Amid tariff war, China appears unfazed, but its economy could be vulnerable; high debt and high deficit loom large

Indian Express

2 days ago

China's economy seems to have ostensibly shaken off the doomsday predictions stemming from the ongoing trade war with the United States, with that country's national statistics bureau presenting a picture of calm in its later GDP data release for April 2025. It showed stable growth with a mild softening in consumption and investment, and overall employment largely remaining stable. Retail sales of consumer goods grew 5.1 per cent year-on-year, just slightly lower than analysts' estimates of 5.5 per cent, while service industry production too increased by 6 per cent, and fixed asset investment rose 4 per cent over the previous year. Officials cited key factors like consumer trading programmes that incentivise purchase of household goods through a discounting scheme, increase in tourist and transportation inflows, as well as the Belt and Road Initiative as 'stabilising forces'. They are upbeat about economic growth projections staying on track, but analysts remain cautious.
China's strengths, apart from its large and diversified economy, include its strong GDP growth prospects relative to peers, its pivotal role in global trade and robust external finances. More importantly, Beijing is seeing success in its efforts to build a whole new economic engine as part of its 'Made in China 2025' national strategic plan, which promises to be a source of future resilience, according to analysts. This includes world-beating companies in areas such as new energy, including solar panels and batteries, electric vehicles, semiconductors, biopharmaceuticals and AI.
Notable among these are GCL Technology, the world's second leading producer of polysilicon — the key material for solar panels; electric vehicles makers led by global auto heavyweight BYD, Leapmotor and Nio and lithium-ion battery makers including CATL and BYD. The Huawei and Semiconductor Manufacturing International Corp. (SMIC) combine, which have been working together to develop and produce cutting-edge chips, particularly in the light of US sanctions limiting Huawei's access to advanced technology, have been successful, quite like the Chinese space programme that also worked around American sanctions. Even as the prolonged slump in China's property market is dragging down consumer confidence and weighing on an economy already suffering from the effects of low productivity in heavy industry and cheap manufacturing, Beijing is seeing remarkable success in its focus on creating a high-tech, clean, and sustainable replacement to its old economy in the forms of these new age companies, with the aim of becoming the global leaders in each of these technologies. These, in turn, are seen as serving to transform China's image as the world's manufacturer of mass-produced goods and materials.
As US President Donald Trump and his cabinet full of China hawks set out to address the trade imbalances, there could some looming concerns for Beijing. While the general impression is that a prolonged phase of higher duties could hurt the US more than China, analysts point to the fact that given the latter's precarious finances and some inherent structural weaknesses, a drawn-out tariff war could hurt Beijing as much as Washington, DC, if not more. If it lingers, China's underlying structural issues that range from high government debt, demographic decline, rising youth unemployment, combined with growing trade tension, could force a stumble, if not a stall.
Festering Problems
What is undeniable is that China's growth over the last couple of decades has been powered by capital investments, especially in the real estate sector, much of which has been financed by an inefficient banking system. With domestic debt levels high and rising, the property market continues to be under severe stress ever since property major Evergrande went belly up in 2023. The real estate crisis has badly dented consumer sentiment, given that nearly one in four Chinese have some sort of an investment in real estate. The investment in China's property market fell by nearly 10 per cent in the first four months of 2025 compared to the same period last year, according to latest official data, amid the renewed trade tensions with the US. For Chinese consumer sentiment taking a hit, the residential real estate market is one important factor.
Then there are structural issues with the Chinese economy as well. While China has leveraged export growth and infrastructure investments to power its economic development over the last four decades, there is now the growing problem of youth unemployment. According to Hong Kong-based Spanish economist Alicia Garcia Herrero, outsiders see less of the unemployment problem than what actually exists there because in the Chinese manufacturing sector, workers are routinely asked to take unpaid leave. So these workers end up working fewer hours, and earning less, while technically being on the rolls. This, according to Herrero, chief economist for Asia-Pacific at French investment bank Natixis and adjunct Professor at Hong Kong University of Science and Technology, is one reason why disposable income is not growing in China. The trigger for that is automation, given that industrial capacity in China is increasingly getting mechanised. 'China's economic power is increasing, but household power, or purchasing power, is not'.
Fitch Ratings said in an April report that the step-up in fiscal stimulus announced by China's government for 2025 is likely to support the economic outlook, but the large budget deficit points to a continued rise in government debt in the next few years. Deteriorating public finances were the key factor behind the rating agency's decision to revise the 'outlook on China's 'A+' sovereign rating' to negative in April 2024.
Debt/deficit Overhang
China's fiscal deficit is budgeted to rise to 8.8 per cent of GDP in 2025, up from 6.5 per cent in 2024 (on a Fitch-adjusted basis) based on government reports at the annual legislative session of the National People's Congress. Experts say this – the combined deficit of the federal government and provinces – could be closer to 10 per cent. This is well above the projected median deficit for 'A' category sovereigns of 2.7 per cent of GDP, Fitch said in its report. The government's official deficit target was raised to 4 per cent of GDP in 2025 from 3 per cent last year. Experts say that China's total-country-debt-to-GDP ratio could be higher than what is put out, if one were to take into account the so-called 'hidden debt' and adjust for 'inflated' GDP claims. Western analysts have consistently maintained that China did not grow anywhere near the reported 5 per cent pace last year and are willing to shave off up to a percentage point from that number.
Lower GDP, consequently, worsens the deficit situation statistically. Some of this increase in deficit is now driven by lower revenue, due partly to a structural decline in property-related revenues and tax cuts. Revenue is budgeted to fall to just 21.1 per cent of GDP in 2025, under Fitch's adjusted definition, down from 28.4 per cent in 2019. The government is discussing the introduction of new revenue-enhancing measures, but fiscal consolidation could face challenges if these are not forthcoming.
'China has grown almost entirely through capital investment,and because there isn't enough to invest in, a lot of good money chases bad, and they have reached a limit,' noted Anne Stevenson-Yang founded J Capital Research. That problem only seems to be worsening.
'External pressures will be particularly acute for Mainland China, at a time when the domestic economy is still finding its footing amid ongoing property sector challenges, subdued household confidence and consumption, and deflationary pressures… Fiscal policy will likely be a key tool for trying to stabilise the property market and offsetting external and domestic headwinds, keeping growth at around 4.3 per cent, but driving wider fiscal deficits and higher government debt, Jeremy Zook, Director, Fitch-Hong Kong said in a report titled 'Greater China Sovereigns Outlook 2025'.
High fiscal deficits, coupled with subdued nominal GDP growth and the materialization of contingent liabilities, could continue to put upward pressure on China's debt problem. 'We estimate that general government debt (including central and local government debt) rose above 60 per cent of GDP in 2024, up from around 55 per cent in 2023 and exceeding the median for 'A'-category sovereigns of 57 per cent. In 2025, the debt ratio is likely to rise to the high-60s per cent of GDP level, based on budget plans and the ongoing 'debt swap' that will bring around trillion of yuan worth off-balance sheet debt onto local government books,' Fitch said.
Expanding consumption remains the top government priority for Beijing in 2025. It is still unclear as to how large the fiscal impulse has to be, or whether it will sustainably lift underlying domestic demand. The government has set an ambitious growth target of around 5 per cent for 2025, and a lot will depend on stking demand, amid headwinds from subdued domestic demand, lingering property-sector stress and rising external challenges.
Growth moderation/local govt debt
According to the IMF Executive Board, which concluded the 2024 Financial System Stability Assessment (FSSA) with China, said that China's investment-led high growth model has given way to more moderate growth amid an unresolved property sector adjustment and an overhang of local government financing vehicle debt.
Financial stability risks are elevated and rising, as compared to the 2017 FSAP, It noted, as asset quality deteriorates and bank profitability declines. While the largest banks are well capitalised and liquid, and appear resilient to shock, mid-sized and smaller banks 'appear more vulnerable'. The property sector downturn and local government financing vehicle debt pose risks, while loss deferral practices reduce transparency and may veil losses, the IMF said.
Amid all this is the unfolding US-China trade war. There is a sense in Washington DC that China has gotten away with low cost manufacturing for too long. No other country has had the same level of global dominance across product categories since the early 1970s. This is more significant now than in earlier decades, when trade represented a much lower share of global goods production and consumption. For instance, the global trade-to-GDP ratio in 1970 was around 25 per cent, but by 2022, that climbed to over 60 per cent. Weakening domestic demand, alongside export-facilitating policies in products, where China is the world's dominant manufacturer, has led to prices collapsing globally and driving other national producers out of business. While the benefit of this has been a phase of sustained lower global inflation, China has simultaneously created a progressive stranglehold over global manufacturing: a level of manufacturing dominance by a single country seen only twice before in world history — by the UK at the start of the Industrial Revolution, and by the US just after the second World War, according to research by the Rhodium Group and from views flagged by Noah Smith's 'Manufacturing is a war now' piece.
What makes China's extraordinary dominance in manufacturing worse is the continuing weakness in domestic demand in China. That too comes from the problem of China's unwillingness to vacate its earlier specialisation in low value-added manufactured products as it moved up the global value chain. This has concomitantly led to a weakness in Chinese demand for imported goods, which was expected to rise if China had ceded the manufacture of low value-added manufactured goods as it progressively moved up the value chain. So, more than Beijing's export competitiveness, weak Chinese imports explain this continuing imbalance.
Anil Sasi is National Business Editor with the Indian Express and writes on business and finance issues. He has worked with The Hindu Business Line and Business Standard and is an alumnus of Delhi University. ... Read More