Discount wars in China: for the People's Republic, overcapacity is worse than Trump's tariffs

The success report from the Chinese National Bureau of Statistics (NBS) contradicts the growing unrest within the government. According to official data from Tuesday, China's economy is expected to have grown by 5.2 percent in the second quarter.

But the comparatively good figures are no reason to sound the all-clear, says Alicia García-Herrero, chief Asia-Pacific economist at the French investment bank Natixis. The positive factors have peaked, and "the problems will come in the second half of the year."

China's leadership set a growth target of around five percent in March . According to official data, the second-largest economy is on track despite the trade war, growing by 5.3 percent in the first half of the year.

But there are doubts about the reliability of the data . In autocratic China , economic growth is seen more as a political target than as an economic indicator. Nevertheless, a look at the details reveals a lot about the state of the economy—and its problems.

Contrary to what the government likes to suggest, these are primarily home-grown: "For China's economy, the overcapacity is worse than Trump's tariffs," García-Herrero told Handelsblatt. Even if the US president vacationed in Florida for the rest of his life, China would still have a problem, she emphasizes – pointing to the ruinous price competition resulting from overproduction.

Rising exports, the main growth drivers in the first half of the year, have so far partially masked the problems. But experts warn that this could be over in the second half of the year.

The increase in private consumption, driven primarily by the government-subsidized old-for-new swap program, could also prove short-lived. There are no "discernible growth drivers that could boost the economy in the second half of 2025," conclude experts at the analysis firm China Beige Book (CBB).

This brings the structural problems of the Chinese economy more into focus:

Producer prices in China have been falling for 33 months. Companies are producing significantly more than demand in the domestic market. They are outbidding each other with discounts to get rid of their goods.

The negative price spiral in the manufacturing sector is the main reason why "deflation threatens to become an increasing risk in the second half of the year," warn CBB analysts. Most economists consider deflation more economically dangerous than inflation because, according to economic theory, buyers hold back in anticipation of even lower prices.

Meanwhile, the leadership of the ruling Communist Party (CP) has recognized that it must take countermeasures. It will combat "disorderly" competition with ever-lower prices and promote the dismantling of outdated production capacity , the Central Committee for Finance and Commerce, headed by President and Party leader Xi Jinping, announced earlier this month.

The price war and subdued domestic demand are causing industrial profits to decline. Many of China's companies are "barely running out of room to breathe," says García-Herrero. According to a Natixis analysis, the number of zombie companies has recently risen significantly.

The selection process is particularly dramatic in the renewable energy segment. While Chinese companies may superficially dominate this market, upon closer inspection, "they are paying a high price for this dominance," the expert says.

A lack of profit prospects and growing uncertainty are causing private companies and consumers to invest little, according to investment data released Monday by the Chinese central bank.

Although government investment has recently increased, especially in green infrastructure, companies and households borrowed less in June, according to Lynn Song, chief China economist at the Dutch bank ING . Credit demand is considered a good indicator of future economic development.

The low demand from companies is remarkable given that borrowing costs for industry are historically low, emphasizes Derek Scissors, Chief Economist at CBB. However, even low interest rates have not led to stronger demand for credit. This means that "monetary policy firepower is in danger of losing its effectiveness."

The negative trend of overcapacity and ruinous price competition is also a consequence of government support for future-oriented industries, celebrated by the government as "new productive forces." These were intended to help modernize the economy and ensure future growth.

But despite high investments in recent years, productivity hasn't increased, says García-Herrero. Innovations haven't driven growth so far.

In addition, the crisis in the real estate market continues, despite all government support measures. With prices continuing to fall, real estate investments fell by more than 11 percent in the first half of the year. In June, prices for new apartments fell by just under 0.3 percent, the sharpest drop in eight months.

The worst times may be over, but the "sector is not an economic engine either," write the CBB experts. Before the crisis, the construction industry contributed up to a third of economic growth, both directly and indirectly. The ongoing crisis is slowing the overall economic recovery. In recent days, rumors of another government bailout attempt have increased. But there is a fundamental problem: As China's population shrinks, there is a lack of demand for new real estate.

The trade war between China and the United States is further exacerbating the problems by making access to the most important foreign market more difficult. Despite the 90-day tariff pause agreed upon in early May, US tariffs on many Chinese imports are 30 percentage points higher than before Trump's second term .

So far, this has hardly harmed the Chinese economy, partly because exports to other countries are growing strongly, Garcia Herrero emphasizes. However, if interest rates remain at this level, it could reduce China's economic growth by 1.6 percentage points in the future. Four to six million jobs are at risk.

But Trump's policies don't just affect direct trade between the two superpowers. The US president is trying to prevent China from diverting its exports through third countries like Vietnam through trade agreements .

Following the party leadership's unusually open criticism of overcapacity, a debate about future growth drivers has erupted among China's economists and policy advisors. It is particularly heated because the new five-year plan for 2026 to 2030 is currently underway.

The business magazine Caixin quotes political consultant Yang Weimin as saying that in previous five-year plans, the demand side of the economy has not been given sufficient importance. He was vice director of the Economic Committee of the Consultative Conference, the highest advisory body to the state leadership, and was involved in the development of previous five-year plans.

Yang advocates increasing the share of private consumption in gross domestic product to over 50 percent by 2035. This would make China's economy significantly more stable.

In view of the current challenges, “increasing domestic demand, especially private consumption, must be a key task in order to achieve growth,” says Wang Yiming, who previously worked on drafting the five-year plans at the influential National Reform and Development Commission (NDRC).

Calls for a boost to domestic demand are by no means new. The government talks "endlessly about stimulating consumption, but 20 years of talk have achieved nothing," criticize the CBB experts. So far, it has instead focused on promoting production, partly because this provides more control over which sectors the money flows to.

Whether the pressure is now great enough to abandon this mantra will become clear in the coming weeks. Recent speculation hasn't only been about new measures to stabilize the real estate sector. The economy is also traditionally the focus of the Communist Party Politburo meeting at the end of July.