China’s rebalancing requires gradual RMB appreciation alongside domestic demand expansion

Overview

The report notes that in the first half of 2026, China’s economy continued to display a clear dual-track pattern: exports and external balances were strong, while property investment, retail sales, and other domestic demand indicators were weak. The June trade surplus reached a record USD 125 billion, equivalent to about USD 1.5 trillion annualized; meanwhile, real GDP grew 4.3% year over year in the second quarter, below the lower bound of the full-year target range of 4.5% to 5%. Goldman Sachs argues that the debate over whether to prioritize demand stimulus or RMB appreciation is a false dichotomy. China needs gradual RMB appreciation to improve external balance, as well as fiscal expansion and structural reforms to restore internal balance.

Core views

First, the RMB is undervalued against the US dollar by at least about 20%, and combined with China’s broad manufacturing competitiveness, this has contributed to trade and current account surpluses far above sustainable levels; gradual appreciation would help the real exchange rate return to fair value and ease protectionist pressure from trading partners. Second, domestic demand has grown only about 1% to 2% this year, the fiscal stance tightened significantly in the second quarter, and economic growth faces the risk of falling below both the target and potential growth rate, so government bond issuance and fiscal spending need to be accelerated. Third, fiscal resources should shift more from expanding production capacity toward public consumption such as education, healthcare, and pensions, while reforms in household registration, property rights protection, private enterprise financing, service-sector access, and income distribution should be advanced. Fourth, China’s policy adjustments can only improve its own balance; resolving global imbalances still requires the United States and other major economies to adjust fiscal and exchange-rate policies simultaneously.

Analysis framework

The report uses the Swan model as its main framework, breaking China’s current problems into two objectives: internal balance and external balance, and matching them respectively with expenditure-changing policies and expenditure-switching policies. Exchange-rate valuation uses a 60:40 weighted result of the GSDEER and GSFEER indicators; current account trends are smoothed using an HP filter; and cross-country comparisons of investment as a share of GDP use a generalized additive model to fit the nonlinear relationship between per capita GDP and investment rates. The report also cross-validates with data on trade, retail sales, fixed asset investment, GDP, debt, fiscal deficits, and inflation differentials.

Methodology notes

• Open-economy policy frameworkSwan model

  Internal balance and external balance

  Internal balance requires demand growth to be close to potential, while external balance requires the current account to be at a sustainable level; achieving both objectives requires two types of policy tools, rather than choosing between stimulating domestic demand and currency appreciation.

• Policy tool classificationExpenditure-changing policy

  Fiscal and monetary policy regulate domestic aggregate absorption

  Tools such as government spending, taxation, and interest rates change the total amount of domestic demand. Given China’s domestic demand below potential, the report advocates fiscal expansion and directing more spending toward public consumption.

• Policy tool classificationExpenditure-switching policy

  Changing demand for domestic and foreign goods through relative prices

  The exchange rate is the main tool. RMB appreciation would raise the relative price of Chinese goods, thereby reducing an excessive external surplus and pushing external balances back toward sustainable levels.

• Exchange-rate valuationGSDEER and GSFEER

  Equilibrium exchange rate and fair-value exchange rate valuation

  The report combines two Goldman Sachs exchange-rate indicators with 60:40 weights and estimates that the RMB is undervalued against the US dollar by about 20%, compared with nearly 25% undervaluation in the previous year.

• Time-series analysisHP filter

  Smoothing current account data

  By smoothing quarterly fluctuations, the report estimates the trend level of China’s current account surplus at about 3.8% of GDP.

• Nonlinear statistical modelGeneralized additive model

  Cross-country comparison of investment rates and development levels

  Data from 1970 to 2024 are used to fit the nonlinear relationship between per capita GDP and investment as a share of GDP, in order to assess the extent to which China’s investment rate is elevated relative to other economies.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Renminbi (CNY)

  Directly benefits from policy-allowed gradual appreciation and the return of the real exchange rate toward fair value

  Strengths

  Valuation undervalued by about 20%, a large current account surplus, strong manufacturing competitiveness, and lower Chinese inflation than major trading partners.

  Weaknesses

  Weak domestic demand, property adjustment, and the need for monetary easing may limit the pace of appreciation.

  Comparison

  Goldman Sachs expects USD/CNY to fall to 6.50 over the next 12 months; the RMB’s undervaluation in the previous year was close to 25%.

  Risks

  Deteriorating trade relations, capital flow pressure, or a continued policy priority on maintaining nominal stability against the US dollar could all delay appreciation.

• China export-related assets

  Supported by strong manufacturing competitiveness, but facing dual impacts from the exchange rate and protectionism

  Strengths

  Exports are strong, industrial competitiveness spans multiple manufacturing categories, and the trade surplus is at a record level.

  Weaknesses

  RMB appreciation may weaken price advantages and affect translation of foreign-currency revenues.

  Comparison

  Compared with weak property investment and retail sales, exports are a clearly stronger component of China’s current growth.

  Risks

  If the external surplus continues to expand, major trading partners may adopt more tariffs or other protectionist measures.

• China domestic demand and service consumption-related assets

  May benefit from fiscal spending shifting toward public consumption and structural reforms

  Strengths

  Education, healthcare, pensions, entertainment, and high-end services have substantial potential demand, and policy easing could improve household consumption capacity.

  Weaknesses

  Household balance sheet repair, household registration restrictions, high social security contributions, and insufficient property rights protection continue to suppress demand.

  Comparison

  Current domestic demand is growing only about 1% to 2% year over year, clearly weaker than exports and the external sector.

  Risks

  Structural reforms are politically and operationally difficult, short-term effects are uncertain, and fiscal resources may continue to flow into traditional investment.

• China interest rates and government bonds

  Fiscal expansion and faster government bond issuance will affect supply, liquidity, and growth expectations

  Strengths

  Expanded government spending can fill the demand gap left by local governments and households, and prevent corporate arrears, bankruptcies, and layoffs from creating negative feedback.

  Weaknesses

  Non-financial debt has reached 301% of GDP, the augmented fiscal deficit has remained high for a long period, and policy space is limited.

  Comparison

  Compared with the global financial crisis and the 2015 downturn, traditional monetary and fiscal easing space is now smaller.

  Risks

  Rising bond supply, low fiscal multipliers, or funds continuing to be invested in excess capacity could weaken policy effectiveness.

Key data

• RMB valuationUndervalued against the US dollar by at least about 20%Based on a 60:40 weighting of the GSDEER and GSFEER indicators; the undervaluation in the previous year was close to 25%.
• USD/CNY forecast6.50 over the next 12 monthsGoldman Sachs expects policymakers to allow the RMB to gradually strengthen, assuming trade relations among major economies remain stable.
• June 2026 trade surplusUSD 125 billionA historical record, equivalent to about USD 1.5 trillion annualized.
• Estimated current account surplusAbout 3.8% of GDPSmoothed using an HP filter, significantly above Goldman Sachs’ estimated sustainable norm of 1.7%; the IMF’s assessment implies the norm may be closer to 1%.
• 2026 domestic demand growthAbout 1% to 2% year over yearGoldman Sachs estimates domestic demand growth is very weak.
• Q2 2026 real GDP growth4.3% year over yearBelow the lower bound of the full-year growth target range of 4.5% to 5%.
• Non-financial debt-to-GDP ratio301% in 2025The People’s Bank of China estimates this ratio rose significantly from 141% in 2008.
• Average nominal GDP growth from 2019 to 20256.0% per yearOver the same period, Goldman Sachs estimates the augmented fiscal deficit averaged about 12.1% of GDP.
• Monetary policy rate1.4%Further rate cuts are constrained by banks’ net interest margins and financial stability considerations.
• Housing price adjustmentDown more than 30%Household balance sheet repair has weakened consumption and domestic demand.
• Investment as a share of GDPPersistently above 40% from 2007 to 2024The report argues that the high investment rate has created substantial capacity, and limited fiscal space should shift more toward consumption.
• Pension and medical insurance contributionsEmployers and employees together contribute about 32% of wagesThe high contribution burden is viewed as one factor constraining household consumption.

Impact & implications

For asset allocation, the report’s clearest directional view is gradual medium-term RMB appreciation, with USD/CNY moving toward 6.50. A stronger RMB may lower import costs and improve foreign-currency returns on RMB assets, while placing some pressure on companies highly reliant on exports, translation of US dollar revenues, and price competitiveness. If fiscal funds are directed more toward education, healthcare, pensions, and other public consumption, domestic services and consumer demand may benefit; but if policy remains tilted toward expanding investment and capacity, improvement in domestic demand may be limited and trade friction risks may rise. The combination of RMB appreciation and fiscal expansion would help China’s own rebalancing, but would not be sufficient on its own to resolve global current account imbalances.

Risks

• If RMB appreciation and fiscal expansion are insufficient, China’s internal and external imbalances may persist.
• Overly rapid RMB appreciation could hit export price competitiveness and related corporate earnings.
• Trading partners may adopt more protectionist measures due to China’s widening surplus, threatening external market access.
• Falling property prices, reduced local land revenue, and corporate arrears may create negative feedback through bankruptcies and employment.
• High debt levels, large fiscal deficits, and constraints from banks’ net interest margins limit traditional policy space.
• Reforms in household registration, service-sector access, property rights protection, private enterprise financing, and income distribution face significant political and execution challenges.
• There are methodological differences in current account, trade balance, and balance of payments data, and estimates of exchange-rate undervaluation and sustainable surpluses carry model uncertainty.
• China’s unilateral adjustment cannot resolve global imbalances; if the United States and other major economies do not adjust fiscal and exchange-rate policies, global tensions may persist.

What to watch

• Whether USD/CNY gradually moves toward Goldman Sachs’ 12-month forecast of 6.50.
• How the People’s Bank of China manages the RMB fixing and the currency’s movements against major currencies.
• The pace of government bond issuance, the scale of fiscal spending, and whether funds shift from productive investment toward public consumption.
• Whether retail sales, fixed asset investment, property investment, and domestic demand growth can stabilize.
• Whether real GDP growth can return to the full-year target range of 4.5% to 5%.
• Whether the trade surplus and current account surplus remain above sustainable levels.
• Inflation differentials between China and other countries and their impact on the RMB real exchange rate.
• Implementation of policies in the 15th Five-Year Plan to promote consumption, household registration reform, social security, and the private economy.
• Whether major trading partners introduce new tariffs, industrial restrictions, or other protectionist measures.
• Local government land revenue, corporate receivables and arrears, and progress in household balance sheet repair.