Why China's deleveraging strategy is struggling

Our briefing on essential developments in China’s economic discussion as of 26 January, 2026.

In this briefing:

• Why China’s deleveraging strategy is struggling, in the wake of a global debt-fuelled growth strategy, and what the Politburo plans to do instead.

• Why China’s state-owned assets are “an advantage unmatched by any other nation,” for supporting debt-fuelled expansionary fiscal policy.

• Beijing’s precondition for allowing the yuan to appreciate, and why Chinese economists believe Washington is to blame for its undervaluation.

• Why Chinese households are on track to diversify from property into stocks, as Xi Jinping seeks a greater role for capital markets, to advance tech sovereignty and achieve consumption-boosting wealth effects.

Why China’s deleveraging strategy is struggling

Zhao Jian (赵建), chief economist at Atlantis Capital and former chief economist at Bank of Qingdao, says China’s current deleveraging strategy is ineffective, and instead only resulting in an increase in the national debt burden.

Zhao highlights the baneful impacts of the debt-fuelled economic growth model that has emerged in the wake of the Global Financial Crisis (GFC).

“In the decade or so since the subprime mortgage crisis, the driving force of the global economy has shifted from the asset side to the debt side, with the debt side merely serving to expand aggregate demand,” Zhao writes in the opinion piece “The Three Main Focal Points for Investment Over the Next Five Years” (赵建：未来五年的投资可聚焦三条主线) published by Sina.

“This has led to a global debt trap, which I refer to as a ‘debt disease.’

“Debt is a part of modern civilization, but also a disease of modern civilization. The evolution from civilization to disease is the period when debt-driven recessions arise.”

While nations around the world are working hard to scale back their debt burdens, Zhao sees a critical difference between the strategies employed by China versus other nations.

The US and Japan are pursuing what Zhao refers to as “inflation-driven deleveraging.”

This form of deleveraging allows debt to persist for longer, so that sustained gains in asset prices, yields and incomes can reduce its relative scale.

China, however, remains in the grip of deflationary pressure, thanks to the confluence of industrial oversupply and insufficient domestic demand

For this reason, Zhao sees China pursuing a “deflation-driven deleveraging” which seeks to scrupulously reduce absolute debt levels in order to avert crisis.

Zhao considers this a failed strategy, which has instead led to a rise in leverage ratios.

“On the one hand, old debt is being reduced, but on the other hand, this debt reduction has created greater pressure for the maintenance of growth,” he writes.

“This has forced the central government to increase debt-driven investment, thus leading to a rapid rise in the overall macro-leverage ratio.”

Zhao says Beijing has already taken pains to correct course, with the adoption of a new macroeconomic strategy over a year ago that focuses on boosting the asset side of the nation’s balance sheets.

“A series of landmark macroeconomic policy moves has driven a top-down revaluation of Chinese assets,” he writes.

“This shift can be seen as a move from a rigid debt-tightening mindset to a flexible asset expansion mindset.”

For Zhao, this is critical because he views the core driver of financial crises as being calamity on the asset side of balance sheets.

“What we commonly refer to as debt defaults and debt crises are essentially situations where assets deteriorate, and the returns on those assets are insufficient to repay principal and interest, plunging debtors into a Minsky moment,” he writes.

According to Zhao, the landmark Third Plenary Session held in July 2024 saw China’s policymakers “adopt a more open-minded, pragmatic, and proactive approach, initiating a shift in debt reduction policies and the overall macroeconomic policy package.”

A key meeting of the Politburo held on 24 September 2024 established a new monetary policy orientation that focused on stabilizing asset prices.

The Politburo also made an explicit call for “stabilisation of the housing and stock markets.”

In the wake of these top-level announcements, China’s fiscal policy saw the launch of ultra-long-term special treasury bonds, while monetary policy saw the introduction of outright reverse repurchase agreements, major reforms of open market operations, and innovations in the use of structured instruments that permit the targeted allocation of credit.

By 2025, China’s top policymakers made the announcement that ‘debt reduction should occur within development, and development should occur within debt reduction.’

Zhao expects the deleveraging process to be a priority mission for Beijing over the remainder of the decade.

“Over the next five years, we not only need to reforge the aggregate supply and demand curves and resolve the problem of inadequate comparative purchasing ability - we also need to restructure the national balance street.”

China’s state-owned assets are “an advantage unmatched by any other nation”

In the same vein Xu Qiyuan (徐奇渊), a scholar from the World Economy and Politics Research Institute at the Chinese Academy of Social Sciences, highlights the critical role of the aggregated balance sheets of China’s state-owned enterprises (SOEs) in supporting Beijing’s plans for more debt-fuelled expansionary fiscal policy.

He sees the sheer scale of China’s SOE assets as compensating for the onerous debt burdens of local governments - long considered a major source of potential systemic risk for the financial sector.

“Although local government debt is heavy, the consolidated balance sheets of state-owned enterprises shows that their asset reserves and financial resources remain vast, creating an advantage unmatched by any other nation,” he writes in the opinion piece “The Three Angles for Looking at China’s Economy in 2026” (徐奇渊：展望2026年中国经济的三个角度) published by the China Macroeconomic Forum.

“As of the end of 2024, the total assets of state-owned enterprises (SOEs) exceeded 400 trillion yuan (USD$57.4 trillion) nationally, with total liabilities of 260 trillion yuan, resulting in a debt-to-asset ratio of approximately 65% ​ - a reasonable range for enterprises.

“From the perspective of state-owned assets, revitalizing existing assets holds enormous policy potential.”

Xu believes that the key challenge will be creating the liquidity conditions that can foster the “revitalisation” of this vast mass of SOE assets.

“Activating this huge stock of state-owned assets and creating synergies with policies is a crucial direction for exploring potential policy options in the future” he writes.

“Tools much discussed by the market - such as real estate investment trusts - face constraints from the tax system and management policies, while the yield on some projects (such as policy-based affordable housing) is relatively low.

“The solution lies in a multi-pronged approach, such as providing a suitable liquidity environment through monetary policy, improving asset ratings through credit enhancement measures, and raising project feasibility through tax reform.”

Beijing’s precondition for allowing the yuan to appreciate

China’s exchange rate has risen to the fore of heated debate over the nation’s trading practices, particularly following the release of customs data indicating that it posted a record trade surplus of nearly US$1.189 trillion in 2025.

US economists such as Brad Setser and Michael Pettis have reiterated their long-standing calls for Beijing to permit appreciation of the yuan, in order to redress China’s mounting trade imbalance.

Chinese economists - such as Xu Qiyuan - also acknowledge an ineluctable trend towards appreciation of the yuan.

They stress, however, that Beijing shouldn’t permit an undue appreciation of the renminbi without first starting to solve its biggest macroeconomic challenge - inadequate domestic demand (in particular consumption).

“Any appreciation of the exchange rate should proceed in tandem with the expansion of domestic demand, and policies for the expansion of domestic demand should precede an appreciation of the exchange rate,” Xu writes.

“In terms of scope, [such policies] should also be greater than the appreciation of the exchange rate.

“If we only allow the renminbi to rise without other conditions changing, then this will exacerbate the pressure of supply being too great, and demand being too weak.

“Because appreciation will suppress exports and spur imports, it will lead to supply further increasing on the domestic market.

“Existing problems with supply-demand relations will thus become more pronounced.”

While outside observers say Beijing is undervaluing the renminbi, Xu argues that Washington is the real cause of China’s exchange rate challenges.

In his estimation, this is because tensions between China and the US put downward pressure on the yuan.

“The main reason for undervaluation is not economic factors, but geopolitical factors,” he writes.

“I regularly say to American friends that when Sino-US relations are poor, this will cause the renminbi exchange rate to be undervalued, and will lead to even greater exports.

“So for the renminbi exchange rate to change, things must start with improvements to Sino-US relations.”

Why Chinese households are on track to diversify from property into stocks

Zhang Yu (张瑜) , a researcher from the Monetary Policy Institute of Renmin University in Beijing, expects Chinese households to rapidly diversify away from real estate into stocks and other financial assets in 2026.

The development arrives in response to a multi-year property slump since the peak of the Covid pandemic, which has negated the appeal of housing as China’s preferred investment opinion.

It’s also driven by the Xi government’s push for capital markets to play a greater role in the Chinese financial system, and for households to acquire greater exposure to equities via mutual funds, pension funds, as well as their own direct investments.

The plan is for a boom in the stock market to improve funding prospects for Chinese tech firms, while also creating wealth effects for everyday households which will make them more willing to spend, thus helping to resolve the dilemma of insufficient domestic demand.

“We expect that in 2026, financial assets will outperform residential property assets,” Zhang writes in an opinion piece entitled “Four Major Hedging Forces Are Strengthening - Comments on December Economic Data” (张瑜：四大对冲力量在增强——12月经济数据点评).

Zhang highlights a decline in the contribution of Chinese households to domestic demand ever since 2021 - when Beijing first engineered the start of the property slump via adjustments to credit allocation conditions.

“As a result of the reduction in new home purchases by households, as well as weak consumption propensity, the propensity of households to spend has continued to decline, from 101.4% in 2021 to 80% in 2025.”

This trend has forced policymakers to rely on fiscal spending and exports to compensate for inadequate domestic demand - which is currently viewed as China’s biggest macroeconomic challenge.