Overall expectations for the second half of 2026 are low among Chinese economists. This is partly a matter of policy—many would have preferred an unambiguous shift towards fiscal stimulus after the mid-year Politburo meeting, which instead focused on incremental policies and accelerating the transition to “new growth drivers”.
Yet, as Wu Ge argues, the fundamental macroeconomic direction is dictated less by policy than structural factors. Mainly, these are the deepening deflationary effects of local-government deleveraging as formerly hidden debts from local-government financing vehicles (LGFVs) are moved onto government balance sheets through debt swaps.
Wu Ge deems that even China’s large trade surplus cannot compensate for the weakening of domestic credit creation as local governments deleverage. He suggests that strong high-tech exports have had a limited impact on money creation because their benefits are constrained by China’s position in global value chains, where foreign firms capture much of the value from high-end chips and AI models.
As a result of the inability of new growth drivers to compensate for the drag in traditional sectors, Luo Zhiheng expects the overall slowdown and resulting fiscal pressures on the state to persist until around 2032. The consequences of these fiscal pressures are illustrated by an unusually probing academic article from Dai Zhixin on the normalisation of fines and confiscations as a revenue-raising measure for many local governments.
Faced with this, what are the proposed policy measures? Rebalancing towards “investing in people” to develop new sources of growth in consumption and services is the longstanding answer. However, that takes time and more money. Meanwhile, investment in high tech remains a key policy priority, placing another demand on strained finances.
Cue the panacea: more government and state-supported bond issuance. Cao Jing’s article represents the most rose-tinted framing of this approach, proposing the novel accounting approach of recognising local-government investments in human capital and welfare as assets on their balance sheets.
Zhang Jiqiang is more measured. The three-year debt-swap programme launched in 2024 to tackle hidden debt has already strained banks’ balance sheets by requiring them to absorb large volumes of long-dated local-government bonds. Amid these pressures, Beijing recently announced a $54 billion recapitalisation of banks and insurers. The main debt-swap programme ends this year, which should ease the strain on banks and help stabilise lending growth in the medium term. However, local governments will still face funding constraints, with Zhang expecting greater reliance on bonds issued by provincial-level LGFVs and policy-backed technology and industrial companies.
Zhang Ming proposes another way to ease the funding squeeze: revitalising local-government holdings by turning industrial parks, logistics centres, transport infrastructure and data centres into publicly investable real-estate investment trusts (REITs)—effectively, reviving land finance in a more regulated manner. Yet repackaging assets does not make them more productive: the scope for this approach ultimately depends on finding properties with sufficiently reliable income to attract investors, and Zhang concedes that currently, participation by non-institutional investors is low.
Amidst this rather challenging outlook, economists regard any improvements in demand as likely to be concentrated in growing first- and second-tier metropolises, as population flows reflect the overall theme of divergence and leave many lower-tier cities behind.
Li Xunlei couples his relative optimism for these metropolises with a damning assessment of lower-tier cities’ fiscal prospects. Faced with the reality of regional divergence, he counsels centralising fiscal powers and directing fiscal transfers towards growing urban centres, while restraining expenditure in shrinking localities: investing in people only works if the investments go where people want to live. Based on his macroeconomic assessment, he identifies property in growing metropolises, consumer stocks and large-cap companies as contrarian investment opportunities (see the “Consumption and Social Security” section below for his reasoning).
What about AI? Just as bond issuance and patient capital have become the optimistic buzzwords in macroeconomic discussion, a Qiushi article by Z.ai co-founder Tang Jie on the “token economy” has prompted much speculation about how commoditised intelligence might benefit China’s tech ecosystem.
We spotlight a couple of more measured takes. Hou Hong argues that the open-source business model desperately needs to find a way to “save itself”, identifying charges for overseas cloud providers as a possible pathway to subsidising the domestic market. Huang Yutao points out that much overseas use of Chinese open-source models currently relies on foreign data centres—an obstacle to the “token export” narrative that needs to be overcome if Chinese providers are to capture revenue from overseas users.
— James Farquharson
In Brief
Policy Support and H2 Assessments:
Wu Ge on the cause of monetary contraction in China’s economy.
Luo Zhiheng on the medium-term effect of K-shaped economic divergence.
Dong Yu explaining the rationale behind the central government’s relatively restrained fiscal posture.
Local Government and Real Estate:
Dai Zhixin, Xie Yihao & Yang Su on the prevalence of fines and confiscations as a revenue-raising tool.
Li Xunlei on “transport overcapacity” and its pronounced risks for shrinking lower-tier cities.
Yao Yang on the importance of real estate and the naivety of seeing tech investments as a funding source for local governments.
Cao Jing on bond issuance as a pathway to fiscal stability for local governments.
Zhang Jiqiang on local government finances after the deleveraging cycle ends.
Zhang Ming on the potential of REITs to revitalise local-government land assets.
Tang Jie on the potential of the AI token economy and token exports to act as an economic engine.
Huang Yutao on overcoming the reliance on overseas data centres for token exports.
Hou Hong on a possible pathway to saving the open-source business model from unprofitability.
Liu Shaoshan on the potential of cheap energy to become part of China’s comparative advantage in token exports.
Consumption and Social Security:
Li Xunlei on the overlooked investment opportunities to bear in mind from 2027 onwards.
Sun Liping on the difficulties facing the establishment of a social security system for gig economy workers.