Assessing China’s “Structural” Monetary Policy

The overarching economic goal of China’s leadership is to transform its old growth model to a more sustainable path, addressing the long-term challenges of an aging population, declining productivity and less and less room for policy stimulus. Ongoing policies such as rebalancing, deleveraging, and “Made in China 2025,” which are designed to achieve this transition, are likely to remain in place with some implementation details to be adjusted along the way.

“Dual circulation” economic strategy – adjusting to the changing geopolitical environment

China has recently unveiled a “dual circulation” economic strategy that is likely to be included in China’s upcoming 14th five-year plan (2021-2025) to guide the country’s economic policies. The idea is for China to rely predominantly on its domestic economic system (“internal circulation"), which will be supported by international markets (“external circulation”). While some may view China’s long-term attempt to reduce its dependence on overseas markets and technology as reverting to a closed-door policy, we believe that it reflects a strategic adjustment in response to a more contentious geopolitical environment.

As U.S.-China tensions escalate and protectionism rises across the globe, foreign demand is becoming less reliable, so China is focusing on stimulating domestic demand to absorb its huge production capacity. China has, over the years, pursued and seen increases in final consumption and services as a share of GDP. However, industrial production remains a key contributor to the economy and the supply chain continues to involve critical links to imports and foreign expertise. With potential disruptions of global supply chains and less accessible foreign technology or key products, China’s policymakers see an urgent need to upgrade the country’s manufacturing sector, to develop a full-spectrum supply chain and to achieve technology self-sufficiency.

Although a forced financial de-coupling remains a tail risk, we believe China will accelerate the internationalization of the renminbi (RMB) to mitigate potential disruptions of international transactions and further open its financial markets to foreign investors. Investors should expect some market volatility during this period of transition, and be more selective when choosing which sectors and asset classes to invest in.