Is China making another bet on its economic model? Is China making another bet on its economic model? Is China making another bet on its economic model?

Is China making another bet on its economic model?

Equities 8 minutes to read
Peter Garnry

Chief Investment Strategist

Summary:  The prevailing narrative on China is that its economic model is broken and the government is not doing enough to stimulate the economy, but balance sheet growth among Chinese banks shows that overall credit growth is the highest since Q1 2012 suggesting that China is actually doubling down on its economic model. The challenges for China is that its economic model works under the condition of low debt levels and plenty of available productive assets, but since 2011, the market realized that too much investment was going into non-productive assets and the equity market outlook slowly deteriorated. China faces several challenges and tough policy choices in the years ahead to advance from its current economic model.

Key points in this equity note:

  • The prevailing narrative on China is that the economic model is broken and that the government is doing too little to stimulate growth. Looking at balance sheet growth among Chinese banks suggest that overall credit is expanding at the fastest rate since Q1 2012.

  • China’s economic model of extensive investment as a share of GDP broke around 2011 judging by how the market valued Chinese banking assets and the drop in balance sheet growth among Chinese banks.

  • China faces some difficult policy choice over the coming years to advance from its previous economic model. The country has several options but they all come with various challenges and time frames.

  • The verdict on China’s outlook in the equity market is quite negative with Chinese equities continuing to underperform its emerging market peers and extending its relative underperformance against US equities that started in 2007.

Credit expansion is potentially the biggest since 2011

China started the year as a positive story with expectations of higher growth after ending its restrictive Covid-19 policies, but this year the narrative has increasingly turned darker. Today, Chinese regulators announced a surprise cut in key prime rates except the 5-year loan prime rate as the government attempts to loosen credit conditions while preserving banks’ profitability to maintain financial stability.

The common narrative on China is that its economic model is broken and that the government is taking a light approach to dealing with the slowdown in the economy. The economic model that propelled China to superpower status run into troubles 12 years ago and the recent economic slowdown this year can partly be explained by inflation in the developed world which is causing a decline in volume of goods which in turn leads to less factory utilisation in China.

The investment driven economic model of China requires constant investments and lending. Many have pointing out that lending growth has slowed as seen by the credit impulse (12 change in net new debt in percent of GDP), but this measure only looks at volume of financing to the domestic non-financial corporate sector and households. As the Chinese banking system is an extended branch of the government we prefer to look at the aggregate balance sheet of Chinese banks. The Chinese banking system is concentrated among four banks and thus the aggregate balance sheet of these four banks provide an adequate picture of overall credit growth.

As the chart below shows, China’s bank balance sheet growth was 14.5% y/y in Q1 2023, the highest growth since Q1 2012 highlighting a rapid expansion going against the prevailing narrative on China. So where is the disconnection between this picture and the common narrative? Social financing is related to the private sector, which faces hard budget constraints and thus under the current economic conditions are holding back on lending due to lack of productive assets. To keep GDP growth afloat the Chinese government is extending credit and investments through sectors with soft budget constraints (local governments and state-owned enterprises). Make no mistake, China is doubling down on its existing economic model as it has no other choice in the short-term.

Overinvestment in non-productive assets, demographics headwinds, and policy choices

In a thread yesterday, Michael Pettis (Senior Fellow at the Carnegie Endowment and scholar of China) outlined his views on China in a comment to the Wall Street Journal article China’s 40-Year Boom Is Over. What Comes Next?. He starts by saying that China’s economic model did not break recently as a function of the pandemic, that was probably just an amplifier, but instead it broke 10-15 years ago. The economic model is the one applied by Japan and the Soviet Union post WWII enabling high GDP growth through excessive investment as a share of GDP. In China, investment share of GDP is 44% which has no comparable historical precedent. It works well under certain conditions, with one being that many productive assets are available to be expanded. This was the case in China from 1980-2011.

Pettis provides an estimated range of 10-15 years for when China’s economic model broke indicating around the years 2008-2013. If one uses the MSCI China relative to MSCI USA in total return USD terms, then China’s economic model peaked in 2007 and thus also its economic model through the lens of financial markets. Using bank balance sheet growth rates as the yardstick the economic model broke around Q2 2011. One could argue that it was 2008, as Pettis indicates when you look at different indicators highlighted in this equity note, but if you look at the rebound in Chinese banks’ market value to total assets in 2010 and early 2011 it shows that around this time there is still confidence in credit provision by Chinese banks and that there is a positive multiplier effect into the economy, at least perceived by investors.

After 2011, the market value of Chinese banks begin to grow much slower than their balance sheet in a systematic way suggesting that the largest Chinese banks are increasingly being incentivized to lend out to local governments and state-owned enterprises despite lower credit quality. Because China was running out of productive assets to reinvest into, the hard budget constraint in the private sector meant that the private credit impulse got less and less potent, because the private sector cannot afford to invest into non-productive assets indefinitely without the risk of bankruptcy. As a result, banks’ balance sheet growth declined rapidly from 2011 to the bottom around mid-2018.

In the years before the pandemic, balance sheet growth accelerates while banks’ market value goes nowhere indicating forced lending with investors acknowledging the limited market value of these additional loans. Under a normal credit cycle this is not the behaviour you would expect as market value of banks would increase with higher loan growth. The overall market value to total assets among the four largest Chinese banks has fallen to just 3.5% in Q1 2023 down from 12.5% in Q1 2011 and the peak of 34% in Q4 2006. This measure highlights pretty well how undercapitalized the Chinese banking system really is and why restructuring is coming to the overall financial system, unless Chinese policy makers choose the Japanese policy of the 1990s. This entailed propping up banks with government capital amortizing the overinvestments over a couple of decades. This is market economic wise a bad policy choice, but politically it might be the most sensible solution.

Beyond the short-term considerations of economic growth, debt, economic models etc. China is alsp facing longer term constraints from its demographic path. These headwinds will in itself cause challenging dynamics, but with negative net immigration making it impossible to offset the domestic demographics tough policy choices will have to be made.

Michael Pettis described back in April 2022 how China has five policy options.

  1. China can stay on its current path and keep letting large amounts of nonproductive investment continue driving the country’s debt burden up indefinitely
  2. China can reduce the large amount of nonproductive investment on which it relies to drive growth and replace it with productive investment in forms like new technology
  3. China can reduce the large amount of nonproductive investment on which it relies to drive growth and replace it with rising consumption
  4. China can reduce the large amount of nonproductive investment on which it relies to drive growth and replace it with a growing trade surplus
  5. China can reduce the large amount of nonproductive investment on which it relies to drive growth and replace it with nothing, in which case growth would necessarily slow sharply

These are the same five paths, by the way, faced by every other country that has followed the high savings, high investment model. Each of these paths creates its own systemic difficulties and each, except for the first, implies substantial changes in economic institutions that, inevitably, must be associated with substantial changes in political institutions. This may be why in the end every previous country followed the last of the five paths.

If our intuition of what is going on in China is right, based on changes in banks’ balance sheets, then China has clearly chosen the first path in the short-term attempting to keep GDP afloat under the old economic model. The second path is also being pursued as China is moving to become technological independent from the US and Europe, although the various trade restrictions from the US are making this path more challenging and potentially longer than imagined before the Trump presidency. The third path is incompatible with the virtues that the Chinese government wants to see. Too much consumerism would be viewed as to Western and decadent in terms of culture. The fourth path is an option, but the fragmentation game and inflation in the Western world have made this path more challenging, but the new BRICS symposium is definitely going be set up along the lines of the fourth path described above. However, if China wants to become the center of the future BRICS economic system then it is more likely that it is the other countries that become trade surplus countries to China and not the other way around. The fifth path is incompatible with China’s core values around government stability. To sum it up, China’s policy choices over the coming years are difficult and investors should pay close attention as what happens in the second largest economy impacts everything around the world.

Chinese equities reflect the negative outlook

Hang Seng futures were down more than 1% again today down 13% for the month extending to new lows this year as the key benchmark index is down 11% year-to-date. Chinese equities are still higher relatively than equity markets from the so-called “fragmentation winners”, but the relative gain is shrinking fast. In USD terms, the Chinese equity market has been in a perpetual decline against US equities since their relative peak in late 2007. With too much investments in non-productive assets and China’s demographic headwinds ahead the policy choices over the coming years are crucial and will determine China’s economic trajectory over the coming decade.

Hang Seng continuous futures | Source: Saxo

Quarterly Outlook 2024 Q3

Sandcastle economics

01 / 05

  • Macro: Sandcastle economics

    Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

    Read article
  • Bonds: What to do until inflation stabilises

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

    Read article
  • Equities: Are we blowing bubbles again

    Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

    Read article
  • FX: Risk-on currencies to surge against havens

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

    Read article
  • Commodities: Energy and grains in focus as metals pause

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

    Read article


The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (
Full disclaimer (
Full disclaimer (

Saxo Bank (Schweiz) AG
The Circle 38

Contact Saxo

Select region


All trading carries risk. Losses can exceed deposits on margin products. You should consider whether you understand how our products work and whether you can afford to take the high risk of losing your money. To help you understand the risks involved we have put together a general Risk Warning series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. The KIDs can be accessed within the trading platform. Please note that the full prospectus can be obtained free of charge from Saxo Bank (Switzerland) Ltd. or the issuer.

This website can be accessed worldwide however the information on the website is related to Saxo Bank (Switzerland) Ltd. All clients will directly engage with Saxo Bank (Switzerland) Ltd. and all client agreements will be entered into with Saxo Bank (Switzerland) Ltd. and thus governed by Swiss Law. 

The content of this website represents marketing material and has not been notified or submitted to any supervisory authority.

If you contact Saxo Bank (Switzerland) Ltd. or visit this website, you acknowledge and agree that any data that you transmit to Saxo Bank (Switzerland) Ltd., either through this website, by telephone or by any other means of communication (e.g. e-mail), may be collected or recorded and transferred to other Saxo Bank Group companies or third parties in Switzerland or abroad and may be stored or otherwise processed by them or Saxo Bank (Switzerland) Ltd. You release Saxo Bank (Switzerland) Ltd. from its obligations under Swiss banking and securities dealer secrecies and, to the extent permitted by law, data protection laws as well as other laws and obligations to protect privacy. Saxo Bank (Switzerland) Ltd. has implemented appropriate technical and organizational measures to protect data from unauthorized processing and disclosure and applies appropriate safeguards to guarantee adequate protection of such data.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc.