The Chinese economy: Important green shoots emerging, but challenges & risks abound

Over the last 30 years, the Chinese economy has experienced phenomenal growth, becoming the world’s manufacturing powerhouse, and lifting itself into the position of the world’s second largest economy. However, more recently, it has started to stutter, and Chinese authorities are struggling to make the necessary structural changes to keep it on a sustainable growth track.

Most prominent structural headwinds

During the great financial crisis of 2008 and 2009, China introduced a massive stimulus package to support its economy. At the time, it relied heavily on debt to boost fixed asset investment spending, particularly in infrastructure and in the real estate sector. This inflated the debt of local governments – through which the infrastructure spend is typically channeled in China – and created overcapacity in the steel and property sectors.

At the same time, in 2010, China’s demographic landscape also started to change. Its “demographic dividend” which has been one of its primary sources of inexpensive labour and rapid economic growth, via cheap manufacturing which boosted exports to the rest of the world, slowly disappeared as the Chinese working-age population peaked, see Figure 1.

Figure 1

As a result of China’s chronic over-investment in infrastructure and in the property sector, its economic structure never transitioned in line with other emerging economies where consumption expenditure’s contribution to economic growth typically grows over time at the expense of the primary sector, like agriculture for example. Instead, to this day, the Chinese economy remains over-reliant on infrastructure and other capital investment spending, while household consumption remains a sub-optimal sector in terms of its contribution to overall economic activity and growth, see Table 1.

According to policy makers in Beijing, however, this is about to change. But will it?

Key cyclical economic challenges

Roughly 60% of Chinese household assets are directly linked to the property market. Five years of property market slump and equity market weakness have hit household wealth and confidence and have suppressed consumer spending, see Figure 2. With demand under pressure, while authorities kept almost exclusively stimulating the supply side of the economy, persistently low inflation, and ultimately deflation (falling prices) were natural consequences of this policy orientation, see Figure 3.

Figure 2

Figure 3

Exports and fixed asset investment spending have carried the economy in recent years, but the Trump Administration’s aggressive trade policy brings major trade uncertainty into 2025 and beyond, see Figure 4.

Figure 4

For China, trade with the United States (US) is as important as trade with Europe, or with its Asian neighbours, see Figure 5. Although China’s exports to the US only constitute 3% of the size of its own economy, major disruptions to trade flows could have significant consequences for Chinese growth during this structural and cyclical slowdown phase. In early April, President Trump announced a further 34% tariff on all Chinese imports into the US, before hiking it numerous times to an effective total of 145% at the time of writing. Initial analysis suggests that these tariff increases could supress Chinese economic growth by 1% to 2% in the next year.

Figure 5

As trade headwinds grow, China realises it needs to do more to boost domestic consumption to ensure its economy becomes less reliant on exports. This, however, is a very slow process. As such, Beijing seems to be getting more forceful and direct in its approach to this matter.

Policy action taken thus far

In September 2024, China announced its “Three Arrow” economic stimulus approach which focused on monetary policy, property market stimulus and explicit equity market support.

In terms of monetary policy, short term interest rates were reduced, reserve ratio requirements of mid-size and large banks were cut, and Beijing initiated a further capital injection into the top six state-owned banks to provide more liquidity for lending. In our view, this was a positive deviation from the Chinese central bank’s typical cautious approach.
Property sector stimulus at the time included a nationwide cut in the downpayment/deposit for the purchasing of second homes from 25% to 15%. Policy makers also announced a program for property destocking whereby Chinese local governments and local state-owned entities (SOEs) could identify unsold property projects which they wanted to buy as part of the destocking program to convert into social housing. Central government would support this initiative via increased lending.
As part of this round of stimulus, explicit equity market support included a new C¥500 billion swap facility for qualified insurance companies, asset management firms, and securities companies to buy stocks, while a C¥300 billion relending facility was also made available for listed companies to do share buybacks.

At the time we were of the view that the September 2024 announced stimulus measures were perhaps sufficient for China to reach its growth target for 2024, but it was not the “bazooka” stimulus that the world was hoping it would be.

In Peregrine Wealth Investment Management, we were of the opinion that aggressive stimulus would probably likely only be triggered if and when there is:

• Widespread labour market pressure, with the urban unemployment rate rising north of 6% or 7% versus a government target of 5.5%.
• A major credit event that threatens internal financial stability.
• A big external shock, like a huge tariff hike on all imported goods from China to the US, for example.

The “Three Arrow” stimulus measures were desperately needed to stabilise China’s economic growth, but we felt at the time that China’s central government needed to do more. The central government, we believe, is in a financially sound position, which can allow it to issue central government bonds to accelerate the housing destocking, and to support household income, and consumption.

In December 2024, during the Politburo meeting as well as during the Central Economic Work Conference later that month, policy makers announced their commitment to strengthen “extraordinary counter-cyclical adjustments” to stimulate growth and undertook to implement more proactive fiscal policies and to apply moderately loose monetary policy as opposed to the People’s Bank of China’s standard “prudent” monetary policy approach. Importantly, during December 2024 the boosting of domestic demand was moved up to the top of China’s priority task list.

While it is still early days, the positive impact on the economy of the December 2024 stimulus has been limited thus far.

In March this year, China announced its “Special Action Plan for Boosting Consumption” which included the following eight-point action plan:

1. Actions to promote the increase of income of urban and rural residents.
2. Supporting actions to ensure consumption capacity including consideration of a childcare subsidy and financial aid, raising student subsidies, and fully implementing the personal pension system.
3. Actions to improve the quality of services consumption including promoting ice and snow tourism, expanding the scope of unilateral visa-free countries, actively developing anti-aging tourism and a focus on the potential of the silver consumer market, like economic activities, products and services tailored to the needs and preferences of the country’s growing aging population, typically for those aged 60 and older.
4. Bulk consumption support, which refers to an expansion of the existing consumer trade-in and subsidy program.
5. Improvement of the quality of services and the creation of more Chinese services company brands, which includes the promotion of digital consumption, high-quality e-commerce and new products such as smart wearables, brain-computer interfaces, and autonomous driving vehicles, to list a few.
6. Promote the notion of safe consumption which encompasses the implementation of an annual paid leave system for employees and the commitment from policy makers that the working hours of workers shall not be extended in violation of the law.
7. The reduction of consumption restrictions including to clean-up and rectify market access barriers and the creation of a stable, fair, transparent and predictable market environment.
8. Improve the coordination and implementation of economic support policies, including fiscal, tax, industrial, investment and other policies, for example.

In our view, none of the announced policy support measures since the third quarter of 2024 on their own are sufficient to meaningfully lift economic growth in China. However, the cumulative effect has started to produce some welcome green shoots in various parts of the economy in early 2025.

The general lack of business and consumer confidence seems to have ebbed, consumers appear to have a bit more capacity and a greater willingness to consume and to invest, and there were early signs of a turnaround in China’s real estate climate indicator in the first quarter of 2025. We are also witnessing at least a stabilisation of the housing market and in some cases, even an improvement of property-related activities off very depressed levels. Forward-looking indicators like the money, credit and fiscal impulses are still depressed but there are tentative signs that economic momentum may be turning a bit more positive.

Market reaction to the stimulus

Chinese government bond yields, which usually have a stronger reaction when bond investors get a sniff of the possibility of stronger growth and higher inflation, remain rock-bottom, suggesting that bond investors remain concerned about growth and deflation and that they are skeptical about the likelihood that the fresh stimulus will lift growth meaningfully.

In contrast, Chinese equities experienced a strong rebound in the second half of 2024 and into early 2025 on the back of the fresh round of economic stimulus announced in September last year, and following the announcement of DeepSeek artificial intelligence (AI) model’s breakthrough which provided a solid catalyst for a rally in Chinese technology shares. China has also been benefiting recently from a recovery in emerging market equities which have been supported by the weaker US dollar.

2 April 2025

But…

All of this changed on 2 April 2025, the US’s so called “Liberation Day”, which marked the day the Trump administration announced its tariff structures on the rest of the world. The announcement sent shockwaves through markets across the globe. An initial additional 34% tariff on all Chinese imports into the US were announced, which effectively brought total tariffs on Chinese imports to more than 60% at that stage.

China almost immediately retaliated with an announcement of a 34% tariff on all US imports while also placing export curbs on key rare earth minerals and adding more US companies to the Chinese “unreliable entities” list. President Trump then retaliated with 64% tariffs and increased that, two days later, to 125%. At the time of writing, the US’ import tariff on most Chinese goods has sky-rocketed to 145%.

Chinese equity markets fell in tandem with global markets during the sell-off and are still significantly lower than their recent highs despite the strong market rally in early April on the back of the Trump administration’s announcement of a 90-day pause on all reciprocal tariffs except on China, see Figure 6 and Figure 7.

Figure 6

Figure 7

What may lie ahead for the Chinese economy?

The US-China trade war opens the door for bilateral trade negotiations with the US. If these are successful then the April tariff announcements could be viewed as the probable ceiling to tariffs, from where tariff rates could possibly decline. However, at the time of writing, the two nations have not yet embarked on any formal trade negotiations.

For the next 12 to 18 months the outlook for the Chinese economy depends heavily on a balance between President Trump’s tariffs and further Chinese stimulus. As things stand now, we are of the opinion that China would probably struggle to achieve its ambitious 5% real economic growth target for 2025 unless further targeted stimulus is announced soon.

At this stage, given the current policy stance, we are anticipating a further cyclical slowdown within the greater structural slowdown for the Chinese economy. As context, the International Monetary Fund, in November last year, released a paper which noted that without reforms, meaning no restructuring away from investment towards consumption and without a productivity boost for example, China’s growth rate would decline towards less than 4% per annum over the next five years. If, however, its reforms, like SOE reforms to increase productivity, rebalancing the economy towards consumption, and labour market reform are successful, then China could achieve growth of around 4.5% by 2030.

A lot is at stake, and we believe China needs to tread carefully in its relationship with the US.

How is our global emerging market equity fund positioned regarding China?

Despite its reduced weight in the MSCI Emerging Market (equity) Index from 36% four years ago to the current 28% weight, China remains a core component of the emerging market equity universe, and a big driver of index returns over time.

On the back of the stimulus and tech-induced sharp recovery in Chinese equity since the third quarter of 2024, its expected return outlook has deteriorated to a point where our internal proprietary valuation work suggests an overweight to China versus benchmark within the emerging market equity universe is no longer warranted. As such, our Peregrine Emerging Market Equity Fund currently has a neutral position in China versus the fund’s MSCI Emerging Market benchmark.

We will keep you updated on any changes to this outlook.