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China's Economy Facing Internal and External Challenges

Osamu Tanaka

Introduction

The COVID-19 pandemic and increasing economic tensions with the United States compelled the CPC and the Chinese government to enhance their holistic security measures.

The Chinese economy was damaged seriously by the 2020-2022 outbreak of the COVID-19 pandemic, the implementation of the COVID-19 containment policy (the so-called "zero-COVID policy"), and the enhancement of regulations and guidance for private enterprises. In 2023, the zero-COVID policy was abandoned, and the Chinese economy was expected to recover smoothly. However, its recovery was slow, and the CPC Central Committee and the State Council implemented economic stimulus measures in the second half of the year in 2023 and 2024. Nonetheless, the Chinese economy has not yet resumed strong growth.

This paper summarizes the internal and external problems facing the Chinese economy and points out future policy challenges for the CPC Central Committee and the State Council.

I. Enhancement of Security Measures

The COVID-19 pandemic disrupted global industrial and supply chains, stagnating production and revealing the vulnerability of the efficiency-oriented construction of global industrial and supply chains.

The US-China economic friction has expanded from trade to cutting-edge scientific fields such as 5G, AI, quantum technology, and space development; the United States took the lead in decoupling the Chinese economy to prevent the transfer to China of cutting-edge science and technology (especially those related to security).

As a result, China is compelled to strengthen its holistic security measures. New Chinese policies that symbolically reflect this trend are as follows.

1. Integration of Development and Security

The philosophy underpinning the Chinese government's ​​economic policy to date is "handling correctly the relationship between development, reform, and stability." Yet, in the years with significant political events, "stability" has been emphasized. The three years 2019-2021 witnessed the 70th anniversary of the founding of the People's Republic of China (2019), the ultimate phase of the realization of a moderately prosperous society (2020), and the 100th anniversary of the founding of the Communist Party of China (2021). "Stability" was prioritized throughout those years; in 2019, the "six stabilities" (employment, finance, trade, foreign investment, domestic investment, and market expectations) were emphasized.

However, in 2020, the domestic and international economic downturn caused by the COVID-19 pandemic and the expanding and prolonged economic friction with the United States compelled the CPC leadership to consider the elements of "security." At the Politburo meeting of the CPC Central Committee on April 17, 2020, in addition to the "six stabilities," the CPC Central Committee advocated "six guarantees" (employment for ordinary people, basic living needs, market entities, food and energy security, stable industrial supply chains, and ordinary grassroots governance).

Furthermore, in his "Explanation of the Proposals" at the Fifth Plenary Session of the 19th CPC Central Committee in October 2020, General Secretary Xi Jinping stated that "security is a prerequisite for development, and development is the guarantee of security," and proposed the "integration of development and security."

2. Enhancement of National Security

General Secretary Xi Jinping's "Report" at the 20th CPC Party Congress held in October 2022 emphasized the importance of national security, stating that "National security is the bedrock of national rejuvenation, and social stability is a prerequisite for building a strong and prosperous China. We must resolutely pursue a holistic approach to national security and promote national security in all areas and stages of the work of the Party and the country, so as to ensure national security and social stability."

As the phrase "holistic approach to national security" suggests, the scope of China's national security includes the security of people, politics, economy, military, science and technology, culture, society, and the homeland, as well as international challenges.

Specifically, Xi Jinping calls for strengthening "the safeguards for ensuring economic, major infrastructure, financial, cyber, data, biological, resource, nuclear, space, and maritime security." Regarding economic security, Xi mentioned food, energy, resources, key industrial and supply chains, and maritime rights and interests.

II. Stagnant Economic Recovery

1. Stagnant Recovery in 2023 and Policy Responses

(1) Initial Economic Policy

After abandoning the stringent "zero-COVID policy," the Chinese government declared adopting the proactive fiscal policy—more powerful and effective—to ensure economic recovery; to this end, it raised the fiscal deficit to GDP ratio for 2023 to 3.0% from 2.8% in 2022.

Regarding public investment, investment from the central government budget was increased to 680 billion yuan by 40 billion yuan from 2022. Special local government bonds, which provide a source of funds for provincial infrastructure investment, were increased to 3.8 trillion yuan by 150 billion yuan compared to 2022.

China's moderately loose monetary policy, said the government, "must be a precise and prevailing one." It went on to say that the growth of money supply should continue being fundamentally balanced with the nominal growth rate; lending to small, medium, and micro enterprises and manufacturing should expand; the overall financing costs of enterprises and the cost of personal consumer loans should be steadily reduced.

(2) Economic Stimulus Measures

In 2023, the Chinese economy recovered smoothly in the January-March period because the government abandoned the "zero-COVID policy." However, in the April-June period, private and foreign-affiliated companies' trust in the future development of the Chinese economy remained weak, and private and foreign direct investments tended to decrease. To look back on 2020-2021, the business of private enterprises deteriorated due to the implementation of a strict zero-COVID policy and a series of enhanced guidance and regulations for private companies, including the enhancement of regulations/penalties on private IT platform companies, coerced large donations, the strengthening of lending regulations for real estate companies, the restriction of online games, and the ban on private cram schools. Coupled with the strengthening of the anti-espionage law in 2023, these policy measures heavily undermined the trust of private and foreign-affiliated companies toward the future development of the Chinese economy. The sluggish performance of private enterprises also led to an increase in the unemployment rate of university graduates.

Furthermore, the pace of economic recovery also stagnated, as consumption recovered at a slow pace due to sluggish growth in personal incomes and a growing tendency to save money due to the negative asset effect of falling house prices.

In response, the Chinese government launched a series of economic stimulus measures from July 2023, including promoting the development and expansion of the private economy, encouraging private investment, restoring and expanding consumption, attracting more foreign capital, providing financial support for the real estate market, lowering lending interest rates, easing requirements for personal housing loans, lowering the reserve requirement ratio, extending the deadlines of and maintaining tax and fee reduction policies. As a result of these policy measures, the Chinese economy in the July-September period bottomed out from July and gradually improved.

In the October-December 2023 period, the central finances increased the issuance of national bonds for fiscal 2023 by 1 trillion yuan. The increased bond funds were all allocated to local governments by an expenditure transfer method to enhance China's national capacity to resist natural disasters by helping enhance disaster recovery/reconstruction, disaster prevention/mitigation, and relief capabilities. As a result, the fiscal deficit to GDP ratio in 2023 rose sharply to 3.77%.

(3) Growth Rate in 2023

China's GDP in 2023 grew by 5.4% in real terms (revised after the economic census), achieving the annual target of "around 5%." Analyzing the GDP growth rate by quarter, it recorded 4.7% for January-March, 6.5% for April-June, 5.0% for July-September, and 5.3% for October-December. However, these are year-on-year growth rates, and since the growth rate is affected by the economic trends in the same period of the previous year, they do not accurately represent the actual trends of the economy.

The National Bureau of Statistics of China releases the year-on-year growth rate—an indicator practiced by many developed countries—as a projection. According to the projections released as of January 2025, the growth rate for the January-March quarter is 1.7%, 1.2% for the April-June quarter, 1.5% for the July-September quarter, and 0.9% for the October-December quarter. Quadrupling these gives annualized rates, but, for example, the growth rate of about 4.8% for the April-June period obtained in this way is widely off from the value of 6.5% officially released by the NBS.

Looking at the contribution ratios to the growth rate by demand item, as of January 2025, final consumption's contribution ratio was 85.6% (4.6 percentage point contribution), capital formation 25.8% (1.4 percentage point contribution), and net exports (exports minus imports) -11.4% (-0.6 percentage point contribution). The contribution ratio of consumption increased by 36.3 percentage points from 2022 (49.3%) due to the backlash effect of abandoning the zero-COVID policy.

2. Stagnant Recovery in 2024 and Policy Responses

(1) Initial Economic Policy

Since the Chinese economy had been recovering thanks to the economic stimulus measures implemented since July 2023, the Chinese government declared that the proactive fiscal policy "must be moderately strengthened, improved in quality, and increased in effectiveness." The fiscal deficit to GDP ratio for 2024 was reduced again to 3.0%.

Regarding public investment, investment from the central government budget increased by 20 billion yuan to 700 billion yuan from 2023, and local government special bonds increased by 100 billion yuan to 3.9 trillion yuan from 2023. The government decided to issue 1 trillion yuan ultra-long-term special treasury bonds to implement major national strategies and capacity-building for security in key areas.

China's moderately loose monetary policy, said the Chinese government, "must be flexible, moderate, precise, and effective." The government announced that the growth of the money supply should be fundamentally balanced with the expected targets of economic growth and price levels.

In February 2024, the People's Bank of China lowered the reserve requirement ratio by 0.5 percentage points. Yet, it stated that "there is still room for further reductions in the reserve requirement ratio in the future." The PBC said that interest rates would be lowered if the overall financing costs of society remained stable.

(2) Economic Stagnation

In terms of economic trends in China in 2024, the Chinese economy recovered smoothly in the January-March quarter because most of the 1 trillion yuan of government bond funds additionally issued in the October-December quarter of the previous year were carried over to 2024, and water supply and other projects were launched one after another. However, in the April-June quarter, personal consumption remained weak, profits and private investment of industrial enterprises stagnated, and the negative margin of foreign direct investment expanded, causing economic recovery to stagnate again. The CPC Central Politburo meeting in July lacked a sense of crisis and did not propose any practical economic stimulus measures. However, it was decided in July that the central finances should strengthen support for the "large-scale equipment upgrade and consumer goods trade-in programs," which had been underway since March.

(3) A Series of Economic Stimulus Measures

The Chinese economy remained stagnant in the July-September quarter, compelling the government to take policy responses. Economic policies are usually debated at the CPC Central Politburo meeting held at the end of the month when the quarterly GDP is released. However, the CPC Central Politburo meeting held on September 26 before the release of the July-September GDP suddenly announced the implementation of comprehensive new economic measures, stating that "new situations and challenges have emerged in the operation of the economy." The new challenges and situations include 1) intensifying trade friction with the United States and the EU, 2) damage caused by storms and floods, 3) the weak recovery of consumption, 4) declining profits of industrial companies, and 5) the continuing decline of housing prices due to the inadequacy of the new real estate policy announced in May.

Earlier on September 24, People's Bank Governor Pan Gongsheng and others announced a policy package for supporting the real economy through finance consisting of 1) a 0.5 percentage point cut in the reserve requirement ratio, 2) a 0.2 percentage point cut in the policy interest rate, 3) a cut in the interest rate on existing housing loans, 4) a cut in the minimum down payment ratio for second housing loans, 5) an extension of the maturity of existing loans to developers and the real estate industry, 6) strengthening support for local state-owned enterprises to purchase housing stock, 7) support for developers to purchase idle land, and 8) the creation of support measures for the stable development of the stock market.

The Chinese Ministry of Finance also announced in October and November that it would: 1) raise the debt ceiling for local governments and generate 10 trillion yuan and replace the hidden debt of local governments with statutory debt by using the fund, 2) support the capital replenishment of large state-owned commercial banks by issuing special treasury bonds, 3) use local government special bonds to purchase and stockpile local land and housing stock, and 4) provide tax support for the real estate market.

(4) Economic Growth Rate in 2024

The 2024 GDP released in January 2025 scored a real growth of 5.0%. As a result of the successive implementation of economic stimulus policy measures from the end of September to November 2024, the annual target of "around 5%" was barely achieved. Looking at the year-on-year GDP growth rates by quarter, the January-March quarter's rate was 5.3%, the April-June quarter 4.7%, the July-September quarter 4.6%, and the October-December quarter 5.4%.

Looking at the quarter-on-quarter GDP growth rates, the estimates released by the National Bureau of Statistics of China as of January 2025 are 1.5% in the January-March quarter, 0.9% in the April-June quarter, 1.3% in the July-September quarter, and 1.6% in the October-December quarter. The annualized growth rate for the April-June quarter is about 3.6%; the real economy was practically bad.

As for the contribution rate to the growth rate by demand item, as of January 2025, final consumption was 44.5% (2.2 points contribution), capital formation (investment) 25.2% (1.3 points contribution), and net exports 30.3% (1.5 points contribution); the contribution rate of net exports turned significantly positive from -11.4% in 2023 due to last-minute exports before the inauguration of the US Trump administration. On the other hand, due to a tendency to save on personal consumption, the contribution rate of final consumption fell by 41.1 points from 2023, confirming a shortage of consumer demand.

III. Economic Policy for 2025

1. Strengthening Macro Policies

(1) Basic Guidelines for Macro Policies

On December 11-12, 2024, the Central Economic Work Conference (referred here to as the "Conference") was held jointly by the CPC Central Committee and the government to decide the basic guidelines for economic policies for 2025.

According to the basic guidelines, "the country's economy still faces many difficulties and challenges, primarily including insufficient domestic demand, operational difficulties in some enterprises, pressures on people's employment and income growth, and many hidden risks (the author's note: risks associated with the real estate market, local government debt, small- and medium-sized financial institutions, and capital markets)."

The 2025 basic guidelines for macro policies aim to implement more proactive and impactful macro policies, stabilize the real estate and stock markets, and prevent and resolve risks in key areas and external shocks. The "external shocks" may refer to increases in tariffs on Chinese export products to the United States, which are likely to be imposed immediately after the inauguration of the second Trump administration.

(2) Fiscal Policy

The basic guidelines defined the 2025 fiscal policy as "more proactive," enumerating the following policy measures: 1) set a higher deficit to GDP ratio (issuing more general government bonds), 2) increase the intensity of fiscal spending, 3) increase the issuance of ultra-long special treasury bonds, 4) increase the issuance of local government special-purpose bonds, and 5) increase investment from the central government budget.

As a result, the fiscal deficit to GDP ratio is likely to exceed 3% by a wide margin. In 2023, when government bonds worth one trillion yuan were issued at the end of the year, it rose to 3.77%; in 2025, it is likely to rise to 4% or even higher.

On the other hand, the Central Financial Work Conference held on December 23-24, 2024, emphasized fiscal discipline and sustainability, stating that "fiscal and economic discipline should be tightened" and "sustainable fiscal development should be promoted."

(3) Monetary Policy

The basic guidelines defined the 2025 monetary policy as "moderately loose"—the phrase used to describe the drastic monetary easing policy implemented during the Lehman Shock. The guidelines articulated that 1) the reserve requirement ratio and 2) interest rates be reduced at an appropriate time.

Meanwhile, the People's Bank of China maintains its previous control stance: "money supply growth should be balanced with the expected targets for economic growth and total price level." If the growth rate target were set around 5% and the price target around 3% or the same as in 2024, money supply growth would be controlled at around 8%.

2. Emphasis on Expanding Domestic Demand

From the outset, the economic policy of the Xi Jinping administration has been characteristic in emphasizing the supply side rather than the demand side. At the 2023 Conference, developing new quality productivity was considered more important than expanding domestic demand. However, in 2024, the order upended; "expanding domestic demand" came first, which was followed by "constructing a modern industrial system." Supply-side structural reform is good for increasing the potential growth rate of the Chinese economy in the medium to long term, but its effect of boosting the growth rate in the short term is small. 2025 is the final year of the 14th Five-Year Plan; the Xi Jinping administration seems to keep the 2025 growth rate at around 5% by every possible means.

(1) Consumption

The Conference stated that "efforts should be made to increase the incomes, alleviate the burdens of low- and middle-income groups, … raise the basic pensions for retirees and increase basic old-age benefits and government subsidies for medical insurance for rural and non-working urban residents." The Conference also stated that "the large-scale equipment upgrade and consumer goods trade-in programs" that have been underway since 2024 "should be promoted with greater intensity and scope."

The cause for the sluggish personal consumption is that increases in personal incomes in urban areas have fallen below the growth rate; the fruits of economic growth have not been sufficiently returned to workers, and the asset effect is working negatively due to the continued decline in housing prices. Since the launch of the comprehensive new economic measures, there have been signs that housing prices are bottoming out, especially in major cities. Yet, unless personal incomes steadily grow, the tendency to save on consumption will continue. For this reason, the Chinese government is currently working on manageable issues, such as financial support for pensions and health insurance.

On January 8, 2025, the National Development and Reform Commission and the Ministry of Finance issued a notice regarding expanding the scope of the "large-scale equipment upgrade and consumer goods trade-in programs." The main contents are as follows.

1) Expansion of the scope of the large-scale equipment upgrade program

The scope of subsidies will include fields with great potential for renewal, such as electronic information, safety production, and facility agriculture.

2) Expansion of the scope of consumer goods trade-in program

China 4 emission standard vehicles that meet specific conditions will be qualified for replacement subsidies. The number of home appliances eligible for replacement subsidies will be increased to 12 items in 2025 from eight in 2024. Three digital products—mobile phones, tablets, and smartwatches—will be added to subsidy-eligible items.

3) Strengthening financial and tax support

Certain businesses that meet specific criteria can be eligible for bank loans when they upgrade their equipment. They will receive subsidies for payment of the interest on these loans from the central finances and the National Development and Reform Commission; the latter will use funds from ultra-long-term special treasury bonds to provide subsidies.

(2) Investment

The Conference stated that measures would be taken to more strongly support "the implementation of national major strategies and capacity-building for security in key areas," to moderately increase investment from the central government budget, and to effectively use government investment to lead private investment.

Ⅳ. Future Policy Challenges

However, with the current policies alone, it is unlikely that China's economic growth rate will reach 5% in 2025.

The Chinese government focuses on consumption as a driver to expand domestic demand, but to expand consumption at a stroke, consumer mindsets must be changed. To this end, a stable increase in personal income through significant wage hikes will be essential. However, industrial enterprise profits continued to trend negatively during 2024; the environment is not yet conducive for companies to make substantial wage increases.

In terms of investment, since the issuance of national and local government bonds is likely to increase significantly in 2025, financial resources appear to be sufficient. However, some of the funds from special treasury bonds will be used to bolster the equity capital of major commercial banks; other funds from special local government bonds will be allocated to purchase idle land and housing stock; the 2 trillion yuan special quota for local government bonds will be appropriated to replace local governments' hidden debt with statutory debt. These are beneficial for preventing and eliminating economic risks. Yet, they will not lead to increases in investment.

Thus, the existing macro policies may not effectively enhance the growth rate, even though they will lead to a substantial increase in fiscal expenditures and the fiscal deficit.

Moreover, the effectiveness of serial policies is short-lived; in fact, the series of economic stimulus measures since July 2023 lost steam in the April-June quarter of 2024. The effects of the current series of policies are unlikely to endure for a long time. The Chinese government will have to adopt additional measures quickly depending on the changing situation.

Furthermore, rather than temporary stopgap measures such as economic stimulus measures in the past, fundamental ones are necessary: stable increases in personal income; full-scale support for private companies; measures to combat youth unemployment; a fundamental restructuring of the real estate industry; increasing financial support from the central government to assume part of the debt burden of local governments; strengthening the basic livelihood, wages, and operational security through local government initiatives.

Net exports accounted for 1.5 percentage points of China's 5% GDP growth rate in 2024—which means China achieved only a 3.5% economic growth rate in 2024 through domestic demand alone. In February 2025, the Trump administration imposed an additional 10% tariff on imports from China. The administration is now considering imposing a 25% tariff on steel and aluminum imports from China and introducing reciprocal tariffs; there is the likelihood that the United States would further enlarge the scope of taxation and tax rates to include automobiles, semiconductors, and pharmaceuticals. If the expansion and intensification of the tariff war leads to a contraction in global trade, external demand will shrink; if its domestic demand remains as weak as it is now, China will hardly achieve a 5% growth. China must avoid a tariff war at all costs through diplomatic efforts; the country will have to take appropriate policy responses at home and abroad.

(Visiting Professor, Takushoku University)

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