Solid GDP growth in Q2 masks China’s challenges

China’ GDP growth held steady over the second quarter of 2025, despite a minor slowdown. The economy expanded by 5.2 percent year on year, down from 5.4 percent in the previous quarter. For the first half of the year, China’s GDP also expanded by 5.2 percent, above the government’s annual growth target of around 5 percent. But headline GDP growth may look stronger than it is, lifted by deflation and base effects of low growth in the reference period last year. On top of that are persistent structural problems. The government responded by introducing further support measures to boost consumption and has initiated potentially significant reforms aimed at addressing overcapacity in key sectors.

Support measures introduced since mid-2024 helped lift consumption in Q2, notably trade-in programs on costlier household purchases like washing machines and fridges. Similarly, labor market measures, including tax relief and employment subsidies, have helped to ease some employment pressures. However, the severity of China’s structural problems has not meaningfully abated. High youth unemployment, weak income growth outlook and the struggling real estate sector continue to weigh down sentiment. Measures introduced by the government so far have helped stabilize the situation but are largely temporary and fail to address the underlying structural challenges.

The most comprehensive policy support to counter struggling consumer demand was introduced by the Peoples’ Bank of China jointly with six other government departments on June 24. The policy marks one of the most coordinated efforts by the government to improve the consumer and service sectors, as well as employment and income. It is also a recognition that its past stimulus policies were not sufficient to lift sentiment. Although many of the specific policies are not wholly new, their political prominence means that boosting consumption in earnest is now a higher policy priority. 

However, it is government’s criticism of overcapacity and fierce price competition in the industrial sector that may signal the beginning of a more substantial course correction in China’s economic policy priorities. China’s strong manufacturing and technology sector growth has come with downside effects, including deteriorating profitability and deflation. This has effectively been reducing the tax base and suppressing consumption in the post-Covid period. 

If implemented meaningfully, economic policy priorities in the industrial sector could begin to rebalance towards consumption. Doing so would require relaxing the current focus on geopolitically driven global tech competition in favor of strengthening domestic demand. China’s industrial policy has unleashed a rapid capacity build-up. Given the economic side effects, the central government will need to put the genie back into the bottle. 

The government’s push for market consolidation in sectors such as electric vehicles and solar panels highlights how market exits in strategic industries must often be orchestrated from the top. The central authorities picking winners is an approach that is likely to meet resistance from local governments. Nevertheless, the recent policy adjustments introduced over Q2 suggest that efforts to address these underlying challenges are finally gaining momentum.

Macroeconomics: Strong GDP expansion masks underlying challenges

• Headline GDP growth beat expectations, expanding by 5.2 percent year-on-year in Q2. After 5.4 percent growth in Q1, the government’s annual growth target of around 5 percent seems well within reach, even if GDP growth was to slow down in the second half of 2025. On the surface, China’s economy appears to have been defying the growing uncertainty overshadowing many economies in the light of US tariffs.
• Stronger service sector growth in supported overall GDP growth in Q2 and helped to counter slowdowns in other areas. After a minor slowdown in Q1, growth in the tertiary sector accelerated to 5.7 percent in Q2. The improvement was the result of stronger expansion in the IT and financial services sector (see exhibit 2). This helped offset a slowdown in other areas of the service sector (including real estate and transportation), as well as in manufacturing and construction.
• Persisting deflation inflated real GDP growth, making growth appear stronger than it is. In addition, relatively strong growth figures in Q2 benefited from base effects. Weaker growth in the same period last year, when GDP expanded by only 4.7 percent, contributed to stronger growth data in Q2 this year (see exhibit 2). China’s GDP growth hit its slowest pace since 2022 in Q3 last year, so base effects are likely to support GDP growth again in the coming quarter. 
  The headwinds facing China’s economy meant quarter-on-quarter economic growth cooled in Q2. Growth slowed from 1.2 percent in Q1 to 1.1 percent in Q2, indicating a loss of momentum.