Excess savings and excess investment, which threaten to be exacerbated by U.S.-China trade conflict, remain China’s greatest structural-economic challenges, but Beijing retains its ability to sufficiently offset any trade-related economic deceleration, if necessary. The Trump administration has targeted China with across-the-board tariffs as well as broader sectoral restrictions. But thus far, China’s economy has continued to register strong economic growth. The full impact of U.S. tariffs has not yet fully materialized and a further increase in U.S. tariffs targeting China remains possible. In the context of increased uncertainty and higher U.S. tariffs, China has taken only modest measures to soften the negative impact of reduced exports on aggregate demand. Aside from declining exports, China’s economy continues to suffer from excess savings and investment, which has translated into low consumer price inflation and outright producer price deflation. Downward pressure on prices increases the real debt burden of the economy and financial vulnerabilities.
> The Chinese government has set a 5% annual real GDP target for 2025. Q1 real GDP growth reached 5.4% year-on-year and 5.2% year-on-year in Q2.
> Producer prices and consumer prices remain under downward pressure. In June, consumer price inflation increased 0.1% year-on-year, after registering four months of year-on-year deflation. Producer prices have been in negative territory on a year-on-year basis since October 2022.
> China’s domestic savings and investment rate exceed 43% and 41% of GDP, respectively. China’s total social financing, a measure of total outstanding credit in the economy, exceeds 300% of GDP and is projected to increase further.
> Since January, U.S. tariff on China have increased by roughly 30% points, translating into average effective tariffs of 41%. This will lead to a reduction of Chinese exports to the United State. But the impact on Chinese aggregate demand will be manageable. Chinese gross exports of goods and services amount to 20% of GDP. Gross goods exports to the United States accounted for less than 2.5% of Chinese GDP. This is significant, but not excessive. The respective figures for Canada and Mexico are 20% and 30% of GDP.
> Various estimates put the negative impact of recent U.S. tariffs on Chinese GDP at less than 100 basis points. Discounting offsetting Chinese macroeconomic measures, this would translate into above 4% GDP expansion, roughly in line in with the IMF’s forecast.
> Producer prices and consumer prices remain under downward pressure. In June, consumer price inflation increased 0.1% year-on-year, after registering four months of year-on-year deflation. Producer prices have been in negative territory on a year-on-year basis since October 2022.
> China’s domestic savings and investment rate exceed 43% and 41% of GDP, respectively. China’s total social financing, a measure of total outstanding credit in the economy, exceeds 300% of GDP and is projected to increase further.
The full impact of recent U.S. trade measures is yet to be felt and the uncertain outlook for Beijing’s trade relationship with Washington (and Brussels) will weigh on China’s economic outlook. But China’s dependence on exports is less today than in the past. High U.S. tariffs will be somewhat offset by the diversion of exports to third countries. But reduced exports will exacerbate already entrenched domestic producer price deflation, while weaker economic growth will further weigh on consumer spending and consumer price inflation. While policymakers have voiced concern about intensifying producer price deflation, they have thus far only implemented relatively modest measures to support prices or implement consumer-focused measures to buoy household. Structurally, the authorities have continued to channel excess savings into so-called “new productive forces”, namely selected sectors, including EV technology, instead of increasing consumption. This has led to significant overcapacity domestically and sharply increased sectoral exports. Excess savings lead to a whack-a-mole situation, where the re-direction of savings from one sector (real estate) to another sector (EV, technology) leads to excess supply and concomitant economic problems related to over-investment, namely excess supply, reduced profitability, deflationary pressure and financial vulnerabilities of borrowers. U.S. tariff measures will exacerbate this situation by reducing China’s ability to exports its export savings and export production, thus putting downward pressure on domestic prices.
> Since January, U.S. tariff on China have increased by roughly 30% points, translating into average effective tariffs of 41%. This will lead to a reduction of Chinese exports to the United State. But the impact on Chinese aggregate demand will be manageable. Chinese gross exports of goods and services amount to 20% of GDP. Gross goods exports to the United States accounted for less than 2.5% of Chinese GDP. This is significant, but not excessive. The respective figures for Canada and Mexico are 20% and 30% of GDP.
> Various estimates put the negative impact of recent U.S. tariffs on Chinese GDP at less than 100 basis points. Discounting offsetting Chinese macroeconomic measures, this would translate into above 4% GDP expansion, roughly in line in with the IMF’s forecast.
To date, Beijing has taken relatively modest measures to support domestic demand, but its ability to implement short-term measures remains sufficient, even if policymakers would rather avoid providing significant stimulus given China’s 2008 experience. Following the global financial crisis, Beijing launched a major credit-driven stimulus policy program. While it helped support economic growth, it also led to a significant increase in debt. This experience is a major reason why Beijing has thus far been reluctant to pursue significant fiscal or quasi-fiscal demand stimulus. It has remained similarly reluctant to engineer greater domestic consumption and has instead retained a focus on “new productive forces” by channeling savings into selected, preferred sectors. Another reason for Beijing’s reluctance to introduce measures is that economic growth has held up thus far. Beijing is concerned about the cost-benefit of vast additional consumer stimulus. Although Chinese public sector debt, including local government debt, is high, a relatively closed capital account and extensive control over the banking system as well as further room to ease monetary conditions mean that Beijing retains its capacity to support economic growth through short-term demand measures, if necessary.
> After downgrading China’s growth forecast to 4.1% at the height of US-Chinese trade tensions, JP Morgan revised upward its full-year 2025 forecast to 4.8%. Before the escalation of US-China trade tensions, JPM forecast growth of 4.6%. This limits the need to launch significant demand stimulus.
> Even before President Trump took office, Chinese policymakers had taken modest measures to support domestic consumption in the context of China’s goal of rebalancing the economy away from excessive real estate sector investment.
If Chinese growth does decelerate in the next few quarters, policymakers will respond by implementing further monetary and fiscal measures to support domestic demand. The more significant the projected economic slowdown, the greater the strength of any macroeconomic measures. A further slowdown would accelerate deflation and exacerbate financial sector problems due to an increasing real debt burden, including local governments. This is something the government will want to avoid. The PBoC has room to cut interest rates. The central government, as opposed to cash-strapped local governments, is well-positioned to provide further short-term stimulus. While not the authorities’ preferred option, such measures would help to partially offset any trade-related economic deceleration. However, it would do little to address China’s excess savings problems unless such measures were combined with broader reform aimed at a structural increase in household incomes and a reduction of pre-cautionary savings government transfers motive (though permanent) as well as a reduction of corporate savings (through higher taxes and reduced subsidies).
> Chinese policymakers have begun to study the implications of a zero-interest rate policy, suggesting they are getting prepared for a further decline of interest rates and monetary easing (Financial Times).
China will continue to intensify its policies aimed at making itself less vulnerable to the global economy and U.S. foreign economic policies. The so-called “dual circulation” strategy seeks to increase domestic consumption and self-reliance while maintaining international trade. Other policy initiatives seek to loosen economic, financial and technological chokepoint. Beyond trade, Beijing has sought to establish alternative financial infrastructure to make China less dependent the. But Beijing will also continue to diversify its trade to reduce its vulnerability in the face of erratic and unfriendly U.S. trade policies, even if in the short term U.S.-tariff-related trade diversion may lead to increased trade tensions.
> China remains keen to diversify its trade relations, including through application to join CPTPP and the establishment of RCEP. This will lead China to diversify its trade away from the United and the EU, at the margin.
> To reduce China’s dependence on the dollar, Beijing has promoted the international role of the renminbi by including through its inclusion in IMF’s SDR basket, the establishment of an alternative financial clearing and settlement infrastructure in the guise of CIPS, the promotion of RMB through the AIIB and Belt and Road Initiative as well as through PBoC swap lines.