China's Deepening Economic Slowdown and Stimulus Dilemma: Supply Chain Demand Uncertainty and South Korea's Response

Executive Summary

China's economic slowdown is a structural phenomenon rooted not in supply disruptions but in contracting demand from households and businesses. Early third-quarter growth fell further to the 4% range, and retail sales turned to a year-on-year decline in July. Beijing is likely to stick to selective, gradual measures, such as expanding the use of public housing funds, rather than implementing large-scale aggregate demand stimulus, due to concerns about rising debt and the need to maintain its political policy narrative. The gap between optimistic messaging from state media and actual economic indicators is expected to persist. The baseline scenario—characterized by entrenched low growth coexisting with credit risks from the real estate sector—has the highest probability of materializing. South Korea should revise down its export plans for raw and intermediate materials to China while simultaneously operating an early warning system for credit events in the real estate sector and reviewing its financial exposure.

I. Situational Analysis

China's Deepening Economic Slowdown: Stimulus Expectations and Supply Chain Demand Uncertainty

1. Background and Developments

China set its GDP growth target for this year at 4.5–5%. This is the lowest target announced in several decades [12]. The downward revision of the target itself can be seen as an admission by Beijing that returning to its past high-growth trajectory will be difficult.

Second-quarter growth already fell below the target range. In July, retail sales shifted to a year-on-year decline [12]. Industrial production and consumer spending also fell short of market expectations in July. Investment also continued its slowing trend [9]. Structural adjustments in the real estate sector are also underway. The verdict against Evergrande founder Xu Jiayin is an example showing that risks originating from real estate developers are still ongoing [12].

Beijing has long pursued a transition to domestic demand-led growth. During the 2012 Eurozone crisis, for instance, China ended its policy of yuan appreciation and simultaneously pursued export diversification and domestic demand expansion [2]. A similar policy direction is being repeated in the current slowdown. However, the addition of the variable of structural adjustment in the real estate market distinguishes the current situation from the past.

2. Current Situation

Goldman Sachs estimated that China's GDP growth in the early third quarter was approximately 4% year-on-year [1]. This represents a further decline from 4.3% in the second quarter [1]. Hui Shan, Goldman Sachs' chief China economist, diagnosed that the weak economic activity in July was "attributable to demand-side factors" [1]. This means the root cause is not supply-side production capacity issues but rather contracting spending by households and businesses.

Beijing's response has been limited so far. Vice Minister of Finance Liao Min announced that additional fiscal policy tools would be activated. However, he added the condition of maintaining the "continuity and stability" of macroeconomic policy [11]. He also mentioned a plan to increase the proportion of fiscal spending directed toward households and consumption [11]. As a concrete policy measure, the scope of use for the 10.9 trillion yuan public housing fund was expanded. Regulations were revised to allow residents to withdraw these funds for large expenditures such as home renovations [10]. This is considered the first policy response since the economic slowdown deepened in July [10]. However, it is closer to a gradual measure that broadens the use of an existing system rather than a large-scale stimulus package.

The People's Daily published a series of commentaries last weekend. These commentaries, published under the pen name 'Zhong Caiwen' (鐘才文), are known to be associated with the Central Financial and Economic Affairs Commission [4]. The commentaries claimed that domestic risks "are being resolved and controlled" [4]. They stated that if major projects gain momentum in the second half of the year and macroeconomic policies take effect in a timely manner, "China's economic performance will be maintained within a reasonable range" and the country "will successfully achieve its annual targets" [4]. A commentary by the same author in the Global Times assessed that "major macroeconomic indicators were generally stable" in the first half of the year, and self-praised the Party leadership, centered on Xi Jinping, for having "effectively responded to internal and external shocks" [7].

This expression of confidence from state media stands in stark contrast to the poor performance of real economic indicators. Among market participants, including Goldman Sachs, expectations for easing are being rekindled [1]. However, Goldman Sachs assesses that the authorities' actual measures remain at a gradual level [1].

3. Key Actors and Interests

Chinese Central Government and Ministry of Finance: The fiscal authorities, represented by Vice Minister Liao Min, have formalized the need to expand fiscal spending to boost consumption [11]. However, they must also consider the debt risks and policy credibility issues that a large-scale stimulus could create. The emphasis on the "continuity and stability" of macroeconomic policy is interpreted as an intention to avoid market turmoil from an abrupt policy shift [11].

Central Financial and Economic Affairs Commission (under Xi Jinping's direct control): Through the 'Zhong Caiwen' commentaries in the People's Daily and Global Times, it plays a role in managing the economic narrative [4][7]. Its clear objective is to prevent the erosion of domestic and international confidence by publicly reaffirming the possibility of achieving annual targets despite weak economic indicators. This is more a strategy of emphasizing the lagged effects of existing policies than admitting policy failure.

Foreign Investment Banks such as Goldman Sachs: Led by Chief Economist Hui Shan, they are diagnosing China's weak demand based on data and betting on the possibility of expanded easing policies [1]. Their forecasts act as indirect pressure on Beijing's policymaking, as they directly influence foreign capital flows into and out of China's government bond and stock markets.

Real Estate Sector Stakeholders: Even after the Evergrande incident, debt adjustments for real estate developers and households are ongoing [12]. The measure to expand the use of the public housing fund can be seen as an attempt to offset the decline in asset values in this sector by bolstering consumption capacity [10].

Export-Dependent Countries in Asia: Asian countries, including South Korea, are directly exposed to changes in Chinese demand. The speculation that the Bank of Korea will raise its 2026 growth forecast to the 3% range is partly based on the performance of exports to China, including semiconductors [14]. Whether China's demand for raw and intermediate materials recovers remains a key variable determining the export performance of these countries.

The EU and European Countries: China's trade surplus with Europe is actually expanding. As of July, its surplus had increased year-on-year with 24 of the 27 EU member states, and its surplus with Sweden quadrupled [13]. This suggests that weak domestic demand in China is leading to an expansion of exports of surplus production. With Brussels' October deadline for pressing China to rebalance trade approaching, the potential for trade friction is growing [13].

United States: The debate over the effectiveness of tariff policies against China continues. According to an analysis by the Peterson Institute for International Economics, the share of U.S. imports from China fell by 7 percentage points from 2017 to 2024, but dependence on a value-added basis, which includes goods routed through third countries, fell by only 2 percentage points [6]. This means that extensive supply chain rerouting has occurred. This point illustrates the structural limitations of U.S.-China supply chain decoupling, separate from China's growth slowdown.

4. Key Issues

The gap between the official narrative and market indicators is the first key issue. There is a significant difference between the optimistic commentaries in the People's Daily and Global Times and Goldman Sachs' growth estimate in the 4% range [1][4][7]. If this gap persists into the fourth quarter, it could escalate into a policy credibility problem.

The intensity and timing of stimulus measures are the second key issue. Measures taken so far have been limited to improving existing systems, such as expanding the use of the public housing fund [10]. The specific scale and implementation timing of the additional measures announced by the Ministry of Finance have not yet been confirmed [11]. The authorities' calculations are not simple, as a large-scale fiscal stimulus could exacerbate debt risks.

The dynamic whereby weak domestic demand translates into export expansion also warrants attention. China's growing trade surplus with Europe shows that the effects of its domestic slump are being passed on to other countries [13]. This could lead not only to trade friction with the EU but also to competition in export markets with rival countries in Asia.

The structural limitations of the U.S.-China supply chain realignment also act as a background variable. The fact that decoupling attempts via tariffs have had limited effect on a value-added basis [6] suggests that the ripple effects of China's growth slowdown on the U.S. market may be greater than surface-level trade statistics indicate. Whether Chinese demand recovers is a matter directly linked to cargo volumes and raw material prices throughout these rerouted supply chains, and it remains an urgent variable for regional supply chain participants, including South Korea, in formulating their response strategies.

II. In-Depth Analysis

China's Deepening Economic Slowdown: Structural Causes and Policy Dilemmas

1. Analysis of Root Causes

China's growth slowdown is not cyclical. As Goldman Sachs pointed out, the economic weakness in July was "attributable to demand-side factors" [1]. This means it is not an issue of production capacity or supply chain disruptions. It means that households and businesses are cutting back on spending.

Retail sales shifted to a year-on-year decline in July [12]. Both industrial production and consumer spending fell below market expectations [9]. Investment also showed a continuing trend of contraction [9]. The simultaneous weakness across these three indicators is difficult to explain as mere statistical noise. The three pillars of growth—consumption, production, and investment—have all faltered.

Vice Minister of Finance Liao Min identified "weak domestic demand" as a key target for policy response [11]. This statement is an admission by Beijing itself of where the problem lies. The judgment is that a fundamental contraction in household consumption capacity is the epicenter of the growth slowdown.

The adjustment in the real estate sector acts as a channel that amplifies this demand contraction. The verdict against Evergrande founder Xu Jiayin shows that risks originating from the real estate sector have yet to be resolved [12]. Housing constitutes the vast majority of Chinese household assets. The structure is one where falling housing prices and developer insolvencies translate into consumption contraction through the household wealth effect. Beijing's measure to expand the use of the 10.9 trillion yuan public housing fund directly targets this channel [10]. In a situation where real estate is acting not as an asset but as a source of debt and anxiety, this can be seen as an attempt to channel savings into consumption.

2. Structural Context

Political Constraints

The People's Daily commentary was published under the pen name 'Zhong Caiwen.' This is known to be associated with the Central Financial and Economic Affairs Commission, led by Xi Jinping [4]. This expression of confidence through state media is disconnected from the real economic indicators. A commentary by the same author in the Global Times self-assessed that "major macroeconomic indicators were generally stable" in the first half of the year [7]. The political need to maintain a leadership-centric policy narrative acts as a constraint on the adoption of bold stimulus measures.

Caution against expanding leverage is also evident. While announcing additional fiscal policy, Liao Min also emphasized the "continuity and stability" of macroeconomic policy [11]. This can be interpreted as a lesson learned from the debt accumulation and shadow banking expansion caused by the 4 trillion yuan stimulus package after the 2008 financial crisis. Wariness about the structural aftereffects of a large-scale stimulus is inherent in the policymaking process.

Economic Structure

China's growth target itself was set at 4.5–5%. This is the lowest official target in decades [12]. The downward revision of the target is a result that already reflects Beijing's recognition that returning to its past high-growth trajectory is difficult. Nevertheless, actual growth is falling short of even this lowered target. It slowed further from 4.3% in the second quarter to 4% in the early third quarter [1].

The transition to domestic demand-led growth is not a new task. During the 2012 Eurozone crisis, China had already ended its policy of yuan appreciation and simultaneously pursued export diversification and domestic demand expansion [2]. At that time, it succeeded in reducing the share of its exports to the EU from 20% in 2008 to 17% in 2012 [2]. However, more than a decade later, the transition to a domestic demand-based economy is still incomplete. The inertia of the real estate-dependent growth model can be seen as having delayed this transition.

External Structure: Supply Chains and Trade Surpluses

China's ability to generate external demand remains robust. As of July, China's trade surplus with the EU had expanded with 24 of the 27 member states [13]. Its surplus with Sweden quadrupled, and its surplus with Malta increased by 166.6% [13]. The pressure to offset weak domestic demand with exports is manifesting as an expanding trade surplus.

At the same time, U.S. attempts at decoupling from China are hitting structural limits. From 2017 to 2024, the share of direct U.S. imports from China decreased by 7 percentage points. However, when including Chinese value-added routed through third countries, the decrease is only 2 percentage points [6]. This means that tariffs have merely rerouted supply chains through third countries, while actual dependence on China has not significantly decreased. This suggests that China's demand slowdown is intertwined with the limits of global supply chain reorganization, which cannot be offset by U.S. tariff policy against China alone.

3. Comparison with Historical Precedents

The 2012 Eurozone crisis period and the current situation show similarities in their response approaches. At that time, too, China opted for a gradual combination of exchange rate policy adjustments, export market diversification, and domestic demand stimulus instead of a large-scale stimulus package [2]. In the current phase, Liao Min's announcement of fiscal policy and the expansion of the public housing fund's use can be seen as the same type of gradual response [11][10].

However, there is a crucial difference from 2012. Back then, the real estate market still functioned as an engine of growth. Now, real estate has transformed into an object of structural adjustment and a risk factor, symbolized by the Evergrande incident [12]. Policy leeway is more limited than in 2012, as Beijing faces the dual challenge of trying to expand domestic demand while simultaneously managing asset deflation originating from the real estate sector.

A comparison with the COVID-19 situation in 2020 also offers insights. At that time, as China succeeded in controlling the pandemic, there were forecasts that its relative position in the global economy would be strengthened. The assessment was that China could turn the crisis into an opportunity for relative ascent while the United States and Europe failed to contain the virus [5]. However, the current situation stems not from an exogenous shock like the pandemic but from endogenous factors such as weak domestic demand and the real estate adjustment. Unlike in 2020, when it could showcase its national capacity in response to an external shock, China is now in a position where it must use state media commentaries to bridge the gap between its policy narrative and real economic indicators [4][7].

4. Key Variables Shaping Future Developments

The first variable is the speed and scale of fiscal policy implementation. The key question is the scale to which the additional fiscal tools announced by Liao Min will be materialized within the constraints of "continuity and stability" [11]. If measures remain at the level of institutional reforms, such as expanding the use of the public housing fund, they are likely to be insufficient to reverse weak demand [10].

The second variable is the end point of the adjustment in the real estate sector. The timing of the conclusion of legal proceedings related to Evergrande and the restructuring of developers is a prerequisite for the recovery of the household wealth effect [12]. The longer the adjustment period, the more the recovery of consumer sentiment will inevitably be delayed.

The third variable is the response of trading partners to external demand, especially to China's expanding trade surplus with the EU. An October deadline is approaching as Brussels pressures Beijing to recalibrate their trade relationship [13]. If Europe takes defensive measures, China's capacity to offset weak domestic demand through exports could be constrained.

The fourth variable is the impact on policy credibility from the disconnect between the optimistic narrative in state media and actual economic indicators. The extent to which a series of commentaries in the *People's Daily* and *Global Times* can temper market expectations for stimulus will be a key gauge of whether consumer and investor sentiment stabilizes in the future [4][7][1].