If you’re expecting policymakers to come to the rescue of China’s flagging economy, we have some bad news.
In case you’ve been living under a rock: The economy has slowed sharply over the past few months – investment is collapsing, the property sector is in freefall, and household income growth has fallen to its lowest level on record.
Calls for a stimulus package have been growing louder, and in previous cycles this is exactly the point where the government would reach for the fiscal fire hose – but not this time.
What looks from the outside like policy drift or stimulus timidity is, in our view, something far more deliberate: Beijing is quietly using the current moment to deleverage the economy.
Here’s why.
China’s debt-to-GDP ratio hit 300% at the end of 2025 – higher than most major economies, and almost 50 percentage points higher than at the property market’s 2021 peak. Left unchecked, it would exceed 400% within a decade.
That matters because healthcare and eldercare costs are set to explode as the working-age population shrinks.
When that moment arrives, the government will need to borrow heavily to foot the bill. And the higher the starting debt burden, the less room it will have to do so.
Deleveraging, in other words, is preparation for a much bigger fight down the road.
The tricky part is that deleveraging usually requires either painful austerity or a prolonged period of below-target growth.
Neither is politically palatable, but for the first time in years, Beijing thinks it has found a way to bring the debt burden down without triggering an outright recession – and it involves pulling three levers at once.
The first lever is inflation.
Producer prices have finally turned positive after years of deflation, thanks partly to the Iran war’s energy shock, and partly to anti-involution efforts.
Rising prices inflate nominal GDP – which in turn shrinks the debt-to-GDP ratio.
The second is exports.
China’s AI and clean-energy export machine is booming, delivering the kind of nominal growth that doesn’t require domestic borrowing to sustain it.
That’s a rare and valuable combination – growth without leverage – and Beijing is making the most of it.
The third is enforced fiscal discipline.
Central state-owned enterprises are being forced to remit a larger share of their profits, gutting their capacity for new investment.
Trade-in subsidies for consumer goods have been cut back.
And the central government has drawn a hard line against bailing out cash-strapped local governments, forcing them to implement tough austerity measures.
This all has significant implications – the most immediate being that China’s domestic demand problems are unlikely to get better any time soon. If Beijing is serious about deleveraging, then the K-shaped divergence between a booming export sector and a struggling domestic economy is not a bug to be fixed – it’s a feature to be tolerated.
Investors pricing in a stimulus rescue are misinterpreting China’s policy playbook.
The second implication is that stimulus, when it comes, will disappoint. We expect Beijing to add a modest supplementary bond allocation in the autumn – probably around RMB 500 billion, similar to last year. But that’s calibrated to keep the economy ticking over, not to reignite growth.
The open question is how long Beijing pursues this strategy. Chinese leaders have historically had little tolerance for prolonged economic pain, though Xi Jinping has shown more than most.
Our base case is that the deleveraging drive runs through year-end at a minimum.
Whether it extends into 2027 will depend on how much pain Beijing is willing to absorb – and how loud the calls for fiscal reinforcement become.
For now, though, the cavalry isn’t coming. And that, more than anything else, will be the story of China’s economy in the second half of 2026.
Dinny McMahon, Head of China Markets Research
What you missed
US-China
A commerce ministry (MofCom) spokesperson revealed for the first time that the US has committed to keeping tariffs on Chinese goods at or below 20%.
By making the US commitment public, China is signalling clearly that it is fine with additional tariffs of up to 7.5% (after the latest 301 trade action from the US put them at 12.5%)
It is also signaling that tariff increases above 7.5% will be met with countermeasures.
Foreign affairs
MofCom added 14 EU entities to its export control list on July 24, barring Chinese suppliers from selling them dual-use goods.
Germany and France were hit hardest: Three firms from each country were added to MofCom’s list, including Germany’s largest defense company, Rheinmetall AG.
Brazilian President Luiz Inácio Lula da Silva called Xi Jinping on Monday.
The call gave Lula the opportunity to showcase his positive relationship with China in the run-up to Brazil’s presidential election in October, in which he faces a close race against right-wing Senator Flávio Bolsonaro.
Econ and finance
Tax revenue registered strong growth in Q2, up 8.6% y/y, the fastest rate of expansion since Q3 2023.
Individual income tax revenue grew 16.4% y/y, corporate income tax revenue increased 11.3% y/y, and value-added tax revenue also grew 7.4% y/y.
Consumption tax was the only category to contract, down 2.0% y/y.
Regulators are trying to create a new channel for families to turn their homes into retirement income via trusts, but their efforts are hitting roadblocks.
The biggest remaining constraint, according to experts, is an ill-suited tax regime that treats the creation of a housing trust as a taxable property transfer.
Tech
Moonshot released Kimi K3’s model weights, as promised.
Anyone can now download and deploy the 2.8 trillion-parameter model.
MofCom made formal statements addressing US Treasury Secretary Scott Bessent’s recent remarks characterizing AI distillation as IP theft.
MofCom stated there is no legal basis for tying distillation to IP theft, pointing out that many US firms distill Chinese models.
They also noted that the timeline of Chinese model releases doesn’t square with accusations of theft.
Beijing’s science commission opened bidding on eight lab machines it wants companies to build for autonomous research laboratories.
Many of these machines appear designed to do semiconductor research, raising an interesting question: Can robots running experiments rapidly beat decades of accumulated process knowledge?
Net zero
18 regulators – led by the environment ministry (MEE) – jointly released the 15th Five-Year Plan (FYP) for National Climate Change Response.
The plan’s most notable feature is its emphasis on non-CO₂ greenhouse gases (GHGs) – including methane, nitrous oxide, and several fluorinated gases.
Politics
The monthly Politburo meeting on July 30 announced that the Central Committee’s Fifth Plenum will be held in October.
The terse readout gave little hint as to what will actually be discussed at the Plenum, but did say: “Efforts must focus on improving the Party’s capacity for long-term governance, preserving its advanced nature and integrity, and maintaining its close ties with the people.”
The Chinese will suffer long.