China – growth dip sharper than expected

What happened?

In July, China’s economy slowed across the board in line with recently weaker leading indicators. Disappointing factory activity, investment and retail sales suggest that Beijing’s crackdown on destructive price wars and the knock-on effects of higher US tariffs are casting a shadow over the start of the third quarter. “China’s economy overcame negative factors including a complex and fast-changing external environment and extreme weather at home, and maintained progress amid stability,” the NBS said in a statement. “The economy still faces numerous risks and challenges.”

• Industrial production growth declined to 5.7% YoY, slightly below expectations (5.9% YoY) and down from 6.8% YoY in June, mainly held back by slowing growth momentum in autos, electrical machinery and electronics - despite stronger-than-expected export growth in July (7.2% YoY overall, but US-bound shipments declined by a significant 21.7% as a result of higher US “reciprocal” tariffs). This marked the smallest increase in industrial production since last November, amid capacity curbs caused by unusually high temperatures and heavy rainfall in some regions.

• Fixed asset investment (FAI) growth slumped further to –5.2% YoY in July from +0.8% YoY in June, its lowest level in more than five years. In the first seven months of the year, FAI expansion slowed to 1.6% YoY, as a contraction in the real estate sector deepened due to adverse weather conditions. Growth in infrastructure and manufacturing fixed asset investment also eased, as the government appeared less under pressure to increase spending, given solid real GDP growth in Q1 2025. The contractionary effect of the ongoing 'anti-involution' policies may also have gradually kicked in. Property investment contraction worsened, slumping 12% over the first seven months of the year.

• Downward pressure on property prices persisted. On a month-on-month basis, the 70-city property price index for new homes fell by 0.31%, i.e. faster than the 0.27% decline in June. Meanwhile, used home prices fell by 0.55%, which is a slightly smaller drop than the 0.61% decline in June. Since reaching their peak, new home prices have fallen by almost 11%, while used home prices have fallen by around 19%.

• Retail sales growth slowed to 3.7% YoY in July, down from 4.8% in June, and well below the expected 4.6%, mainly due to weaker automobile sales. Anti-inflation measures offset some of the impact of the consumption stimulus, as car manufacturers moved away from aggressive pricing strategies and discounts towards fewer promotions and steadier pricing. Nevertheless, sales of new energy vehicles (NEVs) continued to grow sharply due to new model launches and innovations. Meanwhile, the services industry output index, which tracks services GDP growth closely and is on a real basis, fared better, moderating to 5.8% YoY in July from 6.0% in June.

• The urban unemployment rate climbed to 5.2%, disappointing market expectations of 5.1%.

The market reaction to the data releases was mixed, with the offshore yuan weakening slightly to USD/CNH7.18 and the yield on China’s 10 year government bonds edging slightly lower, extending the decline seen in the previous session. At the time of writing, Hong Kong stocks had retreated by around 1%, marking the second consecutive session of losses as most sectors declined, led by financials, technology, and consumer names. Nevertheless, the Hang Seng Index is on track for a second consecutive weekly gain, rising by over 1.2%, supported by this week’s 90-day US-China trade truce extension. In contrast to the subdued sentiment surrounding H-shares, the mainland's CSI 300 index increased by 0.8% on the day, after swinging between small gains and losses.

What does it mean for investors?

The July Politburo meeting fell slightly short of market expectations. However, it reaffirmed Beijing’s commitment to “maintaining policy momentum and stepping up support if needed.” In response, policymakers have recently advanced the implementation of stimulus measures. Though largely preplanned, the accelerated rollout of these measures alongside a blend of fresh pro-consumption and social welfare support (see below) and traditional infrastructure policy tools, such as the Xinjiang-Tibet railway project with total investment of over RMB300bn (USD42bn) over 10 years and the new RMB1.2tn (USD167bn) hydro power station project on the Yarlung Zangbo River in Tibet, reflects a constructive response to China’s persistent challenges, such as demographics and low price dynamics.

In July, price dynamics remained weak. While annual headline consumer price inflation remained unchanged, the core rate increased slightly to 0.8% YoY. Though still muted, this was the highest reading since February 2024. PPI deflation remained at -3.6% YoY, marking its 34th consecutive month in negative territory. Thus far, the impact on prices of the government’s latest ‘anti-involution’ policy measures, such as production restrictions, price controls and cutbacks in subsidies, aimed at counteracting ruinous price competition and overcapacity in certain sectors, has been limited. The campaign has attracted significant attention from markets, given the importance of reflating the economy and its potential impact on corporate profitability in sectors ranging from steel to solar energy and cars. Historical experience (e.g. in 2015–16) suggests that, as policy action gains momentum, these measures might gradually push PPI inflation back into positive territory over the coming quarters.

From an investor’s perspective, supply-side restrictions, e.g. on the production of intermediate goods, are expected to bolster profit margins in upstream industries, such as cement, steel and solar glass manufacturing. However, the impact on downstream manufacturing companies is twofold. While curbing price wars will strengthen these companies' profit margins, higher input prices could offset this benefit. Over the past two years, many local governments have offered subsidies to local companies in sectors such as automotive, pharmaceuticals, solar energy, and raw materials. If these subsidies are reduced or eliminated, overall competition should be strengthened, but some unprofitable companies will probably be forced out of the market. As larger players with economies of scale may benefit from consolidation, a selective, quality-biased stock-picking approach is warranted.

The accelerating downturn in property prices over the past few months suggests that additional policy support may be required. Given how exposed Chinese households are to real estate, stabilising prices are essential for restoring confidence and generating sustained growth in domestic consumption. Chinese households are unlikely to spend with greater confidence if their biggest asset keeps declining in value. This is particularly important as domestic demand is set to become a more important driver of the Chinese economy. In order to boost household consumption and confidence, new social welfare policies have been introduced over the past two weeks to ease the financial burden of childcare (e.g. free preschool education and direct cash transfers of RMB3,600 per year – around 10% of the average annual salary – to families with young children), as well as increasing social security coverage for low-income workers.

Weak private loan demand appears to be one of the factors behind the interest subsidy programmes announced by the Ministry of Finance this week. In July, the creation of new loans saw the first negative reading in almost 20 years, with a notable weakening in both household and corporate loans, highlighting a subdued willingness to borrow and spend in the private economy. The action plan, which starts in September, offers interest rate subsidies for personal consumption, capital expenditure and working capital loans over a one-year period. Transactions of up to RMB50,000 (approximately USD7,000) are eligible for subsidies, as are priority sector transactions exceeding this limit, including those for automobiles and education. Furthermore, an interest subsidy plan has been unveiled for eight service sectors, targeting businesses in key areas such as catering, accommodation, healthcare, elderly care, childcare, housekeeping, culture, entertainment, tourism, and sports. Borrowers may receive interest rebates of 1% for up to one year if the loans are used to improve consumption, infrastructure or service supply capacity. While these subsidies appear to be a follow-up to the 'Action Plan for Special Initiatives to Boost Consumption' introduced by the central government in mid-March, they also address entrenched deflationary tendencies.

From a macroeconomic perspective, interest subsidies can be viewed as a form of targeted interest rate reduction, intended to boost consumer spending without reducing banks' net interest margins directly. Furthermore, the service-oriented approach addresses imbalances in domestic demand. Although China’s consumption of goods as a percentage of GDP stands at around 22% (similar to that of the US), its consumption of services remains lower at 18% (well below the US's 46%). From an investor's perspective, this initiative could increase demand for consumption and service sector loans, thereby improving consumer sentiment and potentially benefitting consumer discretionary stocks in general. However, the financial impact on Chinese banks may be limited, as loans to the eight sectors account for only around 1% of total bank lending.