This article first appeared in Forum, The Edge Malaysia Weekly on October 26, 2026 - November 1, 2026

The Chinese economy today reminds us of the opening lines of Charles Dickens’ A Tale of Two Cities, in which he spoke about it being the best of times and the worst of times. Cyclically, the Chinese economy appears to be in a low-growth trap, dogged by a prolonged period of weak domestic demand. Economic activity did pick up modestly in the third quarter, but that followed an unusually weak second quarter. With investment falling and consumers wary of spending, the economy has developed an unhealthy dependence on exports. Other indicators of the economy such as credit growth are also signalling weakness.

But viewed through a structural lens, there is much strength to be seen. Not only has China become a technology superpower that dominates many sectors, the areas where it is gaining an edge are increasing. That is making its exports so competitive that even tariffs and other restrictions don’t seem to make a dent.

To make sense of these apparently contradictory trends, we need to dig deeper into the structure of the economy and when we do, problems appear. It is not just that the underlying drivers of growth are unbalanced between supply and demand: there are reasons to believe that actual growth conditions are weaker than the official data suggests. Moreover, the export surge is almost certain to provoke a strong backlash that will cast doubt over its longevity. In addition, public debt and the fiscal deficit have also soared, limiting the government’s room for using fiscal stimulus.

The net effect is that the economy will continue to stumble along a desultory growth trajectory. Even if domestic demand responds to the modest stimulus efforts by the government, the likely slowing of external demand will offset that. The economy will still depend on continued government support to ensure that it does not weaken further.

China’s gross domestic product (GDP) expanded by 4.5% in the third quarter, rising modestly above the last quarter’s 4.3%. Some analysts took heart from the fact that average growth during the first three quarters was within Beijing’s growth target of 4.5%-5% for the year as a whole. However, the more detailed data for the month of September was not as encouraging as the headline GDP numbers.

Overall fixed investment fell 7.2% year on year in the January-September period. Even if we exclude investment in the struggling real estate sector, fixed investment still fell by 4.2%. Worse still, capital spending by the key private sector went down by 10.4% (or by 6.7% if investment in real estate activities was excluded). Despite the central government’s exhortations to local authorities to spend more on infrastructure, investment in that segment declined by 4.2%. If businesses did not have the confidence to invest for the future and government capital spending could not make up for that shortfall, then we have an economy with a serious problem.

Similar to private sector investors, the consumer remains in a deep funk, as seen in lacklustre consumer spending. In the January-September period, the value of retail sales of goods and services only inched ahead by 2.6%. Spending by urban consumers barely budged, rising just 0.9%. Since overall economic growth was 4.5%, and since per capita disposable income grew 5.3% in the same period, this must mean that the average Chinese household has increased its savings rate significantly this year. The consumer confidence index is not much above the historically low levels it plunged to during the period of maximum pandemic restrictions. Notably, loans to households have been falling in recent months.

With domestic demand barely contributing to growth, almost all of the increase in output was due to exports this year.

In sharp contrast to the overall weak demand, the supply side of the economy seemed to be moving ahead more robustly. The industrial sector enjoyed growth of 5.3% in the first three quarters while services output expanded by 5.2%.

What does the data tell us about the future direction of economic growth?

The Organisation for Economic Co-operation and Development’s (OECD) lead indicator for China has been edging down slowly in recent months, suggesting that economic growth remains under pressure. Similarly, order books in the manufacturing sector have been growing only slowly in recent months.

In the real estate sector, there are signs of a tentative recovery in the top-tier cities with prices and sales volumes stabilising. This is encouraging because it could be foretelling an eventual recovery in this sector that has been a drag on the Chinese economy for four years. But these improvements would need to be seen in the smaller cities where the bulk of China’s urban population live, before we could become more optimistic about the economy.

There are also question marks over the official GDP data, with some forecasters estimating growth to be well below 4% this year. Former prime minister Li Keqiang once famously said he did not believe the growth data presented to him and used his own proxy indicators to gauge the true pace of economic expansion. Using the approach he favoured, we find that actual economic growth may have been about 1.3 percentage points below what has been officially reported.

More encouragingly, China is becoming extraordinarily competitive in more and more sectors. Given the country’s growing prowess as an exporter and its large external surpluses, one would have expected the renminbi to have appreciated. Instead, the currency has depreciated in real terms, boosting its export edge. Data from the Bank for International Settlements indicates a real depreciation of around 14% since early 2022.

But the bigger reason for China’s surging exports lies in the quality of the ecosystem it has created, an ecosystem that few other countries seem able to replicate. Regions such as the Pearl River Delta provide economies of scale and agglomeration effects that are unmatched elsewhere — component manufacturers compete ferociously with each other, bringing down prices and raising quality and timeliness while world-class transport and logistics networks also help reduce costs. Local governments in the region compete with each other to attract manufacturing activities, helping investors with finance and land acquisition.

Chinese competitiveness has also been helped by its far-sighted planners. They correctly identified the industries of the future and poured money into research and development as well as into skills development and financial support for companies investing in priority areas. What we are now seeing is the success of these policies — Chinese solar panels, electric vehicles, batteries, pharmaceuticals, chemicals and equipment are displacing competitors everywhere. China’s success is the result of bold and highly effective industrial policies that other countries do not seem able to match.

First, over-reliance on exports as the only growth engine could cause difficulties soon. For years, a chorus of voices within and outside China has called for a better balance between external demand and domestic demand, and between overall supply and overall demand. It is clear that neither imbalance has been resolved.

If we look more closely, what China has is also a large gap between its savings rate and its investment rate. Economic theory shows that if savings exceeds investment, then an external surplus is axiomatic.

With the private corporate sector and the consumer increasing the savings rate faster than the fall in investment, the external surplus continues to grow, angering China’s trading partners and provoking more and more retaliatory restrictions on Chinese exports.

Since exports are the only real engine of growth, a sharp increase in protectionism against China — which is increasingly possible – will take away that remaining last engine of growth.

Note that the European Union (EU) is pressing China for voluntary export restrictions and is preparing a range of measures to restrict Chinese exports. Other countries, including China’s friends such as Russia and the Global South, are also imposing more and more tariffs and other restrictions on Chinese-made goods.

Second, China’s fiscal position does not provide much space for aggressive stimulus. While the Chinese government’s official measure of the budget deficit hovers around 3% to 4% of GDP, this does not give the full picture.

If one includes off-balance sheet items such as spending by government-related funds and other quasi-fiscal spending by state-owned policy banks or special investment funds, we get an “augmented budget deficit” which is much bigger than the conventional figure but which better captures the true extent of government spending. The International Monetary Fund (IMF) estimates that China’s augmented budget deficit sat at 14.3% of GDP in 2025. In comparison, the US budget deficit ratio to GDP is around 6%.

As a result, while the official estimate of the public debt-to-GDP ratio is around 30% as at the middle of 2026, the broader measure using the IMF approach gives it as 135.3% in 2026, up from 117% in 2024 and 126.6% in 2025. In other words, public debt is rising quickly in relation to the size of the economy.

These are high numbers for an economy that has to prepare for the higher spending that will come due to its rapidly ageing population. This explains why Beijing has been cautious about using aggressive fiscal spending to support its economy.

First, economic growth is likely to remain lacklustre and excessively dependent on exports as well as on modest policy support for some time to come. A turnaround in the real estate sector will occur at some point but the evidence for that remains patchy right now. The world will have to wait at least a year or more before a material improvement in Chinese demand emerges.

Second, given this as well as trends in Chinese competitiveness and the underlying savings-investment balance in the economy, China’s external surpluses are likely to continue expanding. Its exports will also persistently expand, feeding more trade frictions as more countries complain about how Chinese exports are displacing local producers and contributing to de-industrialisation in their economies. Southeast Asia is certainly at risk here.

Third, we are not likely to see a substantial shift in domestic economic policy. The leadership remains averse to mounting a powerful fiscal stimulus, fearing that its fiscal position will worsen. The overwhelming emphasis of policy will remain on boosting the supply side of the economy so as to strengthen resilience and underpin national security in an age of growing contestation against the US.

Fourth, for now, China remains unpersuaded that it needs to change its export-oriented trade strategy. After all, it successfully forced the US administration to back down on its trade war once it was clear that China’s chokehold on critical items such as rare earths could cause America real damage. Its approach of minimal compromises with the EU has also seemed to have worked — so far the EU has not gone ahead with employing the new tools of trade protection that it had developed with China in mind.

However, we believe this relief is only temporary. There has been a definite shift in the EU’s attitude to how its key industrial sectors such as automobiles and chemicals are threatened by Chinese competition. We suspect that the EU will progressively step up restrictions on China and that many other emerging economies will follow suit. The result will be a surge in trade protectionism that could eventually hurt Southeast Asia as well.

Fifth, while China is not willing to adjust its trade strategy, it is beginning to appreciate that many of its trading partners are increasingly edgy about its exports. China could respond by stepping up foreign investment in Europe and emerging economies to create more of a win-win with its key trading partners. It may also expand its Belt and Road Initiative funding for infrastructure and other development projects in developing economies. If it does so, it will tend to favour regions that have strategic value to it — such as Southeast Asia and Central Asia.

In short, investors and businesses should expect difficulties ahead.

Manu Bhaskaran is CEO of Centennial Asia Advisors

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