China a winner in Mideast War

THE war in the Middle East is increasingly emerging as a double-edged sword for China’s economy. Even while supply side disruptions hit, the efforts to overcome the effects of the war are beginning to kick in.

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

Despite the energy shock in March, 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.

As expected, supply side disruptions are becoming visible.

In upstream sectors, capacity utilisation at major refineries fell sharply from 82.8% to 72%, while utilisation at teapot refiners declined from 61.3% to 55.9%.

The drop was well beyond normal spring maintenance seasonality, which typically reduces utilisation by only two to four percentage points.

In our view, the decline in refinery runs in March was partly a lagging reflection of slower feedstock procurement ahead of the conflict, and partly a leading signal of more severe supply constraints still to come.

State-owned refineries are traditionally more reliant on crude from Saudi Arabia, Kuwait, the United Arab Emirates and Iraq under term contracts routed through the Strait of Hormuz, which likely explains why utilisation at the majors fell more sharply than at teapot refiners.

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.

In the near term, the Middle East conflict could once again provide an incremental tailwind for China’s exports.

First, China may further expand exports of new energy technologies and products to Asean and Global South countries.

Second, it may capture a greater share of energy-sensitive industrial value chain relocation from Japan and South Korea.

As rising input costs put pressure on petrochemical production in these economies, Chinese firms are likely to accelerate import substitution.

In the medium term, China may benefit from the re-rating of its manufacturing sector, driven by the market’s reassessment of its comprehensive and reliable supply capabilities.

From the pandemic to the Ukraine war, investors have already successively re-evaluated China’s delivery reliability and cost competitiveness.

In the current Middle East conflict, what the market is beginning to recognise more clearly is China’s broader industrial resilience – spanning energy security, substitution capacity, supply chain completeness, and alignment with end-demand.

Rising geopolitical uncertainty appears to be providing an additional tailwind for renminbi internationalisation, with global renminbi demand continuing to increase.

Data from China’s Cross-Border Interbank Payment System (CIPS) show that total cross-border renminbi transaction volume exceeded 50 trillion yuan in 1Q26, up 14.96% y-o-y.

Notably, the daily average transaction volume reached 920.5 billion yuan in March after the outbreak of the Iran war, significantly higher than the 2025 average of 664.5 billion yuan.

The continued expansion of CIPS-enabled trade settlement suggests that de-dollarisation demand remains an important structural driver behind the broader use of the renminbi in cross-border transactions.

Geopolitically, China may emerge as the long-term structural winner.

On April 11, Saudi Arabia’s Defence Ministry confirmed that Pakistan had deployed roughly 13,000 troops – equipped with Chinese-origin platforms including fighter jets – to the King Abdulaziz Air Base in the Eastern Province under the Strategic Defence Mutual Agreement signed in September 2025.

According to Pakistani media reports on April 13, Islamabad and Beijing are finalising a landmark US$12bil defence package, including 40 J-35A fifth-generation stealth fighters, six KJ-500 AWACS aircraft, and multiple HQ-19 strategic missile defence systems.

The headline value exceeds Pakistan’s annual defence budget of about US$9bil, fuelling speculation that Saudi Arabia could ultimately be the financial backstop.

If validated, this would represent a rare “triple-win” strategic configuration.

Saudi Arabia effectively trades capital for security optionality; Pakistan exchanges deployable military capacity for next-generation hardware; and China monetises its defence ecosystem while expanding geopolitical influence and securing hard-currency revenues.

Pakistan becomes the de facto “launch customer” for China’s stealth fighter export ambitions.

It also constitutes a “proxy insertion” of Chinese airpower into the Arabian Peninsula – without direct Chinese deployment. In addition, this model provides China with a scalable pathway to establish a strategic footprint in the Gulf without the political and military costs associated with formal overseas basing – consistent with Beijing’s historically cautious approach toward foreign military presence.

To sum up, similar to other Asian economies, China remains exposed to disruptions via its reliance on the Strait of Hormuz and imported oil and gas, implying that a prolonged conflict would weigh on growth.

That said, the impact is likely to be mitigated by China’s relatively resilient energy system and the ongoing re-rating of its manufacturing sector, which positions it to capture incremental order reallocation as global supply chains adjust.

At the same time, the continued push toward de-dollarisation could provide another medium-term tailwind for renminbi internationalisation.

On the geopolitical front, evolving dynamics in the Middle East may create scope for China to expand its strategic footprint – particularly in airpower projection – without incurring the political and military costs typically associated with establishing formal overseas bases.