On February 9, following significant market volatility, Xing Ziqiang, Chief China Economist at Morgan Stanley, discussed the underlying causes during a weekly macro strategy session.
He noted two conflicting market expectations currently in play: One concerns fears of fiscal expenditure contraction and tax increases; The other suggests that major real estate stimulus measures may be introduced.
Regarding the first point, Xing believes that although this year's fiscal policy will be relatively moderate rather than strongly stimulative, the recent value-added tax (VAT) adjustment for the telecommunications sector should not be interpreted as a precursor to broader tax hikes. The likelihood of widespread tax increases is extremely low, as such moves would neither help alleviate deflationary pressures nor align with the spirit of macroeconomic consistency reviews.
On real estate policy, he expects marginal, moderate adjustments rather than transformative "big moves."
Addressing AI's impact on global employment, Xing cited a survey of 935 enterprises indicating that AI has already led to a net reduction of approximately 4% in jobs over the past year, with white-collar service sectors such as information technology and finance being the most affected. While tightened U.S. immigration policies have temporarily mitigated unemployment pressures there, this trend poses additional challenges for China's already high youth unemployment rate.
Additionally, Laura, Morgan Stanley's Chief China Strategist, highlighted a positive development in January 2026: For the first time since 2023, overseas traditional active public funds have resumed monthly net inflows into Chinese stocks, while passive fund inflows remain robust. Furthermore, southbound capital maintained nearly $10 billion in net inflows into the Hong Kong market in January. Current market turbulence will not alter its medium- to long-term trajectory, and there is no need for excessive concern about liquidity in Chinese markets.
Key takeaways from Xing and Laura’s sharing are summarized below:
Fiscal Policy Leans Moderate, Tax Hikes on Private Firms Unlikely Market expectations regarding China's fiscal, consumption, and property policies are currently divided. One view, prominent last week, worries about fiscal and tax tightening, particularly given revenue pressures amid deflationary cycles. Some investors interpreted the recent VAT adjustment for the telecommunications sector as a signal of broader tax increases, sparking concerns about potential VAT hikes for industries such as gaming, e-commerce, and finance, or changes to preferential tax treatments for high-tech firms. Conversely, others have been speculating about potential major real estate stimulus measures.
Morgan Stanley’s view remains clear: this year's fiscal policy will be moderate, not strongly stimulative. However, tax increases targeting private enterprises—especially broader VAT adjustments—are highly unlikely. The telecom sector VAT adjustment is essentially a reallocation between state-owned entities, but raising taxes on other sectors would equate to fiscal tightening for private businesses. Amid weak domestic demand and persistent deflationary pressures, significant tax hikes would contradict goals of stabilizing consumption and confidence, and would conflict with the "macro consistency review" framework introduced in 2024.
Market Concerns Over Fiscal Contraction This year's fiscal deficit tone is expected to be moderate, with possible supplementary measures in the second half. Market anxiety stems from worries that without fiscal deficit expansion or an increase in fiscal revenue as a share of GDP, government expenditure may contract. Although Morgan Stanley does not anticipate this outcome, market concerns are not without logic. Current indications suggest a moderate fiscal deficit stance for 2026, with specifics to be clarified during the Two Sessions. The initial deficit ratio is likely to mirror last year's level, with a potential supplementary fiscal expenditure—around 0.5% of GDP, or nearly 800 billion to 1 trillion yuan—possible in the second half to support consumption and property policies.
Real Estate Unlikely to See Major Moves, Marginal Adjustments Expected Real estate policies are more likely to involve mild, marginal adjustments, such as selective inventory purchases in a few cities, limited mortgage subsidies, or further relaxation of purchase restrictions in key cities. Large-scale measures to support developers or absorb inventory face moral hazard and operational constraints, making transformative policies unlikely.
U.S. Immigration Tightening Mitigates AI-Linked Unemployment Discussions on AI's impact on U.S. economic growth, employment, and long-term implications for the Federal Reserve are intensifying. In the short term, AI has not triggered large-scale unemployment in the U.S., partly due to a historic sharp reduction in immigration—from an average of 3 million annually in 2023–2024 to 1.3 million in 2025, with a projected net immigration of only 320,000 in 2026. This has reduced labor supply, cushioning employment pressures.
Information, Finance Sectors Hit Hard by AI; Blue-Collar, Healthcare Show Resilience A survey of 935 global enterprises found that AI has caused a net 4% reduction in jobs over the past year, with more pronounced effects in other developed countries. Sectors such as information technology, finance, and professional services are most exposed to AI, experiencing rapid declines in new positions. In contrast, blue-collar and healthcare sectors have demonstrated resilience, with continued job growth.
This has implications for China. On the positive side, China's economy has a higher proportion of traditional manufacturing, which may reduce the relative impact of AI compared to the U.S. However, challenges remain, particularly given already high youth unemployment. University graduates, who typically seek white-collar roles, may face greater pressure as AI affects professional services. Future competition between China and the U.S. may hinge on which governance model better addresses wealth concentration in tech and provides welfare and returns to those displaced by AI.
Japan’s Election Outcome Exceeds Expectations, Fiscal Expansion and Industrial Policy Shift Ahead Japan's recent election results represent a significant global political variable, with the ruling coalition securing a supermajority. This strengthens the prime minister’s control over budget and legislation. Key implications include fiscal expansion focused on economic self-sufficiency and defense investment, a shift in industrial policy toward strategic sectors like AI, semiconductors, rare earths, energy, and infrastructure, and potential—though not immediate—consumer stimulus measures such as consumption tax cuts. Overall, Japan’s move toward fiscal expansion and strategic industrial policy warrants close attention.
Foreign Active Funds Record First Net Inflow in Years Laura highlighted that January 2026 data showed a monthly net inflow from traditional active funds into Chinese stocks for the first time since 2023, while passive inflows remained strong. Southbound capital also maintained nearly $10 billion in net inflows into Hong Kong in January. Market volatility does not alter the medium- to long-term outlook, and liquidity conditions in Chinese markets remain sound.
Stock Connect Adjustments Create Short-Term Trading Opportunities Morgan Stanley recommended a short-term trading opportunity starting February 9, ahead of March’s Hong Kong Stock Connect rebalancing. Based on backtesting, a strategy of establishing positions in predicted additions and reductions 30 days before the official effective date has proven effective. The firm predicts 44 additions and 25 deletions in the March rebalance, with February 9 identified as the optimal entry point for a weighted portfolio to capture alpha.