Analysis of China’s Economy in Late 2025: The Paradox of External Strength and Internal Fragility

An analysis of China’s economic indicators in late 2025 reveals a profoundly bifurcated economy, characterized by state-driven strength in high-tech export sectors and systemic fragility in its domestic demand. While real Gross Domestic Product (GDP) growth in the third quarter (Q3) of 2025, at 4.8% year-over-year ¹, keeps the country on track to meet its official target of “around 5%,” this headline figure masks critical underlying weaknesses.

The most significant warning sign is the divergence between real GDP growth (4.8%) and nominal GDP growth (only 3.7%).¹ This gap confirms the presence of economy-wide deflationary pressures, a symptom of severe weakness in demand, pricing power, and corporate profitability.

The central thesis of this report is that China is operating a two-speed economy:

1. Fast Engine (Supply-Driven): A robust expansion in high-tech manufacturing ¹ and a growing trade surplus ⁴, fueled by the flagship “New Productive Forces” industrial policy.⁶
2. Slow Engine (Domestic Demand): A collapse in internal demand, evidenced by a property sector crisis that has not bottomed out ⁷, weak and decelerating retail consumption ⁹, and persistently low consumer confidence.¹⁰

Beijing’s strategy to compensate for this internal weakness through industrial overproduction is exporting its imbalances. This is manifesting in a record trade surplus ⁵ and provoking direct trade frictions with the United States and the European Union, which have responded with significant tariffs.¹¹

Key systemic risks include a solvency crisis in the real estate sector, now impacting state-backed developers like Vanke ¹³; the unsustainable “hidden debt” of local government financing vehicles (LGFVs) ¹⁴; and a historic capital flight from foreign firms, visible in balance of payments data.¹⁵ Beijing’s policy response has been asymmetric, overwhelmingly favoring supply and investment over consumer demand.¹⁶ The outlook for 2026 points to a continued deceleration, with significant risks of a “Japanification” scenario.¹⁸

The 2025 Macroeconomic Landscape: An Uneven and Deflationary Recovery

This section establishes the baseline macroeconomic picture, using Q3 2025 data to introduce the central narrative of deflation and imbalanced growth.

A. Q3 2025 GDP Growth Analysis: Beyond the Headline Figure

Official Q3 2025 data shows China’s economy grew by 4.8% year-over-year.¹ While this is the weakest pace in a year, it aligns with the government’s annual growth target of “around 5%”.¹ Quarter-over-quarter, the economy expanded by 1.1% ¹⁹, exceeding market expectations of 0.8%.² In the first three quarters of 2025, cumulative GDP grew 5.2% year-over-year, reaching 101.5 trillion RMB.¹

While these headline figures appear stable, the composition of this growth reveals the first signs of imbalance. The growth is almost entirely underpinned by “high-tech manufacturing/exports and a growing trade surplus,” while “domestic demand is weak” and the “property sector slowdown continues to weigh on spending and investment.”¹

B. The Deflationary Alarm Bell: Nominal vs. Real GDP

The strongest evidence of weak domestic demand is found in the divergence between nominal and real GDP. While real (inflation-adjusted) GDP grew by 4.8%, nominal (current-price) GDP grew by only 3.7% year-over-year in Q3.¹

This 1.1 percentage-point gap implies that the GDP deflator, the broadest measure of inflation in the economy, was negative by approximately 1.1%. This is a clear signal of economy-wide deflation, which is more severe than that indicated by the Consumer Price Index (CPI). This deflation indicates “weak pricing power” and exerts immense “pressure” on “corporate profits, wages, and fiscal revenues.”¹ In a country with one of the highest total debt burdens in the world ¹⁴, falling prices increase the real burden of existing debt, disincentivize new private investment, and heighten the risk of a “Japanification” spiral.¹⁸

C. The CPI and Consumer Inflation: Trapped in Negative Territory

Demand-side deflationary pressures are confirmed by the CPI. The CPI for September 2025 registered a 0.3% year-over-year decline ²⁰, following a 0.4% drop in August.²¹ This marks the second consecutive month of consumer price deflation.²¹

The decline is largely driven by food inflation (-4.4% in September) ²⁰ and falling transportation prices (-2.4% year-over-year).²² However, core CPI (which excludes volatile food and energy prices) is dangerously weak, rising just 0.6%.¹ This low figure, far below any healthy inflation target, underscores the fundamental lack of consumer demand.

D. The Labor Market: Apparent Stability, Underlying Strain

On the surface, the labor market appears stable. The national surveyed urban unemployment rate fell to 5.2% in September from 5.3% in August.²³ This remains comfortably within the government’s official 2025 target of “around 5.5%”.²⁵ In the first nine months of the year, China created 10.57 million new urban jobs, hitting 88% of the 12 million annual target.²⁴

However, this stability conceals structural turmoil. The collapse of the labor-intensive property sector has displaced millions, while the high-tech manufacturing boom requires a different skill set. The unemployment rate for migrant workers (a key part of the industrial workforce) was 4.9% ²³, lower than the national average, suggesting the manufacturing sector is absorbing labor. Nonetheless, “average weekly working hours” of 48.6 hours ²³ suggest that companies are maximizing productivity from existing employees rather than engaging in mass hiring, set against a backdrop of deflation-squeezed profit margins.

Table 1: Key Chinese Economic Indicators (Q3 2025)

Indicator	Q3 2025 Data (YoY)	YTD Data (Q1-Q3 2025)	Source(s)
Real GDP Growth	4.8%	5.2%	1
Nominal GDP Growth	3.7%	N/A	1
Inflation Rate (CPI, Sep)	-0.3%	-0.1%	[1, 20]
Core Inflation Rate (Sep)	0.6%	N/A	[1, 20]
Urban Unemployment Rate (Sep)	5.2% (Rate)	5.2% (Average)	23
Industrial Production Growth (Sep)	6.5%	6.2%	3
Retail Sales Growth (Sep)	3.0%	4.5%	[1, 9]
Trade Surplus (YTD, Sep)	N/A	$875.1 Billion	5

The Collapse of Domestic Demand: The Absent Consumer and Distorted Investment

The Chinese economy’s deflationary weakness originates from the “slow engine” of domestic demand. A fearful consumer and a tectonic shift in investment have left a void that industrial policy alone cannot fill.

A. The Failure of Consumption as a Growth Engine

Although total retail sales grew 4.5% in the first three quarters of 2025 ¹, the trend is alarming. Year-over-year retail sales growth has decelerated consecutively, hitting just 3.0% in September ², the “weakest since August 2024.”⁹ This follows 3.4% in August ²⁷ and 3.7% in July.⁹

The root of this weakness is a “negative wealth effect” stemming directly from the property sector’s collapse. With real estate representing the bulk of Chinese household wealth ⁷, falling home prices have made consumers feel poorer. This, combined with labor market uncertainty and stagnant wages (implied by the weak 3.7% nominal GDP growth ¹), has reinforced a precautionary savings mindset.²⁸

Consumer confidence remains stalled near historic lows. The index stood at 89.2 in August 2025, far below its historical average of 108.86.¹⁰ In this environment, government stimulus, such as “trade-in programs” for appliances and cars ³⁰, is showing a “diminishing” effect.³⁰ Without a fundamental restoration of confidence, the Chinese consumer will not be the growth engine Beijing needs.¹⁸

B. Fixed Asset Investment (FAI): A Tale of Two Sectors

Fixed Asset Investment (FAI) exposes the stark divergence in the economy. The headline figure shows a 0.5% contraction in the first nine months of 2025.¹ However, this figure conceals a dramatic story of state-driven capital allocation.

An analysis of the components reveals two distinct economies:

• The Market-Driven Economy (Collapsing): Investment in the real estate sector plummeted by 13.9%.⁸ This dragged down the entire Tertiary Industry (services), which contracted by 4.3%.¹ This contraction in the consumer- and employment-oriented services sector is an alarm bell for profound private-demand weakness.
• The State-Directed Economy (Booming): Excluding real estate, FAI actually increased by 3.0%.¹ This growth was overwhelmingly channeled into the Secondary Industry (industry), which saw investment rise by 6.3%.¹ Within this, manufacturing investment rose 4.0%.¹

Beijing is using state levers (bank loans, subsidies) to force investment into manufacturing ³³ to offset the 13.9 percentage-point hole left by the property sector. This strategy guarantees overcapacity. The domestic economy, with contracting services investment (-4.3%) and weak retail sales (+3.0%), cannot absorb the output from booming manufacturing investment. The only outlet for this production is exportation, which directly links China’s domestic investment policy to its external trade conflicts.

Table 2: Breakdown of Fixed Asset Investment (YTD Sep 2025)

Investment Sector	YTD Growth (YoY, Jan-Sep 2025)	Source(s)
Total FAI	-0.5%	1
FAI (Excluding Real Estate)	+3.0%	1
By Main Industry:
Primary Industry	+4.6%	1
Secondary Industry (Industry)	+6.3%	1
Tertiary Industry (Services)	-4.3%	1
By Key Sector:
Real Estate Development Investment	-13.9%	8
Manufacturing Investment	+4.0%	[1, 34]
Manufacturing (Jan-Aug 2025):
Automobiles	+20.2%	[35]
Rail, Ships, Aerospace	+26.2%	[35]
Computers & Electronics	-0.1%	[35]

The Property Crisis: From Liquidity Crunch to Systemic Solvency

The real estate crisis has entered a new, more dangerous phase. What began as a liquidity problem for private developers has morphed into a systemic solvency crisis that is shattering implicit state guarantees and paralyzing domestic demand.

A. The Deepening Downturn: 2025 Figures

The sector shows no signs of bottoming out.³⁶ Investment in real estate development contracted 13.9% year-over-year in the first nine months of 2025.⁸ New home sales are projected to fall 15% in 2025, and housing prices have declined by nearly 10% since early 2024.⁷ Funds available to developers fell 7.5% in the first seven months of the year.³⁷ The crisis, triggered by the “three red lines” policy in 2020, has decimated a sector that once contributed up to 25% of China’s GDP.⁷

B. The Inflection Point: The Case of China Vanke

Dollar debt defaults have surpassed $130 billion ³⁸, leading to the liquidation or deep restructuring of private giants like Evergrande ³⁹ and Country Garden.⁴⁰ However, the most seismic event of 2025 has been the collapse of confidence in hybrid (partially state-owned) developers.

On November 5, 2025, S&P Global Ratings downgraded China Vanke, a developer with a major state-owned shareholder (Shenzhen Metro), to ‘CCC’ with a negative outlook.¹³ This deep “junk” rating reflects S&P’s view that Vanke’s “financial commitments appear unsustainable” and that it “could default on its debt obligations.”¹³

This event is crucial because it shatters the “implied guarantee” of the state. The market had assumed Vanke was “safe” due to its state backing. The downgrade demonstrates that state support is selective, not unconditional. This explains why international creditors for other developers have become “more muted” in negotiations and are “willing to take larger haircuts” ³⁸; they have realized no comprehensive bailout is coming. The crisis has shifted from a liquidity problem for private developers to a solvency problem for the entire sector.

C. The Ineffective Policy Response

Beijing’s policy response has been notably timid. The benchmark rate for most mortgages, the 5-year Loan Prime Rate (LPR), has only been cut by 10 basis points so far in 2025, a stark contrast to the 60 basis points of cuts in 2024.³⁶ The relaxation of home-purchase restrictions in top-tier cities like Beijing and Shanghai in August was only “partial” and largely focused on the suburbs.³⁶

Beijing is caught in a policy trap. Massive stimulus (major rate cuts, bailouts) could accelerate capital flight ¹⁵, destroy bank profit margins (already weakened, according to the IMF ⁴¹), and re-inflate a bubble they are trying to deflate. If they do nothing, the implosion of confidence ⁴² and collapse in consumer spending ⁹ will drag down the entire economy. They have chosen a middle path: “managing the collapse” rather than “engineering a recovery,” confirming that the leadership has abandoned the property sector as a growth engine.

China’s New Industrial Strategy: ‘New Productive Forces’ as the Sole Engine

With the property model broken, China has bet its economic future on a new engine: a massive industrial strategy known as “New Productive Forces.” This is not a simple policy but the country’s new economic growth model, designed to offset the property collapse and push China up the global value chain.

A. From ‘Made in China 2025’ to the New Strategy

The notorious “Made in China 2025” policy (launched in 2015 ⁴³) vanished from public discourse around 2018 due to intense international criticism.⁴⁴ However, its core objectives have continued and evolved under new banners, such as “New Productive Forces.”⁶ This new iteration emphasizes “intelligent, green, and high-quality” industry ⁶, focusing on sectors like electric vehicles (EVs), solar panels, batteries, robotics, artificial intelligence (AI), and biotechnology.⁶ The strategy is fueled by enormous state funding via guidance funds, directed bank loans, and subsidies.⁴⁶

B. Evidence of Supply-Driven Success

The results of this massive supply-side investment are evident in the 2025 production data. Overall Industrial Production grew 6.5% year-over-year in September, far exceeding market forecasts of 5.0%.² The manufacturing PMI stood at 49.8, nearly stable.¹

Growth was explosive in the “New Productive Forces” target sectors. In September 2025, year-over-year output growth was:

• Automobile Manufacturing: +16.0% ³
• Computer and Communications Equipment: +11.3% ³
• Rail, Ships, and Aerospace Equipment: +10.3% ³

China’s physical dominance in these areas is now uncontestable. In the first nine months of 2025, China installed 595,000 industrial robotic arms.⁴⁹ Astoundingly, China now operates more industrial robots than the rest of the world combined and accounted for over half of all new global robot installations in 2024.⁴⁹

C. The Next Frontier: ‘AI plus Manufacturing’

Beijing is doubling down on this strategy. In November 2025, the Ministry of Industry and Information Technology (MIIT) announced a new “AI plus Manufacturing” plan.⁵⁰ The goal is to deeply integrate AI into China’s industrial economy ⁵⁰, with a focus on the intelligent transformation of key industries and critical production processes.⁵⁰ Shanghai’s (2025-2027) plan serves as a model, seeking to integrate AI into 3,000 local manufacturing enterprises.⁵¹ China already boasts over 5,000 AI companies ⁵⁰ supporting this push.

D. The Paradox of Deflationary Overcapacity

This boom in industrial output coexists with the “weak domestic demand” and GDP deflation discussed earlier.¹ Business survey reports show firms are grappling with “weak domestic orders.”¹ This means the new, state-funded production capacity is creating goods that domestic consumers and businesses cannot or will not buy.

To avoid bankruptcy and keep factories running, these firms must sell abroad. This has been dubbed the “Second China Shock.”⁵² The “New Productive Forces” growth model is not just a development strategy; it is a model that requires exporting overcapacity and deflation to the rest of the world.⁵³ This makes trade conflict structural and inevitable.

China’s Global Position: Trade Surpluses and Rising Friction

China’s domestic economic strategy has direct and destabilizing repercussions for global markets. The trade surplus has become the essential escape valve for weak internal demand, exacerbating geopolitical tensions.

A. The Trade Surplus as an Economic Escape Valve

China’s trade surplus has reached record levels. In September 2025, China posted a $90.45 billion surplus.⁵ The total year-to-date (YTD) surplus through September reached $875.1 billion.⁵

The cause of this massive surplus is a trade divergence that perfectly mirrors the country’s two-speed economy:

• Exports (Supply-Driven): In the first nine months of 2025, exports grew 6.1% year-over-year.⁵ This growth is driven by high-tech manufacturing ¹ and electrical products.⁵⁴
• Imports (Demand-Reflecting): In the same period, imports fell 1.1% year-over-year.⁵

This gap ⁵³ is the clearest proof of China’s imbalance. Weak imports are a proxy for collapsed domestic demand (property, consumption).⁵⁵ Strong exports are the direct result of the “New Productive Forces” overproduction.³ China is using the rest of the world as its consumer of last resort and, in the process, is exporting its deflationary pressures.⁵³

B. Reshuffling Trade Partners: The Rise of ASEAN

In response to trade tensions with the West, China has successfully reoriented its trade flows. The Association of Southeast Asian Nations (ASEAN) has solidified its position as China’s largest trading partner ⁵⁴, a title it has held since 2020.⁵⁶ In August 2025, for example, exports to ASEAN topped $57 billion, eclipsing exports to the U.S., which fell to $31.6 billion.⁵⁸ The signing of the China-ASEAN FTA 3.0 Upgrade Protocol in October 2025 further deepens this relationship.⁵⁶

However, this relationship is not without friction. The practice of “origin washing” (transshipping Chinese products through ASEAN countries to evade U.S. tariffs) is a growing concern.⁵⁹ Furthermore, the influx of low-cost Chinese goods, fueled by industrial overcapacity, has forced thousands of local factories in countries like Thailand and Indonesia to close.⁵⁹

C. The Western Backlash: Tariffs and ‘De-risking’

Western economies are responding aggressively to China’s industrial policy. Viewing the flood of green-tech exports not as fair competition but as an “extinction-level event” ⁶⁰ driven by state subsidies ⁶¹, they have erected trade barriers:

• United States: Has imposed a prohibitive 100% tariff on Chinese EVs.¹² The average tariff on all Chinese goods stood at 57.6% in September 2025.¹¹
• European Union: Has imposed provisional tariffs on Chinese EVs ranging from 27.4% to 48.1%.¹²

These tariffs are not standard protectionism; they are a direct defensive response to China’s “New Productive Forces” strategy. This creates a fundamental dilemma: China’s new economic model requires a massive trade surplus to succeed, but that very surplus is provoking a protectionist backlash that threatens to close off its most lucrative export markets.⁶²

D. The November 2025 (Trump-Xi) Trade Truce: A Tactical Pause

Amid escalating tensions, including China’s threat to “choke” supply chains with rare earth export controls ⁵², a temporary “truce” was reached at the late October/early November 2025 summit.⁵²

• U.S. Actions: Agreed to reduce “fentanyl-related” tariffs by 10 percentage points and suspend Section 301 actions on shipbuilding for one year.⁶⁴
• China’s Actions: Agreed to suspend its October 9 rare earth export controls ⁶⁴, suspend retaliatory tariffs, and resume purchases of U.S. soybeans.⁶⁵

This agreement is not a “Phase Two” resolution.⁶⁹ It is a tactical de-escalation to pull both sides back from the brink. The structural issues—the core Section 301 tariffs, the 100% EV tariffs ¹², and the semiconductor tech war ⁵²—remain unresolved. It is a fragile truce, not a reset.⁶⁹

Unpacking China’s ‘Debt Bomb’: LGFVs and Systemic Risk

China’s weak domestic demand and the forced nature of its industrial pivot are intrinsically linked to its debt crisis, particularly the “hidden debt” of its local governments.

A. The Scale of the Debt Problem

China’s total non-financial debt exceeds 300% of GDP.¹⁴ The real concern, however, resides in public debt. IMF data from October 2025 places China’s general government debt at 96.3% of GDP.⁷⁰ But this official figure is misleading. The IMF itself uses an “augmented” definition that includes “off-balance-sheet local obligations,” estimating the real figure at 124% of GDP.¹⁴

That nearly 30-point-of-GDP discrepancy is the crisis. It represents the “hidden debt” accrued by thousands of Local Government Financing Vehicles (LGFVs).

B. The Heart of the Problem: LGFV Hidden Debt

LGFVs are the “central source of stress.”¹⁴ They are off-balance-sheet entities created by local governments (whose tax revenue streams were centralized in 1994 ⁷²) to finance infrastructure construction. They did this by borrowing massively from banks and bond markets, using rising land sale revenues as collateral.⁷²

The property sector collapse (Section III) shattered this business model. The “sharp fall in land sale revenues since 2022” ¹⁴ cut off the LGFVs’ primary income stream, leaving them with no cash flow to service their debts. Now, they rely on “bank forbearance” (i.e., rolling over bad loans) to survive.¹⁴ This has created a “balance sheet recession” ¹⁴, where local governments are fiscally paralyzed, unable to provide social services or stimulate consumption.⁷³ The LGFV debt is the transmission belt connecting the property collapse to weak consumption.

C. Beijing’s Response: ‘Extend and Pretend’

Beijing’s response has not been a bailout, but a forced restructuring that analysts have labeled “extend and pretend.”⁷³ This strategy involves:

1. “Swapping” opaque, off-balance-sheet LGFV debt for on-balance-sheet provincial refinancing bonds, which have longer maturities and lower interest rates.¹⁴
2. Mobilizing state banks to provide 1 trillion yuan in loans to help LGFVs clear overdue payments to private firms.⁷⁴
3. Lengthening maturities and allowing “rollovers.”¹⁴

This strategy has stabilized short-term funding markets, but it does not solve the underlying solvency problem. It merely shifts “hidden” debt onto the “visible” sovereign balance sheet ¹⁴, kicking the can down the road.¹⁴

D. Systemic Risk and IMF Warnings

This “extend and pretend” tactic creates systemic risk for the banking sector. The IMF, in its 2025 Financial System Stability Assessment (FSSA), warned that “accommodative monetary policy is weakening banks’ organic profitability” and that “smaller banks… are more vulnerable.”⁴¹

The People’s Bank of China (PBOC) is trapped. It needs to keep interest rates low to allow LGFVs and property developers to refinance their debt without collapsing. But these low rates compress the banks’ net interest margins (NIMs), evaporating their profits. Small banks, which are most exposed to failing LGFVs and developers, are at risk of insolvency.⁴¹ The IMF concluded the “current crisis management framework does not adequately support” a “systemic distress.”⁴¹ This banking trap explains the timidity of Beijing’s monetary policy.³⁶

Capital Flows and the Foreign Direct Investment (FDI) Paradox

Global investor confidence in China has eroded significantly, a fact obscured by a paradox in foreign investment data.

A. The Official Narrative vs. Balance of Payments Reality

The Chinese government promotes a narrative of success, citing “hard-won gains.”⁷⁵ The Ministry of Commerce (MOFCOM) reports that “utilized” FDI (a measure of gross inflows) reached $708.73 billion since 2021, meeting the 14th Five-Year Plan target six months early.⁷⁵ They also highlight investment growth in high-tech sectors.⁷⁵

However, the balance of payments (BoP) data, which measures net flows (inflows minus outflows), paints a completely different picture. Net FDI inflows have collapsed:

• 2021 (Peak): +$344 billion
• 2023: +$42.7 billion (the lowest level in two decades)
• H1 2024: -$4.6 billion (Negative for the first time) ¹⁵

These two datasets are not contradictory; they measure different things. “Utilized” (gross) FDI ⁷⁵ measures new investments. Net (BoP) FDI ¹⁵ measures new investments minus outflows, which include the repatriation of earnings by existing foreign firms.¹⁵

The only way net inflows can be negative while gross inflows are positive is if existing foreign companies are pulling their profits out of China at a faster rate than new capital is coming in. This is not “de-risking”; it is capital flight. It is the strongest possible signal of a loss of confidence from multinationals.¹⁵

Table 3: Divergence in Foreign Investment Flows (2021-2024)

Period	“Utilized” FDI (Gross, Acc. from 2021)	Net FDI (Balance of Payments, Period Flow)	Source(s)
2021	N/A	+$344 Billion	15
2023	N/A	+$42.7 Billion	15
H1 2024	N/A	-$4.6 Billion	15
To Jun 2025	+$708.7 Billion (5-Year Plan Target)	N/A	75

B. The Investment Climate: ‘Anxiety’ and ‘Restrictions’

This capital flight is driven by a rapidly deteriorating investment climate. Total foreign investment in China fell 27.1% in 2024, the sharpest drop since 2008.⁷⁶ The U.S. State Department, in its 2025 report, labels China “one of the world’s most closed major economies.”⁷⁶ Foreign firms report “growing anxiety” due to the “sluggish” economy, a “restrictive business environment,” and “the Chinese government’s increasingly aggressive use of legal and regulatory tools” against foreign firms.⁷⁶

C. The Impact of ‘De-risking’ on Supply Chains

In response to these geopolitical and economic risks, global firms are actively implementing “de-risking” strategies.⁷⁷ The two dominant strategies are:

1. “China + 1”: Maintaining production in China but diversifying a portion of new investment to other countries like Vietnam, Mexico, or Poland.⁷⁸
2. “In China for China”: Retaining or expanding a local supply base in China for the sole purpose of selling to the Chinese domestic market, while creating a separate, parallel ex-China supply chain for the rest of the world.⁷⁸

This represents a costly and inefficient fragmentation of global supply chains.⁷⁷

Beijing’s Policy Response: Betting on Supply, Not Demand

Beijing’s policy response to this complex crisis has been intentional and asymmetric. It has rejected demand-side stimulus (like direct payments to consumers) and has instead doubled down on supply-side stimulus, exacerbating the imbalances.

A. Monetary Policy: 10-Point Package and Managed Rates

The PBOC has adopted an “appropriately accommodative” stance.⁸⁰ Key actions in 2025 included:

• 10-Point Package (May 2025): A comprehensive package to inject liquidity and confidence.¹⁶
• RRR (Reserve Requirement Ratio) Cut: A 0.5 percentage point cut in May, releasing 1 trillion RMB ($138 billion) in long-term liquidity.¹⁶
• Policy Rate Cuts: A 0.1 percentage point cut to the 7-day reverse repo rate (to 1.4%) and a 0.25 percentage point cut to “structural tools” (e.g., refinancing for SMEs and agriculture).¹⁶

However, these actions are not broad-based stimulus. Most measures are “structural tools” designed to surgically steer liquidity to the “New Productive Forces” sectors (tech innovation, SMEs, service consumption).¹⁶ Meanwhile, the PBOC held the Loan Prime Rates (LPRs) steady in September (1-year at 3.00%, 5-year at 3.50%) ⁸², showing reluctance to flood the property sector with credit. This is “supply-side monetary policy” designed to fund the investment strategy in Section IV.

B. Fiscal Policy: The Central Government Takes Control

Fiscal policy tells the same story. With local governments fiscally paralyzed (Section VI), the central government has taken control of the investment lever. The 2025 budget includes a significant fiscal expansion, funded by the issuance of ultra-long special treasury bonds (reports suggest 1-3 trillion RMB).¹⁷

Crucially, these funds are earmarked for “major national strategies,” “security capacity in key areas,” “technological innovation,” and “fostering new productive forces.”¹⁷ The central government is bypassing the broken LGFVs and directly funding its industrial priorities.

C. The Critical Policy Imbalance

Both monetary and fiscal policy are overwhelmingly aimed at funding supply (investment, manufacturing, high-tech). There are almost no significant policies ³¹ aimed at boosting demand (consumption, household support). This is Xi Jinping’s fundamental gamble: that massive investment in high-tech production ⁶ will create high-quality jobs, which will eventually drive consumption.

But in the interim, this strategy worsens the economy’s central imbalance: massive overproduction ⁸⁴ and weak domestic demand.¹⁸ This policy choice is the root cause of China’s domestic deflation and its external trade conflicts.

2026 Outlook and Strategic Conclusions

China’s old growth model (property + LGFV-funded infrastructure) is irrevocably broken. The new model (high-tech manufacturing + exports, funded by the central government) is in place. This reconfiguration defines the outlook for 2026.

A. 2026 Forecasts: A Consensus on Deceleration

There is a consensus that China’s economy will continue to slow, though disagreement exists on the severity:

• Multilateral Institutions: The IMF forecasts 4.2% growth for 2026.⁸⁵ The World Bank projects 4.2% ⁸⁶ or 4.0% ⁸⁸, assuming a “gradual stabilization of the property sector” ⁸⁹ that our analysis questions.
• Investment Banks: Investment banks are more pessimistic. UBS forecasts a much sharper deceleration to 3.0% for 2026.⁹⁰ Crucially, their forecast aligns with this report’s deflationary narrative, projecting the CPI to be negative in 2026 at -0.2%.⁹⁰ Morgan Stanley also sees an “underperformance” from China and expects the economy to battle deflation.⁸⁴

The risks are tilted toward the more pessimistic scenarios, given the profound weakness in demand and the inability of policy to address it.

B. Long-Term Structural Risks: Demographics and Productivity

China’s long-term growth potential is being undermined by two inexorable forces:

1. Demographics: The “demographic dividend” has become a “demographic drag.”⁹² The working-age population peaked in 2013 ⁹² and is now in rapid decline, while the population ages.⁹³
2. Productivity: Productivity growth, the only other source of growth, is slowing.⁸⁹

The “New Productive Forces” strategy (Section IV), with its manic focus on robotics ⁴⁹ and AI ⁵⁰, must be understood in this context. It is not just an industrial policy; it is a desperate attempt to use technology to generate productivity gains and offset the demographic collapse. The 15th Five-Year Plan (2026-2030) ⁹⁴ is an all-or-nothing bet that AI and robots can boost productivity fast enough to pay for an aging population’s pensions and manage the mountain of debt inherited from the property boom.

C. Strategic Conclusion: China’s Unstable New Model

China’s economy at the end of 2025 is not collapsing. It is reconfiguring into a technologically advanced, but structurally unbalanced, industrial power. The new growth model is in place, but its costs are immense. Internally, it generates deflationary pressures, ignores the consumer, and fails to resolve the debt crisis. Externally, it relies on unsustainable trade surpluses that provoke direct trade conflicts and supply chain fragmentation.

China’s economy shows immense strength in supply and dangerous fragility in demand. This paradox will define its trajectory and its contentious relationship with the global economy for years to come.