STIMULUS AND INNOVATION

The delayed third plenum in July 2024 and the subsequent Central Economic Work Conference (CEWC) last December already laid down China's economic path with focus on reviving consumption while mitigating other structural domestic challenges. The 2025 Government Work Report (GWR) presented by Premier Li Qiang at the Two Sessions was highly anticipated to include actionable policies that could strengthen this economic reorientation. However, the urgency for technological self-reliance through innovation has taken the center stage in this year’s GWR in the wake of the looming US-China trade war. Despite the growing acceptance in China to not heavily rely on short-term economic growth and focus on “high-quality development”, Li’s work report falls short of addressing necessary structural reforms in fiscal decentralization and shift in China’s growth drivers away from real estate. While China will hope to boost demand in the coming months with the increased fiscal stimulus, the sustained pessimism among Chinese consumers along with uncertainties in the global economic landscape can limit the effectiveness of these measures.   

Fiscal Push Amid Deflationary Pressure

Continuing with last year’s growth targets, China has set this year’s GDP growth at 5 percent, as it was already clear from provincial growth projections for 2025. Despite China continuously meeting its growth targets in the past two decades except 2022, the existing severe deflationary pressure, evident from mere 0.2 percent growth in Consumer Price Index (CPI) continuously for the second year as against the targeted 3 percent, has overshadowed its growth narrative. Moreover, given the lack of consumption uptick in the last year, achieving a 2 percent CPI increase this year would still be a herculean task and may further push China into deflationary cycle. Although the GWR claims that China achieved its employment target by creating 12.56 million jobs and kept the surveyed unemployment rate below expected 5.5 percent, its limited impact on increasing domestic demand suggest that there are deeper structural issues at play restricting growth in demand.   

Given these limitations, Li Qiang has continued on providing more fiscal stimulus through bond issuance and investments, in line with recent calls for “more proactive fiscal policy at the December Politburo meeting. A notable change in this regard is the increase in fiscal deficit ratio to 4 percent, offering more fiscal space for stimulating demand. Further off-budget support will also be provided through the issuance of RMB 1.3 trillion ultra-long special treasury bonds, introduced last year specifically to support consumption. Majority of this year’s RMB 300 billion of additional funds will be used for trade-in programs and industrial equipment upgrades as ways to spur demand in the market. However, such measures can only raise demand temporarily and will be inefficient to boost confidence in the economy which is caused by lack of social safety net and fear of low investment returns. While real estate, which has been a major destination of Chinese household investments, continues to struggle, the GWR has finally talked about comprehensive reforms in the capital market to allow retail investors to earn additional income, albeit without any specific directions. 

Furthermore, Li Qiang also calls for “vigorously developing modern services” as one of the means to attract consumer spending. In this regard, Li Qiang had also called for focusing on strengthening the supply of services such as education, culture and tourism during a State Council special study session last month. Provinces are also expected to play a crucial role in strengthening supply of certain services specific to local conditions; for instance, winter tourism in northern provinces or digital services in coastal provinces. Taken together, although these measures aim to push consumption at different levels, it certainly underlines the fact that China is still not ready to shift to consumption-driven growth, thus still relying on exports and the consequent exposure to the external environment.  

Redemption of the Private Sector

Owing to Xi’s emphasis on state-owned enterprises to fulfil his global ambitions, private sector in China suffered from lack of policy support, fear of crackdown, lack of access to funds, while also facing global competition. This had not only caused a fall in private sector's share in national fixed asset investment, but could also endanger Xi’s self-reliance ambitions as private players are more adept for innovation. Given these impediments, China finally began to reverse policies for the private sector last year with the introduction of a draft private sector promotion law which aims to create a conducive business environment for the private sector. Since then, revival of private sector has become a recurring theme in all economy-focused discussion in China. By supporting the private sector, it aims to create more DeepSeek-like disruptions in the global market and thereby, restore falling FDI inflows in its emerging tech sector.

While provincial governments like Zhejiang (birth province of DeepSeek and Alibaba) had already undertaken measures to support private sector which led to rapid development in emerging fields like AI, a show of support from the highest echelons of the Party was witnessed at Xi’s recent symposium with China’s tech giants. During this meeting, Xi called for “healthy and high-quality development of private sector”, thereby highlighting the need for aligning the private sector with Xi’s priorities. The GWR echoes this sentiment and calls for settling balanced payments to private enterprises so as to enable more funds for innvoation. Further, during the press conference at the Two Sessions, NDRC chief Zheng Shanjie announced the launch of a venture capital fund to ensure adequate supply of finances for innovation-driven private firms.

In the wake of growing protectionism across the world, Xi realizes that the private sector can play a critical role in strengthening China’s supply chain resilience while also fostering innovation in emerging areas. However, he also reminded private players during the symposium to “serve and nurture a deep love for the country” while pursuing their business activities, thus indirectly suggesting to adhere to the Party line at all times. Xi further warned private players to be careful about punishment and investigation, thereby reiterating the Party control over all economic affairs. This can seldom help to shed away policy uncertainty among the private sector. Moreover, these supply-side efforts for tech firms can again have limited impact if domestic demand does not gain momentum. The problem of overcapacity caused by ‘neijuan’ (内卷) or rat-race competition, as described in the GWR, has further complicated business environment for private companies. This refers to cut-throat competition between Chinese companies, especially in emerging fields like electric vehicles and solar, which leads to profit squeezing for many companies. Although the GWR and even Xi’s speech to the Jiangsu delegation mentions this as a critical issue, any measures on this front will take years to resolve this issue.    

Bracing for the Trump Effect 

One of the principal reasons for Xi’s reconciliation with the private sector is to set up a united front of the Party and private sector against the potential tariffs from the US and overall global protectionism. As this is not achieved yet, China has resorted to a moderate response to initial tariffs from the US as it announced product-specific tariffs against the US’ blanket tariffs on China. This posture aims to suggest China’s retaliatory capacity while also avoiding sudden escalation of tariff war, especially when China is grappling with severe problems on the domestic front. With China’s continued reliance on exports as a major driver of growth, prolonged trade war with the US can affect China’s GDP growth - one of the few indicators that China has been able to achieve without much aberration. Thus, China’s economic policymaking seems to have divided between addressing domestic issues on one hand, while also preparing against external uncertainties. 

As the GWR is largely known as an agenda document, it only sets a direction for the economy in the coming year, which is currently relying on two wheels of stimulus and innovation. The impact of fiscal support will continue to unfold, with more stimulus measures expected in the coming months to mitigate weak domestic consumption. On the other hand, China will undergo a shift in terms of the resurgence of innovation-driven private sector, hoping to act as a guardrail against external headwinds.

Image credit: Xinhua