Zhang Ming on 2023 global & Chinese macroeconomy and investment strategies in China

Senior economist at CASS says the focus of China's macroeconomic policies should at least partially shift from enterprises to households.

Below is a February 24 Q&A with Dr. Ming ZHANG, Senior Fellow and Deputy Director of the Institute of Finance & Banking (IFB) under the Chinese Academy of Social Science (CASS).

The Q&A was conducted at the 5th Global Wealth Management Forum held in Beijing by Caijing, a Chinese financial media outlet.

Q: What are your opinions on the macroeconomy and the financial market of China and the globe in 2023?

A: Good afternoon, everyone. Due to limited time, I will spend about 7-8 minutes sharing with you my main views on the current macroeconomic situation of China and the world.

In 2023, there are three major uncertainties globally.

The first uncertainty remains to be the continuing aftermath of the pandemic. Although the impact of the pandemic on economic growth is gradually disappearing, its impact on the global industrial chain is still ongoing. The global industrial chain has become shorter and more regionalized, which would increase global production costs.

Secondly, international geopolitical conflicts are rising, such as the conflict between Russia and Ukraine and the China-US competition. The evolution of geopolitical conflicts and their impact on the global economy is the most difficult to predict.

Thirdly, the trend of de-globalization is accelerating. Take the examples of Brexit in 2016 and trade friction between China and the US in 2018. Both events are intensifying the trend of de-globalization. 

The three uncertainties combined have caused the pressure of global stagflation today. On the one hand, factors such as the impact of the pandemic, the increase in interest rates by central banks in developed countries, and the financial crises in emerging markets and developing countries will all further the pressure of economic stagnation. On the other hand, the rise in commodity prices caused by geopolitical conflicts and the cost increase caused by the adjustment of global industrial chains will exacerbate inflationary pressures.

In 2022, we already witnessed global growth being lower than global inflation. This year, we expect global growth to be around 2-3%, while global inflation to be around 5%. Consequently, stagnation will continue this year

But if we look further ahead, after the current wave of inflation, I think stagnation would remain in the long term. Why? The reason is that the structural factors that cause long-term stagnation have not changed. The aging population, deepened imbalance of global income and wealth distribution, intensification of de-globalization, and the slowdown of measurable technological progress remained constant. As a result, after this round of stagflation, the global economy is still likely to face long-term stagnation.

As for the trend of global asset prices in 2023, I believe the key turning point lies when the U.S. Federal Reserve stops raising interest rates.

Based on the current domestic inflation of the US, services have replaced products as the major driving force behind price increases, while the price stickiness of services is also stronger. In addition, both wages and house rentals are quite high. This means that the domestic inflation of the United States will remain relatively high in the first half of this year. We predict that the Federal Reserve will raise interest rates twice in the first half of this year, each time by 25 basis points, and may not stop until the end of the second quarter.

[Pekingnology: please note the Q&A was conducted before the Silicon Valley Bank collapse and the Fed’s latest interest rate hike.]

The Silicon Valley Bank run and lessons for China

If the above judgment is correct, then in the first half of this year, the global financial market will face bi-directional fluctuation, whether it is the stock market, currency market, bond market, or commodity market. In the second half of the year, if the Federal Reserve stops raising interest rates, the US long-term interest rates and the US dollar index may significantly decline, which could create some trading opportunities.

China's economic growth in 2023 faces both pressures and opportunities. The pressures mainly arise from two aspects.

On the one hand, the pressure comes from the scars left by the three-year pandemic. It will affect economic growth through at least three channels. First, it will weaken the confidence of residents and enterprises, decreasing their willingness to take risks to the extent that they are reluctant to increase leverage, making it difficult for consumption and investment to grow. Second, it will impact the balance sheets of enterprises and financial institutions, which may lead to a rise in local financial risks, such as third- and fourth-tier (local government financing) platforms, real estate developers, some private enterprises, and small and medium-sized financial institutions. Third, it will impact the income of the middle and lower-income groups, which may affect their accumulation of human capital and cause medium- and long-term effects.

On the other hand, the pressure comes from the aging demographic. The year 2022 was a landmark, as the total population of China began to decline, implying that we have reached the second turning point in population. The first turning point was in 2010 when the proportion of the working-age population in the total population began to decline. In 2022, the total population began to decline. International experience shows that after the second turning point, we will frequently face negative impacts from the demand side in the future. From this perspective, the focus of China's macroeconomic policies moving forward should at least partially shift from enterprises to households.

However, despite the pressures mentioned above, we remain very optimistic about China’s economic growth in 2023 due to three main reasons.

Firstly, at the end of last year, China adjusted our pandemic prevention and control policies. Chinese society is quickly returning to normalcy, with both consumption and investment growth rates significantly rebounding. The second reason is the low base effect. Last year's low economic growth rate provided a good foundation for higher growth rates this year. Thirdly, fiscal and monetary policies this year are expected to be further relaxed.

The following is my rough outlook on this year's fiscal and monetary policies.

In terms of fiscal policy, firstly, the ratio of the central government’s fiscal deficit to GDP will increase from 2.8% last year to 3.0% or even higher; secondly, the quota for the 地方政府专项债券 special bonds for the local government, which was 3.65 trillion yuan last year, may increase to 3.9 to 4 trillion yuan this year; thirdly, the scale of central government bond issued this year may expand compared to last year; fourthly, the policy-oriented and development-oriented financial instruments in the second half of last year, which are favored by local governments, namely new financing instruments by way of the China Development Bank and the Agricultural Development Bank of China which could be used as partial capital for local construction projects, is likely to continue this year.

As for monetary policy, although the central bank has been emphasizing the importance of structural monetary policy, overall easing is still indispensable. This year, we may see new cuts in the reserve requirement ratio and interest rate. Personally, I believe that interest rate cuts are more important than reserve requirement ratio cuts at the moment because the former can directly lower the financing costs of micro-entities and stimulate their credit demand.

Finally, here are my predictions for the macroeconomy and financial markets in 2023. China's GDP growth rate is expected to reach 5.5% or higher this year, with a CPI growth rate below 3.0%. The surveyed urban unemployment rate will be around 5.5%, while the unemployment rate for the 16-24 age group is expected to decrease by about five percentage points. Regarding asset prices this year, we are optimistic about the stock market and the RMB exchange rate. The bond market faces significant uncertainty, especially with the possibility of high chances of defaults by bonds. Regarding the real estate market, there may be some improvement in the core areas of first-tier cities this year, but it is unlikely that the national real estate market will pick up.

Q: Thank you very much. What do you think of domestic demand? This year, there is a lot of pressure on foreign demand and exports, correct?

A: During the three years of the pandemic, net exports have been one of the most important drivers for China's economic growth, with export growth continuing to be resilient. However, as the pandemic subsides and global economic growth slows down, the contribution of net exports to economic growth this year is expected to decline significantly, making domestic demand especially important.

Two major drivers can stimulate the growth of domestic demand this year: household consumption and infrastructure investment. On the one hand, as the pandemic gradually subsides, the service industry is starting to recover. Companies within the service industry are expanding, and corresponding industry wages are beginning to rise. Simultaneously, consumer confidence is also beginning to recover. All these factors contribute to a rebound in consumption growth. On the other hand, infrastructure investment is mainly led by local governments. As long as fiscal policy is eased further, there will be a high probability that infrastructure investment will remain at a high growth rate in 2023.

In contrast, the trend in manufacturing investment growth is somewhat uncertain. The growth of manufacturing investments based in the domestic market may rebound, while those oriented towards foreign demand may decline. In addition, the growth rate of real estate investment may remain relatively low.

Hence, the main sources of growth for domestic demand this year are likely to be household consumption, infrastructure investment, and manufacturing investment - in that order. In contrast, growth rates of net exports and real estate investment may lag. Thank you.

Q: In the current complex and ever-changing situation, do you have any suggestions for financial investments for ordinary families?

A. Let me start the discussion by asking how ordinary families should avoid risks in financial investments under the current situation. There are indeed many professional institutions in asset management, but to enjoy the high-quality services provided by professional institutions, a relatively high asset threshold is required. In addition, selecting suitable professional institutions and financial products is beyond the ability of ordinary families.

Here, I would like to provide five suggestions for ordinary investors on financial investment.

Firstly, it is important to keep learning and enhancing your understanding of financial investment concepts, investment strategies, and related products. If an investor does not understand concepts such as risk-return trade-offs, risk assets vs. safe haven assets, risk-free assets and risk premiums, investment duration and liquidity, and the correlation between different types of assets' prices, they will find it difficult to form their independent views and may easily follow the crowd as well as chasing market trends, which usually does not lead to good returns.

Secondly, due to the rising uncertainty of global geopolitical conflicts, my advice is to increase holdings of safe-haven assets appropriately. For example, if gold prices are not very high, Dollar-Cost Averaging investments in gold could be made. Sovereign and institutional investors worldwide currently value gold investment. However, there are disagreements about whether the current price is reasonable. In my opinion, if the international gold price is below $1800 per ounce, it is an opportunity to start building up positions. Additionally, since the assets of ordinary Chinese investors are mostly in RMB, an appropriate allocation of foreign currency assets can hedge against some exchange rate risk.

Thirdly, we must stop the frenzied pursuit of real estate. Over the past twenty years, ordinary Chinese families’ increased wealth has mainly relied on real estate. However, the game rules of the real estate market have now changed, and the expectations of developers and ordinary people have changed. The COVID-19 pandemic has brought structural shocks while the demographic structure is changing. Under the current situation, buying an expensive apartment with high leverage is a high-risk choice. Therefore, either buy a suitable house according to actual housing needs or optimize and reduce holdings of real estate assets. For home buyers with real needs, my advice is to choose core cities, core regions, large developers, and medium to small units. These four suggestions can help maintain the liquidity of real estate.

Fourthly, in the future, we should pay more attention to the equity market. After the real estate boom, most high-yield investments in the future would likely come from the equity market. Of course, ordinary investors need to change their past investment ideas. First, they should buy industry-leading stocks and high-quality mutual funds on dips. Second, they should avoid chasing market trends or even high-leverage speculation. Third, they should construct investment layouts based on China's economic and industrial development patterns.

Fifth, we must guard against negative impacts caused by possible corporate bond defaults in the future. In the short term, the Chinese corporate bond market may frequently see defaults. Although ordinary investors generally do not directly purchase corporate bonds, if they buy many 信托产品 trust products or 银行理财产品wealth management products sold by banks, a large part of the underlying assets of the products may be corporate bonds. This means that the default risk is also worth our attention.

In summary, my five suggestions are: 1) keep learning, 2) increase holdings of safe haven assets, 3) appropriately reduce holdings of real estate or optimize the structure of real estate properties, 4) invest in high-quality stocks at the appropriate time, and 5) guard against negative impacts caused by possible corporate bond defaults in the future. Thank you!

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