More patient policy framework for China's economy

China's economy can no longer be described simply as either strong or weak. Its defining characteristic is a structural transition accompanied by growing divergence, often described as K-shaped recovery. New growth drivers — such as artificial intelligence and advanced manufacturing — are gradually replacing traditional engines, including real estate and infrastructure. Against this backdrop, two trends stand out.

First, overall economic growth remains under pressure, as the property downturn continues to weigh on related sectors, including home appliances, furniture, ferrous metals and machinery, while also weakening local finances and local governments' capacity to support growth.

Second, economic divergence has become increasingly pronounced, as indicated by widening gaps between supply and demand, across industries, among income groups and between regions. This has created a gap between official macroeconomic indicators and the actual economic experience of households and businesses.

Over the medium and long term, China's economy has followed an L-shaped path. The slowdown began around 2010 when the country entered a period of growth deceleration and transition from old to new growth drivers. GDP growth fell from 10.6 percent in 2010 to 5 percent in 2025, more than halving in just 15 years. This year, growth has moved into the 4.5-5.0 percent range, marking the beginning of what may be called an era of "around 4 percent growth". Japan stayed in the 4-5 percent range for about two decades before slowing further, but by then its per capita GDP had reached around $30,000 and its social security system was relatively mature. China's per capita GDP remains below $14,000, making it essential to settle into a stable medium-growth range of 4-5 percent during the 15th Five-Year Plan (2026-30) period.

Each year, the economy has exhibited a U-shaped rhythm: a strong first quarter, pressure in the second, policy support in the third and a year-end lift in the fourth. After the September 2024 policy package, fourth-quarter growth reached 5.4 percent, following 5.3 percent, 4.7 percent and 4.6 percent showings in the first three quarters. This pattern reflects two underlying features: the economy remains highly dependent on policy support, while self-sustaining growth momentum is still weak and the vitality of households, businesses and local governments has yet to be fully restored.

The strong first-quarter performance is largely the result of policy-driven economic mobilization. After the Central Economic Work Conference sets annual priorities, fiscal and monetary policies are often front-loaded, and local governments accelerate projects and resource allocation, pushing construction and investment activity to a high level. By the second quarter, policy momentum naturally moderates, putting pressure on growth. This year, combined spending under the general public budget and government-managed funds rose 6.1 percent year-on-year in January-February, but fell to minus 0.3 percent in January-May, partly reflecting a limited pipeline of shovel-ready projects. The consumer goods trade-in program also boosted home appliance consumption with double-digit growth, but base effects and demand front-loading later became more evident.

Self-sustaining momentum remains weak. Falling property values have encouraged households to reduce debt, with the household leverage ratio edging down from 60.5 percent to 59 percent as many repaid mortgages early. Enterprises face weak demand, pressure along the property supply chain and low capacity utilization. Local governments' land sale revenue fell from 8.5 trillion yuan ($1.25 trillion) in 2021 to 4.2 trillion yuan last year, and declined another 28.7 percent year-on-year in the first five months of 2026, weakening their capacity and willingness to promote growth. Weaker local finances have also affected payments to firms and public services, further impeding household consumption. Government spending under the two budgets dropped from 30.6 percent of GDP in 2021 to 28.6 percent last year, meaning that 2-3 trillion yuan less flowed into the economy as income for enterprises and households.

Growth in the next stage will hinge on the performance of real estate and exports. AI-related products now account for about one fifth of China's export value and roughly half of export growth, making overall export outlook increasingly linked to AI development. Real estate is likely to remain a drag, while AI-supported exports may provide upward support, with a lower base also improving headline data.

The property downturn persists and three issues must be addressed. First, prices remain unstable. Although secondhand home prices in first-tier cities have risen for three consecutive months, national prices, sales and investment are still falling. In smaller cities, some inventory may become permanent as populations decline and outflows continue. Pressure comes from developers' cash-flow constraints, new-home discounts, higher-quality and "fourth-generation" housing products, and rising foreclosure sales. Second, a self-sustaining stabilization process has yet to take hold in the real estate sector. Local governments alone cannot break the cycle of property adjustments, falling fiscal revenue and weakened stabilization capacity. Therefore, central government support is needed to fill fiscal gaps. Third, fiscal pressure in some cities continues to worsen supply-demand conditions, as land supply increases despite high inventory. Stabilization therefore requires both supply control and demand support, backed by stronger transfer payments.

The writer is chief economist and president of the Research Institute at Yuekai Securities.

The views do not necessarily reflect those of China Daily.