Since the beginning of this year, the economy has faced certain downward pressure, and how to stabilize the economy has become a focus of the market and policy. Currently, under multiple favorable policies, the improvement of the financing environment has become a market consensus. However, under the high pressure of real estate regulation, the land finance chain is difficult to form a closed loop. In addition, the faith in urban investment has loosened compared to the past. How can local governments lacking general fiscal revenue engage in large-scale construction as they did in the past? At this time, we cannot help but ask: if low infrastructure growth becomes the norm, where will the economy or the bond market go?
　　Infrastructure investment declines, policy advancement accelerates
　　From January to July, fixed asset investment grew by 5.5% year-on-year, lower than the expected 6.0%, continuing to create a new low since 2000. Among them, infrastructure investment (excluding electricity, heat, gas and water production and supply) grew by 5.7% year-on-year, down 0.5 percentage points from the previous value. Against the backdrop of both real estate and manufacturing investment growth picking up, the decline in infrastructure investment caused by tightened financing has become the biggest drag on fixed asset investment.
　　On the other hand, the pace of policy shift from signaling to implementation and then to execution has clearly accelerated. From the State Council executive meeting on July 23 releasing easing signals to the "six stabilities" of the Politburo meeting on July 31; the central bank injected a large amount of MLF funds of 502 billion yuan on July 23, then relaxed MPA assessment parameters to encourage commercial banks to extend credit. The second-quarter monetary policy report also increased the need for "several lifts" policy synergy to solve the problem of broad credit; on August 7, China Railway Corporation confirmed that railway fixed asset investment in 2018 will return to more than 800 billion yuan; on August 14, the Ministry of Finance issued the "Opinions on Doing a Good Job in the Issuance of Local Government Special Bonds," requiring acceleration of special bond issuance progress, proposing that this year's local government bond issuance progress is not subject to quarterly balance requirements, and that the cumulative issuance ratio of new special bonds in various regions by the end of September should in principle not be less than 80%; on August 18, the China Banking and Insurance Regulatory Commission issued the "Notice of the General Office of the China Banking and Insurance Regulatory Commission on Further Improving Credit Work and Enhancing the Quality and Efficiency of Serving the Real Economy," mentioning the need to unblock the monetary policy transmission mechanism, meet the effective financing needs of the real economy, not blindly withdraw or cut off loans, and at the same time support the filling of shortcomings in the infrastructure field and promote stable growth of effective investment. The shift in tone from important meetings to the rapid response of relevant ministries, regulatory agencies, and enterprises shows the great downward pressure on the economy and the urgency of infrastructure support.
　　However, under the high pressure of real estate regulation, the land finance chain is difficult to form a closed loop. In addition, the faith in urban investment has loosened compared to the past. Without the development and supplementation of other financing channels, how can local governments lacking general fiscal revenue engage in large-scale construction as in the past? At this point, we might as well conduct a sandbox simulation. First, clarify several realistic reasons that may prevent infrastructure from high growth, and then propose some ideas on the impact of the normalization of low infrastructure growth.
　　Realistic genes that infrastructure will not continue past high growth
　　From the current policy direction, activating small and micro enterprises and the private economy is a major focus of policy, and the crowding-out effect of infrastructure is constrained. From the latest economic data, while the completed amount of fixed asset investment is still declining, the growth rate of manufacturing investment has expanded, and private investment has continued to rise, becoming a major support for economic growth. However, from the perspective of industrial added value, since the advancement of supply-side reform in 2015, the year-on-year growth rate of state-owned enterprises has significantly increased, while that of private enterprises has trended downward, indicating that supply-side reform has somewhat crowded out the output of private enterprises, which may to some extent affect subsequent investment momentum. On this basis, in the direct pulling effect of infrastructure on industrial enterprises such as steel and cement, private enterprises benefit limitedly. Secondary industry investment accounts for about 50% of private investment, of which industrial investment accounts for the vast majority. Therefore, the stimulating effect of infrastructure on private and small and micro enterprises from production to investment may be weak. On the other hand, increased infrastructure may also squeeze the credit resources of small and medium-sized enterprises and private enterprises, causing the private economy to be trapped on both the supply and demand sides of funds. Considering the crowding-out effect of infrastructure and the current policy mix's strong tilt toward small and micro enterprises and private enterprises, the magnitude of infrastructure increase may not be as high as expected.
　　Under the current macroeconomic environment, fiscal fund allocation will pay more attention to efficiency. The marginal benefit of infrastructure investment is diminishing, and significant increase is of little significance. From the perspective of return on investment, the marginal pulling effect of China's overall fixed asset investment on economic growth continues to decline. By the end of 2017, the pulling effect of unit total fixed asset investment on total GDP had dropped to 1.27. In the context of weakening pulling effect of fixed asset investment, infrastructure investment, as an important sub-item, cannot remain immune. The labor of unit infrastructure investment on GDP growth has dropped from 9.30 in 2004 to 4.69 in 2017, a reduction of nearly 50%. The decline in investment efficiency of infrastructure investment will also have a negative impact on local government fiscal revenue, leading to a decline in debt sustainability, which in the long run does more harm than good for local governments. The current international economic environment has clearly deteriorated. Under internal and external troubles, fiscal funds will be more carefully calculated and measured in terms of input and output. Affected by the continuous decline in overall investment returns, a significant increase in infrastructure investment is of little economic significance.
　　The necessity for large-scale infrastructure demand in first-tier cities has decreased. Non-first-tier cities are constrained by real estate regulation and their financing qualifications have deteriorated, so infrastructure investment may also be difficult to expand. From the recent perspective of local governments, the net financing scale of debt, including urban investment bonds and local government bonds, has declined. As of August 20, 2018, the net financing amount of local government debt since 2018 only accounts for 52.37% of the whole year of 2017. On the other hand, the year-on-year growth rate of national fiscal revenue continues to be higher than fiscal expenditure, and government spending is relatively restrained. Taking Shanghai as an example, social infrastructure investment has shown a year-on-year decline. Although there have been factors of tightened financing channels since last year, from the perspective of urban development, for first-tier cities with relatively high overall infrastructure levels, the demand for continuing large-scale infrastructure is also weakening. Therefore, in fact, the main force of future infrastructure demand should be in second-, third-, and fourth-tier cities. Even though policies have recently relaxed financing channels for infrastructure, based on the continuous escalation of real estate regulation, the previous financing channels built on land transfer fees will face an unstable foundation. Therefore, non-first-tier cities that already lack general fiscal revenue will be constrained by the shackles of land finance.
　　Under real estate regulation, if infrastructure increment becomes normal, how much role does manufacturing need to play to stabilize the economy?
　　Starting from the GDP expenditure approach, investment is an important component of GDP. A regression equation is established between fixed asset investment and real GDP. The results show that the correlation between the two is as high as 0.99, and the explanatory power of the regression equation reaches 97.51%. The regression equation is as follows:
　　Real GDP = 52503.11 + 1.124138 * Completed Fixed Asset Investment
　　Assuming the real GDP target is 6.6%~6.8%, according to the equation, the target fixed asset investment amount can be inferred to be approximately 87,630~839,202 billion yuan. Assuming the proportion of infrastructure investment and manufacturing investment in fixed asset investment in 2017 remains unchanged, at 27.40% and 30.65% respectively, it can be inferred that under different GDP targets, infrastructure investment year-on-year needs to rise to 10.57%~10.79%. Assuming infrastructure only recovers from the current level to 6%, 7%, and 8%, the corresponding manufacturing year-on-year growth needs to roughly recover to 15%, 14%, and 13%.
　　New drivers still need time
　　Private manufacturing and high-tech manufacturing may become the destination of policy guidance. Considering that the crowding-out effect of increased infrastructure on the private economy may run counter to the policy's encouragement direction, encouraging private economy manufacturing investment may be a policy approach that kills two birds with one stone or even more. First, an increase in private manufacturing investment will directly boost capital formation and thus drive economic growth; second, tilting resources toward private manufacturing is also beneficial to achieving the policy task of helping small and micro enterprises; in addition, there is a high call in the market for tax and fee reductions. From another perspective, the government can actually consider helping enterprises increase income to achieve economic output recovery. Encouraging the development of effective investment in the private economy can not only help enterprises and residents increase income, which is conducive to boosting aggregate demand in the economy, but also enhance economic vitality. From the perspective of specific industry guidance, the State Council executive meeting on August 16 specifically mentioned lowering the threshold for private capital access, including environmental protection, transportation and energy, elderly care, and medical care-related fields. Correspondingly, equipment manufacturing in related industries such as general equipment manufacturing, special equipment manufacturing, and electricity, heat, and water production and supply may have certain development opportunities. Currently, the above-related industries account for about 25% of private manufacturing investment, so encouragement of related industries will have a certain promoting effect on total investment.
　　The ZTE and Hongxin incidents since this year have continuously exposed the scars of China's lack of core technologies. Under the current wave of manufacturing intelligence, China's pursuit of core technologies and high-tech fields is not only a requirement to get rid of technological dependence and achieve technological autonomy, but also an important channel to seize a new round of capacity upgrading and achieve total factor productivity improvement. On August 8, the "Notice of the General Office of the State Council on the Establishment of the National Science and Technology Leading Group" was announced. The leading group added members including the Minister of Industry and Information Technology compared to its predecessor, strengthening the coordination of industry-university-research integration in industrial manufacturing, which also means that investment in technology-related manufacturing such as electrical machinery and equipment manufacturing, and computer, communication, and other electronic equipment manufacturing will face opportunities.
　　The economy has stagnation, no inflation, and the bond market rebounds after overshooting
　　The recent double kill of stocks and bonds reflects the market's hesitation about infrastructure driving the economy. We believe it is too early to talk about stagflation. Returning to fundamentals, if considering the decline in investment efficiency of infrastructure, the crowding-out effect on the private economy, and the unstable financing foundation of local governments, the intensity of infrastructure may be constrained. In this context, to maintain an economic growth rate of 6.6%~6.8% within the year, manufacturing needs a growth rate of 13%~15% to support the economy. Overall, the intensity and effect of infrastructure investment are limited, and investment in new manufacturing drivers still needs time. The economy is unlikely to improve significantly in the short term. At the same time, due to the lack of demand, the current transmission of upstream industrial product price increases to downstream is limited. Overall, the economy has stagnation but insufficient inflation, so the risk of stagflation may not be as pessimistic as the market expects. On this basis, we believe there is a certain overshoot in the bond market in the short term, and the current level may rebound toward our range. We maintain the 10-year government bond yield in the range of 3.4%-3.6%.