The Chinese stock markets surged following the announcements, with the CSI 300 rising 15% and the Shanghai Composite up 12%. Some economic commentators suggested that these measures could help China curb slowing GDP growth and shift the economy from investment to consumption. However, with India’s weight in the MSCI AC World Investable Market Index recently surpassing China’s, some are concerned that foreign investors may now reallocate more funds to China.
The ultimate investment outcomes will hinge on whether China successfully reorients its economy or follows Japan’s trajectory, where the “lost decade” (or, as some term it, a “lost generation”) has left investors cautious and tested their patience. In today’s article, we explore the key areas where China is striving to diverge from Japan’s experience and the potential implications for foreign investment flows into India.
To begin, it is important to understand what China may be attempting to avoid. Japan experienced prolonged stagnation from the late 1980s into the early 2020s, marked by low growth, deflation, and limited effectiveness of traditional interventions like monetary easing and fiscal stimulus. This stagnation was so severe that, as of now, Japan’s Nikkei 225 index still trades below its 1989 peak, despite briefly surpassing it in 2024.
This raises the question: how did Japan become entangled in such a fate? Akio Mikuni and R. Taggart Murphy, in their book Japan’s Policy Trap, argue that Japan’s post-war economic “miracle” is closely tied to its current financial struggles.
The roots of Japan’s economic mindset can be traced to the Meiji Restoration of 1868, which ended the Tokugawa Shogunate and initiated the nation’s modernization. This transformation established Japan’s centralized economic system, prioritizing production and exports over profitability and market efficiency. Post-war institutions, such as the Ministry of Finance (MOF) and the Bank of Japan (BOJ), reinforced this approach by supporting export-driven firms and allocating credit based on policy objectives rather than market forces, leading to inefficiencies and financial imbalances.Japan’s mercantilist strategy prioritized trade surpluses and the suppression of the yen to promote exports, but this focus led to overinvestment in unprofitable sectors. The emphasis on savings over consumption funnelled wealth into industrial investments, fuelling asset bubbles in real estate and equities. When these bubbles burst in the 1990s, Japan faced a banking crisis, deflation, and an accumulation of bad loans. Despite efforts to stimulate demand, monetary policy remained constrained by the focus on managing trade surpluses. Resistance to market-based reforms further hindered innovation, rendering Japan’s economic system poorly equipped to adapt to globalization.However, today’s China differs significantly from Japan of the 1980s. Let us examine how China is learning from Japan’s mistakes and seeking to improve upon them.
1. Economic Growth and Policy Adjustment: China’s projected GDP growth for 2024 is 4.7%, slowing to 4.3% in 2025, reflecting a deceleration compared to previous decades but still higher than Japan’s post-bubble stagnation. Unlike Japan’s slow and reform-resistant response to its 1990s stagnation, China is actively adjusting its policies, with measures such as easing monetary and fiscal interventions, though concerns about the effectiveness of these actions remain.
2. Monetary Policy and Inflation: China’s CPI inflation forecast for 2024 is 0.5%, with PPI at -1.6%, similar to Japan’s deflation during its lost decades, which hindered recovery. However, unlike Japan’s focus on low interest rates to boost exports, leading to overinvestment, China is prioritizing a balance between domestic consumption and investment.
3. Domestic Demand vs. Export-Led Growth: China is increasingly focusing on domestic consumption and services, with growth in sectors like new energy vehicles. Unlike Japan, which maintained an export-led model at the expense of domestic demand, China is actively working to stimulate consumption and reduce its reliance on exports.
4. Bureaucratic Control and Policy Flexibility: Both China and Japan have strong bureaucratic systems, but China demonstrates more flexibility in policy adjustments compared to Japan’s rigidity in the 1990s. While Japan’s bureaucratic resistance prolonged stagnation, China is cautiously implementing reforms to boost consumption and improve local financing.
5. Asset Bubbles and Financial Imbalances: China is facing a housing downturn similar to Japan’s 1980s bubbles, but unlike Japan, which experienced a prolonged banking crisis due to bad loans, China is proactively managing housing market risks to prevent a similar outcome.
That said, reorienting an economy from an investment-driven model to one focused on consumption is an exceptionally challenging task. Given that Japan’s experience remains fresh in investors’ minds, China’s margin for error is relatively narrow. However, Chinese frontline indices offer attractive entry points for those confident in the success of recent policy measures, with the CSI 300 Index down over 40% from its 2021 peak.
In contrast, Indian markets, while offering strong long-term potential, are trading near all-time highs. Foreign Institutional Investors, who recently turned positive on India after significant outflows in 2022, now face a difficult decision. Domestic investors, many of whom cannot directly invest in Chinese markets, will closely observe these developments to assess the impact on sector rotation within India.
