Boosting domestic demand key to growth

Amid the external uncertainty posed by the incoming administration of the United States, China should make expanding domestic demand a crucial focus for 2025, with consumption and services emerging as rising priorities as well as augmented fiscal spending being on the horizon.

The election of Donald Trump as the next US president has signaled a potential shift in US policy toward allocating more resources domestically. Trump's inclination to reduce overseas military commitments and cut fiscal expenditures abroad could enhance the growth potential of the US economy. Meanwhile, his advocacy for strict restrictions on illegal immigration and additional tariffs on imported goods may heighten US inflation.

If US inflation expectations rise, the US Federal Reserve may slow down or even halt its interest rate cuts, resulting in a further strengthening of the US dollar, which could weigh on the Chinese yuan.

Consequently, the pace of interest rate cuts by the People's Bank of China, the country's central bank, may also decelerate, as PBOC has two significant monetary policy goals: to maintain exchange rate stability and to effectuate price level stability. Any pressure on the yuan exchange rate could lead to a slower pace of interest rate reductions, which, in turn, could negatively impact the country's real estate market.

After all, external demand is an uncontrollable variable. If the size of exports shrinks, the domestic market will face the pressure that many goods will shift from exports to domestic sales. Additionally, the export sector is related — directly and indirectly — to the employment of approximately 150 million in China. A reduction in export volume could hit employment in the export sector.

Internal demand, on the contrary, can be adjusted autonomously. The policy focus for the coming year should be on expanding domestic demand, including investment and consumption. I suggest reducing reliance on investment and promoting consumption growth. Policy efforts should continue to stimulate consumer spending.

We also need to further encourage the development of the services sector and absorb more labor forces. In short, China's response in the next year to the US policy uncertainty should be expanding consumption and reducing institutional constraints that impede the services sector from further development.

China's growth model over the past 30 years or so has been investment-driven. Transitioning to a more balanced growth model will face significant resistance, so it is essential to advance various reforms, especially fiscal and tax reforms.

Through income redistribution mechanisms, the country can increase the income level of low- and middle-income groups and expand fiscal spending in social welfare areas such as eldercare, employment, healthcare and public services. All these will help create more secure livelihoods for the public, shape more optimistic expectations and thereby promote consumer spending.

Meanwhile, I believe that the services sector lies at the core of stable employment, which can create significantly more jobs than the manufacturing industry when it contributes the same amount of economic growth.

Since 2014, due to mechanization and automation, the number of employees in China's secondary industry has continued to decline. In some cases, an increase in manufacturing investment could even exacerbate the slowdown in job creation.

The services sector has tremendous potential to drive economic growth. A notable characteristic of the services sector is that it involves transactions between residents, leading to a variety of new service demand. The growth of such demand does not rely on the development of specific industries, but is realized as household savings rates decrease while willingness to consume increases.

Releasing service sector development potential is not something that can be done overnight, but a long, gradual process. No simple decisions can drive the rapid development of the services sector in the short term.

To develop the services sector effectively, we must increase household incomes. It can be said that the relationship between a well-developed services sector and increased household incomes is like a chicken-and-egg scenario. We must first increase the number of either eggs or chickens to kick off a virtuous cycle.

The problem facing China is that household incomes account for a relatively low proportion of the country's total GDP, making the development of the services sector somewhat challenging. Therefore, the country must increase household incomes through multiple channels — increased social spending, job creation and tax and fiscal reform.

At present, high-income groups account for a high proportion of total household incomes, but they typically have lower marginal propensities to consume. Income redistribution through tax reforms can address this issue and boost the income level of middle- and low-income groups, narrowing the wealth gap.

Given a more challenging external environment, China's general fiscal deficit may increase to 3.5 percent to 4 percent of its GDP in 2025, with the broad fiscal deficit potentially reaching approximately 12 trillion yuan ($1.65 trillion), up from over 9 trillion yuan this year. This broader deficit ratio could increase from 7 percent in 2024 to around 9 percent next year.

The raft of incremental policies to promote a sustained economic recovery includes increasing support for key demographic groups and enhancing overall consumption. It is anticipated that the size of consumption-promotion policies for next year will be relatively large.

To support this, the issuance of general treasury bonds will likely expand. On Oct 12, at a news conference, Minister of Finance Lan Fo'an said that the central government still has considerable space for borrowing and increasing deficits, which, in my view, provides more policy tools for countercyclical adjustments.

Meanwhile, I predict that the size of next year's ultra-long-term special treasury bonds will be at least 2 trillion yuan, including at least 1 trillion yuan to support capital replenishment of major commercial banks.

Next year's local government special bond quota may be around 5 trillion yuan, including 2.8 trillion yuan for local government implicit debt replacement and at least 1.5 trillion to 2 trillion yuan for the acquisition of idle land and unsold housing.

The expansion of the scope for special bond usage is beneficial to stabilizing the property market. Unlike traditional project-based investments, which often involve lengthy approvals and evaluation processes, allocating special bonds for land acquisitions or purchasing unsold housing can significantly improve capital efficiency and provide immediate support to the domestic economy.

Li Xunlei is chief economist at Zhongtai Financial International Limited.

The article is compiled based on his opinions in a recent interview with 21st Century Business Herald.

The views do not necessarily reflect those of China Daily.