Rebalancing China’s economy

CHINA’S economy grew by 5.3% year-on-year (y-o-y) in the first half (1H) of 2025, above the government’s annual target.

The stronger-than-expected performance was underpinned by three key drivers: robust external demand, continued upgrade in high-tech industries, and policy support from the consumer trade-in programme.

Net exports contributed 31.2% to gross domestic product (GDP) growth in the first half, surpassing the 30.3% contribution in 2024. Excluding the external demand, China’s economy would only grow by sub-4%.

Given the rising uncertainty surrounding external demand in the second half of the year, the focus is shifting back to China’s domestic consumption.

Domestic consumption is not only essential for sustaining China’s economic recovery, but it has also become a critical lever in the country’s international positioning.

In recent trade negotiations between the United States and China, Treasury Secretary Scott Bessent repeatedly emphasised that China has an opportunity to stabilise its economy by rebalancing away from excessive export-oriented manufacturing towards stronger domestic demand.

Such rebalancing is not only in line with external expectations but is also in China’s own long-term interest. The question, however, is no longer whether China needs to rebalance, but how to do so effectively.

China’s efforts to reflate its economy hit the bottleneck.

The consumer price index for 1H25 remained in slight deflation at minus 0.1% y-o-y, with core inflation staying below 0.5%, underscoring the persistent challenges along China’s reflation path.

The prolonged downturn in the property sector – now entering its fourth year – continues to erode household wealth and dampen consumer confidence.

As a result, China’s GDP deflator has been in negative territory for nine consecutive quarters.

The weak nominal growth despite above target real growth may weigh down corporate profitability as well as income growth.

The performance of durable goods sectors of industrial profit – particularly automobiles and furniture – acted as a drag.

Despite robust car sales in volume terms, the ongoing price war significantly eroded profit margins.

The persistent disinflationary trend was partially due to involution. The involution also led to the lengthening of the accounts receivable cycle.

The average collection period has now extended beyond 70 days, reflecting growing payment delays and rising financial strain within the corporate sector.

A necessary precondition for boosting domestic consumption is reflating the economy.

Beyond conventional monetary easing and fiscal stimulus, China is likely to explore two additional strategies in the second half to reflate its economy and unlock household spending potential.

First, China has stepped up its anti-involution campaign. On June 29, the People’s Daily published an article titled Achieving High-Quality Development by Breaking “Involution-Type” Competition, which emphasised that “multiple measures by government departments and coordinated efforts from relevant parties” will be key to advancing anti-involution governance.

This marks a notable departure from the supply-side reforms in 2015-16, which were predominantly government-led.

The current anti-involution campaign is positioned as a joint effort between the government and market participants.

Industries currently targeted under this governance framework fall into two broad categories.

First are traditional sectors such as cement, steel, aluminum, petroleum, chemicals and coal-fired power. Second are fast-growing emerging industries, including photovoltaics, lithium batteries, new energy storage, new energy vehicles and eCommerce platforms.

Based on recent policies and regulatory meetings, the approach varies by industry structure. In sectors with a high concentration of state-owned enterprises – such as steel, coal, aluminum and coal-fired power – administrative tools like production curbs and capacity reduction remain the primary instruments.

In contrast, industries dominated by private enterprises, such as photovoltaics, new energy vehicles, energy storage and cement are more reliant on industry association-led self-regulation and market-based discipline.

As such, the rollout of anti-involution measures is expected to be more gradual compared to previous supply-side reforms.

The short-term impact may be more catalytic in shaping sentiment than in delivering immediate fundamental improvements.

Second, the key to restoring price momentum lies in expanding effective demand, which depends on three parameters: income growth, income expectations and the wealth effect.

With income growth still lagging, the wealth effect, particularly from a sustained equity market recovery, could play a critical role.

The recent announcement of China’s 1.2 trillion yuan investment in the world’s largest hydropower dam in Tibet has sparked a rally in the domestic stock market.

Going forward, China may continue to inject optimism through the promotion of technological breakthroughs and the rollout of mega projects, bolstering sentiment and supporting household risk appetite.

In conclusion, China’s domestic consumption challenge is no longer purely an internal matter. It now carries diplomatic weight, particularly amid global concerns over China’s export of deflation.

A stronger push to reflate the economy, through structural reforms and market-driven confidence building, is essential.

In this context, the anti-involution campaign and a sustained equity bull market could serve as critical pathways for China to exit deflation in 2H25.

A successful rebalancing would not only stabilise China’s economy, but also bring positive spillovers to the broader Asian region.