China’s K-shaped growth

CHINA’s economic growth reaccelerated to 5% year-on-year (y-o-y) in the first quarter of financial year 2026 (1Q26) from 4.5% in 4Q25, coming in above market expectations.

Despite the energy shock in March due to the Middle East conflict, the economy delivered a solid start to the year, supported primarily by the earlier transmission of macro policy support, which helped offset still-fragile domestic consumption.

However, China’s growth data slowed again across the board in April. China’s April data told similar K-shaped story with four factors worth highlighting.

First, real estate remained a key drag. Real estate development investment fell 13.7% y-o-y in January to April period, with the decline widening from 11.2% in 1Q26.

This suggests that the property sector remains in a deep adjustment phase, as developers are still constrained by weak investment appetite and limited funding capacity.

The weakness also continues to spill over into the broader supply chain.

Cement output declined 10.8% y-o-y in April, underscoring sluggish construction activity and the persistent drag from the property downturn on upstream materials and heavy industry.

China’s households remained reluctant to add leverage.

Household loans fell by 340.8 billion yuan in April, with medium- to long-term household loans declining 225 billion more than a year earlier, suggesting that property demand remains weak.

Second, autos were another major drag.

Nationwide passenger vehicle retail sales fell by more than 20% y-o-y to around 1.42 million units in April, while automobile output declined 2.6% y-o-y.

The sector faced multiple headwinds, including the restoration of the new energy vehicle purchase tax from 0% to 5%, a high base from last year’s trade-in subsidy programme, and increasingly cautious household sentiment.

Longer decision cycles for big-ticket purchases also weighed on auto demand.

The recovery in consumption remains uneven and uncertain.

Income growth has softened, with nominal disposable income rising 4.9% y-o-y (versus 5% in 2025) and real income growth slowing more notably to 4% (from 5%).

Third, slower fiscal support in 2Q26 likely added pressure on fixed asset investment.

The strong investment performance in 1Q26 was supported by three temporary factors: the early deployment of fiscal carryover funds from the second half of last year, the lingering impact of the 500 billion yuan in new policy-based financial instruments launched in 4Q25, and front-loaded fiscal support this year.

As these effects faded in early 2Q26 and amid a higher base, April to May became a relatively tight funding window for investment.

This was reflected in survey data, with the construction purchasing managers’ index falling to 48% in April and construction new orders index dropping to 41.6%, both near the lower end of their ranges for the same period over the past five years.

Fourth, elevated raw material costs, partly linked to the Iran war, continued to squeeze margins for mid- and downstream manufacturers.

This margin compression likely weakened corporate willingness to expand production, especially in sectors with limited pricing power.

That said, high-tech manufacturing remained the key bright spot.

Integrated circuit output surged 22.1% y-o-y in April, broadly consistent with the resilience in technology-related exports.

Artificial intelligence- or AI-related manufacturing, semiconductor production, and technology exports continued to provide an important growth cushion for the broader industrial sector.

Resilient demand for AI-related products remained an important structural tailwind for China’s exports.

Imports also beat expectations, mainly supported by strong demand for integrated circuits.

Integrated circuit imports surged 54.7% y-o-y in April, with the monthly import value reaching a record high, underscoring the strength of the AI supply chain.

Meanwhile, higher crude oil prices linked to the Iran war lifted the import bill.

Although crude oil import volume fell 20% y-o-y, import value still rose 13.2% y-o-y.

Looking ahead, the AI supply chain should remain a key source of resilience, further supporting exports of mechanical and electrical products.

Elevated oil prices may also strengthen China’s relative competitiveness in energy-intensive goods.

Compared with more energy-import-dependent economies, China benefits from a more complete and stable supply chain, as well as relative energy cost advantages.

This could allow China to capture additional export substitution demand. In addition, the Iran war is increasingly emerging as a double-edged sword for China’s economy.

On the one hand, supply-side disruptions are becoming visible.

On the other hand, substitution effects are beginning to kick in.

Coal-chemical production is gaining cost competitiveness, while structurally higher oil prices are accelerating the energy transition – supporting new energy vehicle penetration, renewables, and energy storage deployment.

Simultaneously, relative resilience in China’s production capacity – compared to more directly affected Asian economies – raises the likelihood of incremental order reallocation back to China, providing a partial external buffer.

As for 2Q26, growth momentum may moderate at the margin.

Infrastructure investment could soften as the initial wave of front-loaded fiscal support fades and bond issuance normalises.

In addition, local government debt constraints and weak land sale revenues continue to cap investment appetite.

As such, whether infrastructure can remain a reliable growth stabiliser will increasingly depend on stronger central government support.

Against this backdrop, we expect growth to ease to around 4.7% in 2Q26.

Nevertheless, the economy remains broadly on track to achieve the official 4.5% to 5% target for the year, and we maintain our full-year growth forecast at 4.7%.