transactions. In October 2021, the proportion of second-hand home transactions in sample cities was only 22.9%; by July 2024, this proportion had risen to 56%, averaging an annual increase of about 12 percentage points.

The proportion of second-hand home transactions in mature markets typically exceeds 70-80%. For example, the proportions in the UK, France, and the US are 94.9%, 91.4%, and 86.0%, respectively, while Hong Kong and Japan are lower but still at 75.0% and 63.8%. As the gap between the proportion of second-hand home transactions and mature markets rapidly narrows, the growth rate of new home sales area is expected to gradually converge to within -10%, and the growth rate of real estate development investment will be slightly better than this year, mainly because the decline in the growth rate of newly started construction area will begin to converge.

Infrastructure investment may see slight improvement next year, as large-scale debt issuance helps local governments maintain normal cash flow, pay infrastructure contractors and suppliers, and ensure that projects can start normally to generate physical workload. Manufacturing investment will continue to maintain stable high growth under the support of the central economic work conference's call to expand effective investment.

The difference in the economy next year is that the downward pressure on prices will gradually ease, with real estate being the main reason for price pressure. For PPI, real estate investment is significantly declining, and prices of construction materials represented by black metals are facing downward pressure; for CPI, the decline in housing prices not only directly affects rental and housing price indicators but also indirectly influences residents' consumption willingness through property income and wealth effects.

The negative drag of real estate on the economy will gradually weaken next year, and signs of improvement in the fundamentals will be observed. It is expected that by the end of next year, second-hand housing prices and new home sales will have basically bottomed out, and CPI and PPI will begin to return to normal levels. By the end of next year, CPI growth is expected to exceed 0.5% and approach 1%, while PPI is expected to return to positive growth; the GDP deflator may turn positive in the fourth quarter of next year.

In an environment of price pressure, corporate profit growth may be negative, especially for traditional enterprises. Once nominal growth exceeds real growth, corporate profit margins will begin to improve. It is expected that in the second half of next year, the ROE of listed companies may show improvement and recovery, and the profit growth rate of industrial enterprises may turn positive. By the end of next year, nominal growth may exceed real growth, emerging from the price decline period brought about by economic transformation and the downward adjustment of real estate

Keyword Three: The Fluctuation of Exports and Consumption

Exports may be a fluctuating factor in the economy. During the first round of trade shocks in 2018, exports, especially to the U.S., faced significant downward pressure, and the countermeasures at that time were relatively limited. Since 2018, China has not been isolated from trade frictions, and the U.S. government's tariff policy towards China has not changed. However, the results show that the export share has risen amidst twists and turns, and the export growth rate has consistently exceeded expectations, with global reliance on China gradually increasing. After enduring the trials of trade frictions, going overseas has become a consensus, and the risk resistance capability of the Chinese supply chain has continuously strengthened, significantly improving the ability to cope with trade frictions.

The main means of coping with export fluctuations is to boost domestic demand and stimulate consumption. After the pandemic, the growth rate of retail sales has generally been in the range of 2-5%. In September and October, benefiting from the old-for-new policy, the growth rate of retail sales rebounded to the upper end of the 4-5% range. The Central Economic Work Conference emphasized the need to vigorously boost consumption and comprehensively expand domestic demand. It is expected that in the second and third quarters of next year, policies will increase consumption stimulation to counteract the negative impact of trade frictions on exports, and in certain months, the growth rate of retail sales may exceed 5% under low base conditions.

Next year, there may still be a discrepancy in export expectations. Through re-exports, going overseas, and enhancing manufacturing capabilities, the impact of tariffs on Chinese exports may be smaller than the market expects. By the end of next year, the price decline period caused by real estate adjustments will gradually end, and the endogenous profitability of enterprises will begin to improve. The exogenous impact of tariffs will be better than the market expects, and there will be a valuation repair logic for assets priced on fundamentals.

Author of this article: Song Xuetao from Tianfeng Macro, Source: Xuetao Macro Notes (ID: gh_5f81fe86a5dd), Original title: "Song Xuetao: The Fluctuation of Exports and Consumption in 2025"

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