Signals for economic rebalancing

China Policy Signals for economic rebalancing Bingnan YE, Ph.D(852) 3761 8967yebingnan@cmbi.com.hk In response to economic imbalance with overcapacity, deflation, confidenceerosion and trade tensions, China's policymakershavesignalled a strategic pivotrecently, making "boosting domestic demand" the top economic priority for 2026.Demand-side policies will focus on stabilizing the property market by loweringmortgage rates and purchasing unsold property and stimulating consumption byincreasing fiscal subsidies and strengthening the social safety net. On the supplyside, a new round of structural reform aims to address overcapacity throughreduced supply, stricterregulations on energy saving and environment, andencouraged M&A toboost industry concentration and profitability for leading firms.To mitigate trade tensions, China will employ a four-pronged approach: adjustingVAT rebates, allowing Outward Direct Investment (ODI), supportingstrong RMB,andfurther opening domestic market.The rebalancing process,despite apotentialGDP growth target reduction to 4.5%-5%in2026,isstructurally positivein our view. Investors should focus on globally competitive industry leaders, asthese efforts are expected to improve their market shares and earnings prospects.China’s economic rebalancing and global liquidity easing should support stocks,commodities,and EM currencies through 1H26. This momentum may facechallengesin 2H26 if resurgent US inflation sparks liquidity fearsanda strongergreenback. Frank Liu(852) 3761 8957frankliu@cmbi.com.hk Economic imbalance state and challenges.China’s economic imbalanceis primarily characterized by a low consumption ratio, a high investment ratio,a massive trade surplus, and persistent deflationary pressure. Data indicatesthat Chinese household consumption as a percentage of GDP is significantlylower than the global average, fundamentally driven by an extremely highhousehold savings rate. This high propensity to save, combined with localgovernments' long-standing pursuit of high GDP growth, has supported adisproportionately high level of fixed asset investment as a percentage ofGDP. The continuous expansion of fixed asset investment has accumulatedsupply capacity that far exceeds domestic consumer demand. This mismatchbetween supply and demand not only leads to deflationary pressure butalsocompels enterprises to seek overseas markets, thereby generating a massivecurrentaccount surplus.More critically,this imbalanced model hasexacerbated debt accumulation: once investment surpasses the point ofdiminishing marginal returns, the efficiency of capital drops sharply. Chinamust spend increasinglyon investment to achieve the same unit of GDPgrowth, which has directly led to a massive buildup of corporate and localgovernment debt. Furthermore, the overcapacity resulting from excessiveinvestment has triggered cut-throat competition or involution across broadindustries, severely eroding corporate profitability and business confidence.The reliance on exports to absorb this overcapacity has, in turn, fuelled tradetensions with major trading partners. Policy signals for economic rebalancing.From late 2025 to early 2026,China's top leadership has sent strong, concentrated signals of a strategicshifttowards "demand-side management." The Central Economic WorkConference held in December 2025 explicitly designated "boosting domesticdemand" as the top economic priority for 2026, with a commitment to "build astrongdomestic market".The conference outlined five"New Musts”,positioning the expansion of domestic demand as the core driver for unlockingthe economy's full potential, and pledged to adopt a proactive fiscal stanceand a moderately loose monetary policy. In January 2026, President XiJinping further stressed in a speech to provincial leaders that consumptionmust become the main engine of economic growth. He clarified specific policypathways, including increasing urban and rural residents' income throughmultiple channels, strengthening the social safety net to reduce precautionary savings, and vigorously developing service consumption. Subsequently, atthe Davos Forum, Vice Premier He Lifeng publicly stated that China wouldnot deliberately pursue a trade surplus and was willing to transform from the"world's factory" into the "world's market," sharing its development dividendsby expanding imports globally. These statements signify a clear strategic pivotfrom the traditional investment-driven model to a consumption-driven one. Possible demand-side policies.On the demand side, China is expected tolaunch a combination of stimulus policies targeting both the property marketand consumer spending. To stabilize the property market, the central bank islikely to implement Loan Prime Rate (LPR) cuts by approximately 20 basispoints, while the Ministry of Finance (MoF) may provide direct subsidies fornew mortgage interest payments. These two measures are expected to lowerthe effective mortgage financing rate for homeb