China economic outlook: How China’s two-speed economy will weather the storm in 2026

What was all the fuss about?

In April last year, the global growth outlook looked grim -the US led trade war was expected to hit major economies hard.  Since that time, growth expectations have been steadily upgraded (chart 1).  Much of the focus has been on the stronger US economy, fuelled by the AI investment boom. Less has been said about the resilience of the Chinese economy. 

Arguably, China faced even more headwinds than the US in 2025.  It was the key target of President Trump’s new tariff policies.  At the same time, China’s domestic economy continued to be weighed down by structural challenges, including its shrinking and rapidly ageing population, property sector deleveraging, weak consumer confidence, industrial overcapacity and deflationary pressures.

Taking this together, it was reasonable to assume that China’s overall growth momentum would slow sharply in 2025.  This led us (and others) to predict that significant stimulus measures would be needed in 2025 to defend Beijing’s growth target of ‘around 5%’.

Holding up better than expected

In fact, China’s economy has held up better than expected. In quarterly terms, GDP grew by 1.2%, 1.0% and 1.1% over the first three quarters of 2025. Annual GDP growth was running at 4.8% in the September quarter 2025 (chart 2).  This is without Beijing having to roll out large scale, infrastructure led, stimulus packages to boost short term growth.

Central government debt issuance was massive in 2025, at around 10% of GDP (chart 3).  While some of the funds were used to fund strategic investments in technology and green energy with long lead times, the bulk was financial transfers to refinance local government debt, assist the work out of troubled property developers and re capitalise banks. 

The impact on the economy from this type of stimulus is far smaller than traditional infrastructure investment.  At the same time, borrowing by local authorities has slowed due to weaker land sales and other revenue, already high debt burdens, and tighter central government oversight.

One foot on the gas, one on the brake

So why has the Chinese economy proven so resilient?  The economic data paints a clear picture of an economy operating at two speeds.  Despite the trade war, China’s export sector has again been the saviour.  It continued to perform strongly, boosting growth and industrial production.  In contrast, domestic demand has been anaemic thanks to the extended property sector slump, pessimistic consumers, and plummeting investment.

The export sector comes to the rescue yet again

China’s export sector was not immune from the US led trade war (chart 4).  Over the year to November, Chinese exports to the US fell by $US89bn or 19% compared to the same period in 2024.  Since the first trade war in 2018, the US share of total Chinese exports has fallen from 19% to just under 12%, behind both ASEAN and the EU (chart 5).

Despite this hit, total Chinese exports have held up well, growing by 5.4% over the year to November and contributing 1.2ppt to annual GDP growth in the September quarter.  The slump in exports to the US has been more than offset by robust exports to emerging market countries.  Over the same period, Chinese exports to Africa, ASEAN and Latin America are up by 26%, 14% and 7% respectively.  Exports to the EU are also up by 8%.

There are three main reasons why Chinese exports held up through 2025:

• frontloading to beat tariffs;
• transhipment through third countries;
• and diversification to new markets. 

All have played a role, but the relative impacts and implications heading into 2026 vary.

There is clear evidence that many US importers tried to frontload shipments in early 2025 ahead of President Trump’s tariff announcements -this was not just a China phenomenon.  However, the lift in Chinese exports to the US over that period is quite limited (charts 4 and 5).  So, while frontloading provided some early, modest support for Chinese exports in 2025, it was not the main driver of China’s economic and export resilience.

Transhipment, which involves shipping via an intermediary location, is a very different story.  Much of the decline in the US share of Chinese exports has been directly offset by a rise in Chinese exports to other East Asian countries.  The same pattern was seen during the first US China trade war in 2018.  Indeed, since that time there is an almost perfect inverse correlation (0.95) between the US and ASEANs share of China’s exports (chart 5).  Most of these exports were likely transhipments intended to evade higher US tariffs against China.

These East Asian countries have highly export oriented economies, with relatively small domestic markets.  Most of their imports from China are intermediate goods used for re-exports rather than final goods used to meet domestic consumption.  We estimate foreign value-added content accounts for a high share of these economies’ exports (chart 6).  In our view, transhipment was the most important driver of China’s overall export resilience in 2025.

America’s tough talking on tariffs

On the surface, this is surprising.  The US did a lot of tough talking when tariffs were first announced, suggesting they would crack down hard on transhipment.  Initial ‘Liberation Day ‘tariff rates were higher on countries linked to China’s wider export machine (e.g. Vietnam 46%, Thailand 36%, and Taiwan 32%).  This was followed by an executive order on 31 July 2025 that applied a flat 40% penalty tariff on any goods identified as transhipped through third countries. This order remains in place.

In practice, the US has not delivered on this tough talk.  There are a few key reasons for this, some strategic, some practical.  First, it was understood in Washington that an overly aggressive crackdown would have a major impact on US supply chains, costs and inflation.  Second, the US didn’t want to further destabilise relations in the lead up to the Trump Xi meeting in October.  And third, it quickly became apparent that working out which goods are ‘transhipped’ and which are ‘transformed’ and then enforcing the new rules was highly complex and would require a lot of time and investment.

While we still expect the US to gradually strengthen its compliance systems and selectively target certain exports, the prospects of a severe, blanket crackdown on transhipment have diminished.  In addition, the US China trade deal has lowered effective tariff rates, significantly reducing the incentive for transhipment through third countries.

Diversification to new markets

The third explanation for China’s export strength is diversification to new markets.  This has also been an important factor.  China was successfully able to redirect a large share of its exports to other markets.  There was a clear strategic focus on emerging markets, particularly Africa and Latin America.  China has been steadily growing these export markets and deepening economic ties over recent years.

We consider members of China’s Belt and Road Initiative (BRI), its flagship infrastructure program, are structurally positioned to support China’s export engine as the US led west increase trade barriers against China.  These infrastructure and development projects are set to generate sustained demand for construction materials, machinery, vehicles and consumer durables – sectors in which Chinese firms are highly competitive.

Africa received the highest value of investment and construction contracts under China’s BRI in H1 2025 (here).  And with China accounting for less than 20% of total African imports, there is considerable headroom for further trade expansion (chart 7).

China was also able to redirect some exports to the EU and other western countries.  From January to November 2025, Chinese exports to the EU rose by $US39bn (or 8%) (chart 8).  However, further trade diversification will prove more challenging in these developed markets.  Concerns continue to rise over China’s soaring US$1 trillion trade surplus and industrial overcapacity.  These concerns have encouraged the EU to impose new anti-dumping duties and other restrictions on Chinese trade and investment.

In summary, transhipments and export redirection/diversification explained the resilience of Chinese exports in 2025, despite the sharp drop in direct exports to the US.  Export resilience flowed through to strong industrial production, which has recorded growth every month in 2025 (red bars in chart 9).

But domestic demand remains anaemic

Unlike China’s export sector, China’s domestic activity has continued to disappoint.  The government’s consumer goods trade in program played a key role in boosting retail sales in the first half of 2025 (green bars in chart 9).  But with most of the subsidies disbursed and consumption brought forward, retail sales again lost momentum in the second half of the year.

The property sector slump remains the major drag on consumer confidence given a large proportion of household wealth is tied to the property market. 

• Multiple property sector indicators have continued to deteriorate despite government pledges to ‘halt the declines’ (chart 10). 
• Established and new home prices have declined by 20.8% and 12.1% respectively from their peaks in 2021 (chart 11). 
• Floor space starts have fallen by 21%/yr over the year to November and the contraction in property investment accelerated.

Lifting consumer spending

Trying to lift consumer spending has been a perennial headache for Beijing and it is generally understood that deleveraging (reducing debt levels) in the property sector is a ‘necessary evil’.  However, in 2025 infrastructure and manufacturing also weighed on overall fixed asset investment which contracted by 2.6% per year over the year to November, the weakest since June 2020. 

Government spending has slowed in recent months after being frontloaded earlier this year.  As noted above, local governments have prioritised restructuring their off-balance sheet debt over investing in new infrastructure projects.   At the same time, Beijing’s ‘anti involution’ campaign aimed at tackling industrial overcapacity and excessive price competition also placed downward pressure on investment.

Given such weak domestic demand, it is not surprising that the economy remains stuck in a ‘lowflation’ rut (chart 12).  Consumer prices have bounced around 0%/yr for more than two years.  Meanwhile, producer prices have been in deflationary territory since October 2022.  It remains to be seen how effective the ‘anti involution’ campaign will be at reducing deflationary pressures and supporting corporate profit margins (chart 13).  This low inflation is another reason households appear stuck in a ‘liquidity trap’.

2025 has again clearly demonstrated that China is committed to moving away from its traditional growth model driven by infrastructure, property and broad-based exports to one centred on ‘high quality development’ -prioritising strategic industries, technology and financial stability.

Prospects for 2026

Despite some slowing in momentum towards the end of the year, resilient exports should see the government achieve this year’s growth target of ‘around 5%’.  We expect GDP growth of 4.9% in 2025.

For now, policymakers appear content with the economic performance and show no urgency for large scale new policy stimulus. Fiscal policy is likely to remain supportive in 2026 but structurally different from past cycles.  We expect central government bond proceeds to continue to be mostly directed towards resolving local governments’ off-balance sheet debt and supporting strategic industries.  We expect additional modest and targeted policy support for consumption, the property sector and banks.  The old playbook of stimulating growth through massive state led infrastructure investment is effectively over.  On monetary policy, we expect the People’s Bank of China (PBoC) to modestly cut the 7-day reverse repo rate by 10 basis points and the reserve requirement ratio by 50 basis points to Q1 2026.

A modest upgrade to growth expectations

As discussed in our global economy update, we modestly upgraded our 2026 China GDP growth forecast to 4.5%.  We expect the global demand outlook to be brighter in 2026, providing ongoing support for Chinese exports.  The partial trade deal agreed between Trump and Xi in late October has also reduced some downside risks.  We now estimate the US effective tariff rate on imports from China will settle at about 28% compared to our previous estimate of about 35%.

Importantly, policymakers are committed to moving further up the value-added ladder in manufacturing.  The 2026 2030 five-year plan suggests modernising the industrial system -particularly through advanced manufacturing – will be the government’s top development priority.  We expect aggressive industrial policy will continue to be deployed to enhance international competitiveness in strategically important industries such as renewable energy equipment and semiconductors (chart 14).

At the same time, the structural challenges plaguing China’s domestic economy are not going away.  China has already forced a major downshift in property leverage, but the sector is still in a multi-year process of balance sheet repair.  Even without a banking collapse, property busts can suppress growth for years via weak prices, impaired cashflow, and slow cleanup of bad debts (as seen in Japan in the 1990s and early 2000s).

Policymakers have vowed to significantly boost the share of household consumption in its economy over the next five years.  However, previous pledges and policy initiatives have failed to deliver, and there is no reason to think that current efforts will have greater success.  The continued property correction, low consumer confidence, deflationary pressures and an acute demographic profile all work against a sustainable lift in consumption.

These structural pressures will continue to see overall growth rates (and targets) in China step down over coming years.  Beijing has shown it is willing to accept slower economic growth and some pain in parts of the domestic economy, provided its broader strategic objectives are being met.

The geopolitical landscape remains the major wildcard for the Chinese (and global) economy in 2026.  The external strategic environment will continue to become more challenging and hostile to China.  The US is aggressively pursuing its interests abroad and pushing back harder on Chinese and Russian influence in third countries -as demonstrated by recent US actions in Venezuela (i.e. the ‘Donroe Doctrine’).

Broader western efforts to de risk from China and limit its dominance of strategic sectors (e.g. critical minerals) will accelerate in 2026.  And as this pressure grows, and the global rules-based order continues to fray, the risk of conflict in the South China Sea will loom larger.