Pivoting to long-term resilience in 2023

The year 2023 is set to be a critical turning point for China, not least because the country downgraded its level of COVID-19 management from the strict "Category A" to a much less strict "Category B", starting from Jan 8.

This implies most of the domestic and international COVID-19 restrictions have been removed and China has "re-opened" up to the world. The swift adjustment of the COVID-19 policy marked a resolute move toward renormalization, which is surely a catalyst for China's economic recovery in 2023.

Amid rising global recession risks and heightened geopolitical uncertainties, it has become more pressing for China to re-orient its macro policy toward its medium- to long-term economic and social development objectives. This year is also the "opening year" after the 20th National Congress of the Communist Party of China, and we expect the country to implement the next decade's development plan as outlined in the 20th Party Congress report.

Good news for platform firms

After two years of regulatory upgrades and adjustments to platform enterprises, we (Greater China Macro Strategy) believe the regulatory environment will gradually stabilize from 2023 onward. Platform enterprises play the leading role in driving innovation and growth in the digital economy, with about 14 platform enterprises having largely completed adjustments to their financial service business. And once the residual adjustments are done, we believe platform enterprises would focus on business growth.

China's digital economy has been growing substantially in recent years, and digital transformation remains a powerful growth engine as China pursues innovation-driven quality upgrade of its economy in the next decade. The 20th Party Congress report put "Digital China initiative" as a key development target of the country's modern industrial system and pledged to accelerate the development of the digital economy in the next five to 10 years.

Assuming China's digital economy will grow at an average of 10 percent a year till 2025, we estimate it will be worth 66 trillion renminbi ($9.75 trillion) by the end of 2025 and its share of GDP will likely rise to 45 percent.

This year, the authorities are likely to give a number of regulatory approvals for capital financing and the permission for new investments by platform enterprises. We also expect fiscal and financing accommodation to platform enterprises regarding research and development investment, cross-border business and overseas expansion, administrative cost, and talent policies.

In 2022, credit events by property developers, mortgage defaults and the spillover to the financial sector were the main threats to China's financial stability. That's why China's policymakers have been announcing sweeping measures since late November to address the supply and demand sides' risks in the property market including:

* pledging policy accommodation to restore confidence in the property sector;

* providing comprehensive financing solutions to developers to help manage liquidity and liability risks, as well as to accelerate sector consolidation;

* and allowing for mortgage rate cuts by local authorities to boost property demand.

Financial stability risk management a priority

China is also expected to continue prioritizing financial stability risk management to resolve debt risks in 2023.

But property default risks will linger in 2023 considering the repayment of heavy debt. Developers that manage to secure funding may receive near term relief of liquidity, while those unable to take advantage of the latest financing support may default.

Also, regulatory easing of funding constraints is possible, and we see room for relaxation of the "three redlines" to broaden the regulatory easing of funding constraints, especially for the relatively weak developers.

Besides, more measures may be needed to drive a rebound in property demand. And while monetary policy accommodation, such as the lowering payment ratio, loan prime rate cuts and mortgage rate cuts, appear likely, fiscal policies will be geared toward providing public housing and rental housing, which may help absorb excess inventory in the commercial residential market.

Besides, successful completion of debt restructuring by defaulted developers will be positive to credit sentiment. Credit default risks remain concentrated with the relatively small and highly leveled privately-owned enterprises.

And as policymakers step up policy support to the property sector, local government financing vehicles' (LGFV) default risk would be controllable in 2023 for four reasons: first, growth recovery and property sector rebound in 2023 is positive to the cash flow outlook of LGFVs; second, fiscal stimulus in 2023 will alleviate funding requirement for LGFVs; third, LGFV debt swap into local government bonds (LGBs) can be considered to manage default risks; and fourth, monetary and fiscal policies can coordinate to defuse LGFV debt risks.

Achievements in green and sustainable finance

In 2022, China made important progress on the green and sustainable finance front. It established the 1+N policy framework to peak its carbon emissions before 2030 and achieve carbon neutrality before 2060, and continue to refine the green industrial policies of key sectors.

The country refined the fiscal and monetary policy toolkit to support green development. For example, the People's Bank of China (the country's central bank) introduced the carbon emissions reduction tool — a special re-lending quota to support the clean and efficient use of coal — in November 2021, initially to national commercial banks.

Moreover, China's green finance market grew in depth across green loans, green bonds, green insurance, green trusts, green funds and carbon financial products. By the end of September 2022, the outstanding balance of green loans rose by 41.4 percent year-on-year to 20.9 trillion renminbi, with the country's green bond market having 1.26 trillion renminbi worth of outstanding green bonds, the second-largest accumulation of green bonds globally.

Also, on international collaboration in green finance standards, the central bank and the European Union jointly released the Common Ground Taxonomy in November 2022, which serves as an important reference facilitating green financing and investment in China's and the EU's green bond markets.

Transition finance to drive financing demand

In 2023, we expect transition finance to take the lead in driving financing demand in China's sustainable finance market. We also expect China to develop a taxonomy of transition finance and to collaborate with more countries on developing common taxonomy for green and transition finance.

While key breakthroughs are expected to be made in equity financing such as green stocks or transition stocks, climate financing and investment remain another area of potential financing growth.

China's central bank, on its part, is expected to continue using structural and targeted tools to lower financing cost and support sustainability and transition financing, as well as to refine policy tools to attract private capital to invest in environmental, social and governance (ESG) initiatives.

More green finance products will adopt CGT, while issuers are expected to take advantage of the relatively low financing cost in the renminbi bond market to issue CGT-based Panda green bonds and Panda transition bonds.

And standardization of ESG information disclosure, ESG statistics report, and carbon calculation remain areas for potential regulatory refinements.

Further high-level opening-up expected

This year marks the 45th anniversary of China's reform and opening-up policy and the 10th anniversary of the Belt and Road Initiative. So China is expected to steadily and orderly promote high-level capital account opening-up.

We expect further expansion of mutual financial market access between the Chinese mainland and the Hong Kong Special Administrative Region. On Dec 19, the China Securities Regulatory Commission, the Hong Kong Securities and Futures Commission and the Hong Kong Exchanges and Clearing Limited jointly announced the further expansion of eligible stocks under Stock Connect.

And the Hong Kong Exchange is likely to introduce a new Hong Kong dollar-renminbi Dual Counter Model and an inaugural Dual Counter Market Making Programme in its securities market, allowing investors in the Hong Kong market to interchange securities listed at both HKD and RMB counters, and allowing mainland investors to trade in renminbi-denominated securities via Southbound Stock Connect.

On July 4, the PBOC, the Hong Kong Securities and Futures Commission and the Hong Kong Monetary Authority jointly announced the mutual access arrangement between the interest rate swap markets on the mainland and in Hong Kong (Swap Connect). The Northbound Trading of the Swap Connect program will provide offshore investors a channel to hedge the interest rate exposure on their RMB bond positions.

We also expect more foreign banks and foreign institutions to be granted access to the domestic bond futures market. In the Hong Kong market, we expect renminbi bond futures to be relaunched by the HKSE.

Internationalization of renminbi will steadily develop

While China may continue to refine its foreign exchange management policies to facilitate cross-border renminbi settlements, cross-border financing flow and foreign exchange risk hedging, we expect it to expand the pilot program on renminbi and foreign exchange cash pooling for multinationals, optimize foreign exchange hedging services to small and medium-sized enterprises, and enhance macro prudential policy framework to keep the renminbi exchange rate broadly stable.

Furthermore, the cross-border renminbi payment volume is expected to grow at 15 percent in 2023 for four reasons: because the renminbi clearing and payment network continues to expand; because more Belt and Road countries and Regional Comprehensive Economic Partnership member states will use the renminbi for cross-border trade and investment settlement; because the renminbi will be adopted by more countries as the pricing and settlement currency for commodities; and because the expansion of mutual market access program will bring increasing cross-border renminbi flows under the capital account.

In fact, we believe the combination of broader renminbi adoption for trade and settlement, further liberalizing financial market access, deepening trade and economic collaboration with Belt and Road and RCEP countries will support the internationalization of the renminbi in the years to come, and forecast that the renminbi's settlement volume will grow by 10-15 percent a year in the next five years.