J.P. Morgan On China Potential Growth & Policy Areas To Focus On

The US bank notes lower potential growth in coming years and outlines potential policy reforms that can improve the outlook.

J.P. Morgan: "A confluence of domestic and external shocks has lowered China’s potential growth ...
… and it is likely to slow further to 3-4% over 2025-30. China’s incomplete recovery points at a negative output gap of 2-3%pts, weighing on inflation.

The negative output gap and divergent cross-sector performance jointly explain most urgent macro problems faced by the Chinese economy, i.e. deflation pressure, structural unemployment problem, weak income expectation among upper-middle income households and a shift from consumption upgrade to “value-for-money” consumption.

What can be done to deal with these problems? The government seems to be aware of them but not, in our view, take them seriously enough. Even within the market, there are two lines of different proposals that focus on cyclical and structural aspects, respectively. The cyclical view is that the government should step up counter-cyclical fiscal and monetary easing, or adopt a “whatever it takes” approach to close the negative output gap. The structural view focuses on the imbalances in the economy, calling for a shift of policy support for household consumption and domestic demand, and measures to restore confidence in the non-SOE sector.

In the current situation, we think both cyclical and structural measures are important, but our bias is that structural measures are more important, as they not only address the near-term cyclical problems but also helps to lift potential growth in the long run. In addition, it is not only negative output gap, but more importantly also a demand-supply imbalance that has contributed to the unique deflation phenomenon in China after reopening.

In our view the government needs to more aggressively promote domestic demand through policy (e.g., trade-in program, policy support for childcare and elderly care, measures to crack down overdue salary payment, and improved social safety net), while being pragmatic about the pace of adjustment in policy headwind sectors (to reduce near-term drag, restore employment and income expectations and improve market confidence). A stepped-up public housing program is also important, in part to offset the contraction in commodity housing activity and in part an indirect way to support consumption (public housing is another form of government transfer to the household sector). These measures will involve increased support from fiscal and monetary policy, but not necessarily a massive stimulus. A change in policy direction and improvement in policy environment (more transparent, predictable, market- and rule-based) could fill the gap that stimulus economic policies cannot achieve."