Gradual RMB Appreciation and Expanding Domestic Demand Should Advance Together

Overview

The report uses the Swan Model to analyze China’s internal and external economic imbalances. In the first half of 2026, strong exports and a record trade surplus coexisted with weak consumption, real estate investment, and fixed asset investment. Goldman Sachs argues that treating expansion of domestic demand and RMB appreciation as an either-or choice is wrong: fiscal expansion and structural reforms should address the problem of domestic demand being below potential, while RMB appreciation should move the real exchange rate closer to fair value and reduce excessive surpluses and the risk of trade friction.

Core views

China needs to pursue both internal balance and external balance. In the short term, it should accelerate government bond issuance and fiscal spending to stabilize growth; over the long term, limited fiscal space should be directed more toward public consumption, while private demand should be unlocked by easing services-sector restrictions, reforming the hukou system, improving financing and property rights protection for private enterprises, and increasing labor’s share of income. At the same time, significant RMB undervaluation and manufacturing competitiveness have jointly pushed up the current account surplus, and gradual nominal appreciation would help restore external balance. Although this policy mix is not sufficient on its own to solve global imbalances, it can improve China’s own growth structure and provide a more robust foundation for achieving medium-term growth objectives.

Analysis framework

The report first identifies China’s internal and external economic divergence based on growth, trade, consumption, and investment data, then uses the Swan Model to divide policy objectives into internal balance and external balance, matching them respectively with expenditure-changing policies and expenditure-switching policies. RMB valuation uses the 60:40 weighted result of the GSDEER and GSFEER indicators; the current account surplus is smoothed using the HP filter and compared with a sustainable benchmark formed from a long-term factors model, historical averages, and economists’ judgment. The report also assesses China’s manufacturing competitiveness through cross-industry cost and price comparisons, and uses a generalized additive model to study the nonlinear relationship between per capita GDP and the investment-to-GDP ratio.

Methodology notes

• Open-Economy Policy FrameworkSwan Model

  A dual-objective, dual-instrument framework for 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 typically requires two types of policy instruments and cannot rely on a single policy.

• Demand Management PolicyExpenditure-Changing Policy

  Changing the level of domestic aggregate absorption through fiscal and monetary policy

  Tools such as government spending, taxes, and interest rates are used to expand or contract aggregate demand. The report argues that China should alleviate insufficient domestic demand through fiscal expansion and consumption-promoting structural reforms.

• Relative Price PolicyExpenditure-Switching Policy

  Changing the relative prices of domestic and foreign goods through the exchange rate

  Currency appreciation raises the price of domestic products relative to foreign products and shifts demand from domestic products to foreign products. The report believes gradual RMB appreciation will help reduce excessive external surpluses.

• Exchange Rate ValuationGSDEER and GSFEER

  RMB equilibrium exchange rate valuation indicators

  Goldman Sachs assesses the degree of RMB undervaluation against the U.S. dollar using a 60:40 weighted result of GSDEER and GSFEER, with the current result at about 20%.

• Time-Series ProcessingHP Filter

  Smoothing short-term volatility in current account data

  The report uses the HP filter to reduce sharp quarter-to-quarter fluctuations, based on which it estimates China’s current account surplus at about 3.8% of GDP.

• Nonlinear Statistical ModelingGeneralized Additive Model

  Estimating the nonlinear relationship between per capita GDP and the investment-to-GDP ratio

  The model uses data from 1970 to 2024 to compare China’s investment share with the development stages of other economies.

Asset mapping & comparison

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

• Renminbi (CNY)

  The report explicitly expects the RMB to appreciate gradually against major currencies, with a 12-month USD/CNY forecast of 6.50.

  Strengths

  Significant undervaluation, a large current account surplus, and manufacturing competitiveness provide fundamental support for the RMB.

  Weaknesses

  Low domestic inflation, insufficient demand, and the real estate downturn may limit the pace of appreciation.

  Comparison

  The combined GSDEER and GSFEER valuation shows the RMB is undervalued against the U.S. dollar by about 20%, making it one of the more undervalued currencies among the G10 and emerging-market currencies covered by Goldman Sachs.

  Risks

  Deteriorating trade relations, a renewed policy tilt toward exchange-rate stability, or a further slowdown in domestic growth could all delay appreciation.

• Chinese equities related to domestic demand and services consumption

  A shift in fiscal spending toward education, healthcare, pensions, and public consumption, as well as services-sector access reform, may improve demand in related industries.

  Strengths

  Domestic demand is at a low level; if policy shifts toward consumption, there is room for recovery.

  Weaknesses

  Household balance sheets are affected by falling real estate prices, and private-sector confidence and willingness to consume remain weak.

  Comparison

  Compared with exports and manufacturing, domestic retail, services consumption, and real estate chain activity are clearly lagging.

  Risks

  Fiscal resources may remain tilted toward investment, structural reforms may be difficult to advance, or short-term multiplier effects may be insufficient.

• Chinese equities related to exports and manufacturing

  Strong competitiveness and external demand support current earnings, but RMB appreciation and trade protectionism may weaken price advantages.

  Strengths

  China has broad cost competitiveness in industries such as electric vehicles, machinery and equipment, industrial robots, photovoltaics, home appliances, smartphones, and display equipment.

  Weaknesses

  The growth structure has become more dependent on net exports and is vulnerable to changes in global trade policy.

  Comparison

  Export performance is significantly stronger than retail sales, real estate investment, and other domestic activity.

  Risks

  RMB appreciation, tariffs, and market access restrictions may compress margins and external market share.

• Chinese government bonds

  Short-term fiscal expansion and accelerated government bond issuance will increase supply, while weak growth and low inflation continue to exert downward pressure on interest rates.

  Strengths

  Low inflation and insufficient domestic demand help maintain a relatively accommodative financial environment.

  Weaknesses

  Increased government bond supply may put pressure on term premia.

  Comparison

  The monetary policy rate has been cut to 1.4%, and bank net interest margin constraints limit further rate cuts, increasing the relative importance of fiscal policy.

  Risks

  Stronger-than-expected fiscal expansion, concerns about debt sustainability, or a rebound in inflation may push yields higher.

• Chinese real estate-related assets

  A more than 30% decline in real estate prices has dragged on household balance sheets and is an important source of weak domestic demand.

  Strengths

  Government spending can reduce the risk of negative feedback among local government arrears, corporate bankruptcies, and layoffs.

  Weaknesses

  Falling local land-sale revenues, household deleveraging, and continued investment slowdown remain structural drags.

  Comparison

  Real estate and consumption performance are clearly weaker than the export sector.

  Risks

  Further price declines may further suppress consumption, local government finances, and financial stability.

Key data

• June 2026 trade surplusUSD 125 billionA record high, equivalent to about USD 1.5 trillion annualized.
• RMB valuationUndervalued by about 20% against the U.S. dollarBased on the 60:40 weighted result of GSDEER and GSFEER; the undervaluation was close to 25% last year.
• China’s current account surplusAbout 3.8% of GDPGoldman Sachs estimate after smoothing with the HP filter.
• Sustainable current account benchmarkAbout 1.7% of GDPDerived by Goldman Sachs based on long-term factors, historical averages, and economists’ judgment; the benchmark implied by the IMF’s assessment is closer to 1%.
• USD/CNY forecast6.50Goldman Sachs’ 12-month forecast, reflecting expectations for gradual RMB appreciation.
• 2026 domestic demand growthOnly about 1% to 2% year-on-yearGoldman Sachs’ estimate for domestic demand growth during the year.
• Real GDP growth in Q2 20264.3% year-on-yearBelow the lower bound of the full-year target range of 4.5% to 5%.
• Non-financial sector debt ratio301% of GDP in 2025People’s Bank of China estimates show this ratio rose significantly from 141% in 2008.
• Augmented fiscal deficitAveraged 12.1% of GDP from 2019 to 2025Nominal GDP grew at an average annual rate of about 6.0% over the same period, indicating that policy space for traditional stimulus is more limited than in the past.
• Decline in real estate pricesMore than 30%Household balance sheet repair and falling local land-sale revenues jointly suppress domestic demand.
• Investment-to-GDP ratioPersistently above 40% from 2007 to 2024Prolonged high investment has created large capacity; the report argues that fiscal resources should be shifted more toward consumption.
• Combined pension and medical insurance contributions32% of wagesCombined employer and employee contribution ratio, higher than in many other countries.

Impact & implications

If the policy mix advances as envisaged in the report, fiscal expansion will first support short-term growth, while public consumption and institutional reforms are expected to raise the medium- to long-term contribution of household consumption and private investment; RMB appreciation will reduce the degree of real exchange rate undervaluation and ease excessive trade surpluses and external protectionist pressure. At the asset level, the RMB may receive medium-term support, assets related to domestic demand and services consumption may benefit, while export sectors that rely on price advantages will face dual pressure from currency appreciation and trade frictions. Since global imbalances also involve the U.S. fiscal deficit, current account deficit, and exchange rate overvaluation, unilateral adjustment by China can address only part of the problem.

Risks

• Domestic demand continues to weaken, causing economic growth to fall further below the full-year target or potential level.
• High non-financial sector debt, pressure on banks’ net interest margins, and declining local fiscal revenue limit the room for traditional fiscal and monetary stimulus.
• Structural reforms to promote consumption, the hukou system, services-sector access, property rights protection, and financing for private enterprises face political and implementation resistance.
• RMB appreciation may weaken the price competitiveness of some export industries in the short term.
• If the RMB remains undervalued and the trade surplus expands further, major trading partners may adopt more tariffs or market access restrictions.
• There are discrepancies between trade balance and balance-of-payments data, and factors such as gold imports also affect judgments about the true external surplus and the degree of exchange-rate undervaluation.
• China’s policy adjustments are insufficient on their own to solve global imbalances; if major economies such as the United States do not make fiscal and exchange-rate adjustments, protectionist pressure may persist.
• The forecasts and policy judgments in the report are based on public information as of the report date, and subsequent data and policy changes may alter the conclusions.

What to watch

• Government bond issuance, the pace of fiscal spending, and whether policy implements “strengthening countercyclical adjustment.”
• Whether retail sales, fixed asset investment, real estate investment, and domestic demand growth can stabilize in subsequent quarters.
• Whether real GDP growth can return to the full-year target range of 4.5% to 5%.
• Whether fiscal spending shifts from new capacity investment toward education, healthcare, pensions, and other public consumption.
• Actual progress in reforms of the hukou system, services-sector access, property rights protection, private enterprise financing, and labor income distribution.
• Whether USD/CNY gradually moves toward the 12-month forecast of 6.50, and changes in the RMB real effective exchange rate.
• Whether the trade surplus, current account surplus, and their share of global GDP continue to rise.
• Gold imports and differences between customs trade data and balance-of-payments data.
• Whether tariffs, industrial policies, and market access measures by major trading partners tighten further.
• The impact of bank net interest margins, real interest rates, and real estate price changes on monetary policy space and financial stability.