President Xi Jinping and US President Donald Trump have met twice and are expected to meet two more times this year. Will the meetings deliver stability in trade, investment and broader economic ties? Can businesses now proceed with their trade and investment plans with greater clarity and confidence? Is the two-month extension of the tariff truce a disappointment?

The successful meetings this year could help steer the US-China relationship towards managed competition: modestly expanding cooperation in non-sensitive areas such as trade, agriculture and other commercially practical sectors, while important strategic differences – particularly around technology and national security – are likely to persist.

Deep economic interdependence gives both sides an incentive to maintain a floor under the relationship and reduces the potential for broader escalation. That should make bilateral ties more predictable, even as de-risking, localisation and restrictions in sensitive areas continue.

We expect the improvement in clarity and confidence to be concentrated in non-sensitive sectors. Recent progress around the Board of Trade, including reciprocal tariff reductions on around US$30 billion of non-sensitive goods, suggests that both sides are willing to offer incremental stability where national-security concerns are less prominent.

However, in technology, critical minerals and other strategically sensitive areas, we believe the broader direction remains towards localisation and tighter controls.

Amid the slowdown, Beijing has rolled out new measures recently, including mortgage loan subsidies and rate reductions. Are they enough? Has Beijing become more tolerant of the slowdown while remaining convinced of long-term prospects?

China is undergoing a challenging economic transformation, as old growth drivers face diminishing returns. Deflation pressures have persisted, and domestic demand remains weak.

But in the meantime, there is a structural transformation taking place in the country towards what we call the Industrial Revolution 5.0.

This transition will require a lot of spending and capital expenditure. We estimate around US$6 trillion factory upgrade investment in areas like robotics, smart machinery, industrial software, power grids and related infrastructure. In addition, we see another US$6 trillion investment being directed towards strategic new capacity. In total, this represents about US$12 trillion in incremental capex over the next 10 years.

The hope is that this decade-long capex supercycle in advanced manufacturing can help offset the drag from deflation and gradually replace old growth drivers like housing and infrastructure investment.

China is now in a two-speed, K-shaped economy. The top half of the K is showing some bright spots in manufacturing, artificial intelligence and in different emerging sectors.

But you also have a huge bottom half of the K: an “old economy” like housing, consumption, a job-intensive services sector and so on. They are now under a cyclical, very painful adjustment.

Beijing has stepped up targeted easing to cushion the downside. This signals a greater willingness to deploy central fiscal resources directly to support housing demand.

Yet the overall package remains modest, unlikely to reverse confidence-driven household deleveraging due to a weak job market outlook while the existing mortgage rate is still at 3 per cent. There is still the risk of continued pro-cyclical policy tightening amid structurally lower land sales and elevated local government debt.

We thus expect full-year real GDP growth to remain near the lower end of the 4.5 to 5 per cent target range. So, what is your take on this two-speed, K-shaped economy?

My view is that the top half of the K will be stronger in the future, leading to the next industrial revolution, contributing to US$12 trillion in new capex, and that’s going to be very powerful in offsetting the drag from old sectors.

Housing investment as a share of GDP will decline to only 3 per cent, and the share for traditional infrastructure will also decline to 4 per cent. Industrial capex right now is 17 per cent of GDP. We think it will increase to close to 20 per cent in 10 years.

That being said, 10 years is a very long horizon. For now, we are seeing deflationary pressure lasting longer than expected.

At the end of last year, some observers assessed that China was gradually reflating, with housing prices stabilising and [consumer price index] and [producer price index] showing signs of improvement. They argued that maybe China was “out of the woods”. We disagree. China’s deflationary pressure remains quite prolonged.

Another key issue is the ongoing household deleveraging cycle, which began around 2021, when the housing market peaked. Nearly five years on, households are still deleveraging.

Household debt growth has now turned negative, marking the first absolute contraction on record. This suggests that precautionary savings remain very high, with households prioritising debt repayment while the housing sector continues to adjust.

Even though households have not borrowed much in the past five years, the issue is that asset prices have also been falling. In other words, the denominator is shrinking as well. This creates a typical deflation trap: asset prices decline, sometimes faster than households can pay down debt. Thus, household leverage remains relatively high.

People still feel the need, the urgency, to continue to deleverage. Deleveraging, in turn, is bad for consumption.

In this environment, I think a typical approach should be much more aggressive countercyclical central government borrowing: the central government widens the deficit to support consumers and corporates.

But I think policymakers appear to remain cautious about a much larger demand-side stimulus. They likely view a broad consumption transfer as unsustainable, which will not contribute to long-lasting productivity growth.

Instead, the strategic priority remains firmly anchored on the supply side: self-sufficiency, manufacturing resilience, national energy security and related objectives. These remain the real priorities.

That’s why, in my view, the bottom line for near-term policy is that it will likely defend the growth floor, rather than deliver a meaningful consumption- or housing-led reflation package.

Deflationary pressure may persist until the housing market finds a structural bottom and until the productivity benefits from AI are more fully unleashed as part of the transition towards a new industrial revolution. Over time, that could contribute to stronger potential GDP growth – but that will take time.

Various government departments have recently made regulatory moves, including controls on cross-border capital flows and taxing offshore products, that have been seen by some as a signal of tightening. What is your view? How do they compare with the curbs seen in 2021?

There are currently two contrasting narratives. The first is that there is growing discussion and hope for another pivot like September 2024: a larger demand-side stimulus package or a “bazooka”, aimed at reflating consumption and stabilising housing prices.

Many argue that such support is needed because the economy is still in deflation, second-quarter GDP fell short of the target and high-frequency data is tracking at a subdued level.

But on the other side, a lot of corporate leaders and foreign investors are asking a very different question: do recent policy moves signal a return to the 2021 playbook – that is, another round of broad-based regulatory tightening? My answer is “neither”.

The 2021 tightening cycle was unique. It was a proactive, top-down regulatory reset across multiple sectors, including internet and tech, after-school tutoring, property, gaming, healthcare and others. It also took place against a different macro backdrop: China had been first into the initial Covid-19 shock, and among the first to recover from it.

China’s growth was more robust back then. Against that backdrop, policymakers proactively initiated this broad regulatory reset.

Today, however, I do not think what we are seeing is another policy reset. It looks more like stricter enforcement of existing regulations, because the overarching regulatory framework has already been in place for some time.

In a deflationary environment, the housing market remains under adjustment, which means new project launches and land sales are likely to remain weak. At the same time, subdued nominal GDP growth weighs on corporate revenue growth. The result is growing pressure on government revenues from land and corporate value-added tax.

The macro challenge is the “fallacy of composition”. Each micro-level action may be rational on its own – controlling risk, collecting revenue, closing fiscal gaps or maintaining stability. But if many agencies tighten enforcement at the same time, the aggregate effect can become macro tightening.

That is essentially pro-cyclical tightening. This means when the economy is already under deflationary pressure, policy should arguably be moving in the opposite direction: widening the deficit, supporting households and easing pressure on corporates. Instead, we are now seeing pro-cyclical tightening due to micro-level enforcements.

Pro-cyclical tightening can occur when governments enforce contradictory policies during an economic turndown, which can worsen the slump. What types of enforcement policy are currently in place that may contribute to this effect? There are three areas of recent enforcement.

First, in housing, the shift from presales towards completed-home sales will slow developers’ asset turnover.

Second, social pension contributions are being tightened. In the past, many small and medium-sized enterprises (SMEs) contributed based on the minimum salary; but starting this year, they need to contribute based on a higher real wage.

The third is taxation. Tax authorities are now paying closer attention to higher-income individuals. And lastly, some companies that previously benefited from local tax rebates or preferential treatment are also facing tax clawbacks.

Based on our estimate, the tax and social security contribution measures could create a fiscal and cash-flow drag equivalent to around 1 to 2 per cent of GDP. This may not sound large, but in a deflationary environment, the last thing corporates and households need is an additional burden.

In fact, there has been a de facto fiscal consolidation in the last 12 months, with the augmented fiscal deficit narrowing by 2.5 percentage points of GDP.

The bigger issue is confidence. While this could further weaken private-sector sentiment and capex, more broadly, this kind of micro-level tightening runs counter to the need for more proactive reflationary policy.

In September, Beijing unveiled a capital injection of 360 billion yuan (US$53.7 billion) in state-owned banks and insurers. What is your take?

That was already part of the 2024 plan, which widened the deficit for a few purposes: partly to support consumers through trade-in programmes and partly to stabilise the financial system. So this is not new.

The key issue is the trade-off between state-owned financial sector stability and household balance sheet stability.

If we look at other countries, policy has often supported household deleveraging more directly, for example through aggressive rate cuts. In China, however, policymakers appear to have placed greater emphasis on financial-sector stability. As a result, while rates have been lowered, the reduction in household debt-servicing burdens has been more modest than in many other economies.

The trade-off is that household deleveraging may take longer. Households are trying to pay down debt, but their mortgage burdens have not fallen meaningfully, especially as income growth has also slowed.

So the risk is that the harder households try to deleverage, the more demand weakens – reinforcing a classic deflationary trap.

Over the longer run, China needs to address unbalanced growth and weak consumption, which means shifting from a supply-led growth model to a more consumption-driven one.

This can be realised by building a stronger social safety net. Better access to public housing, education, healthcare, pensions and unemployment protection would reduce precautionary savings and help unlock household spending.

If China’s priorities remain as technology self-sufficiency, supply chain resilience, energy security and geopolitics, then fiscal and financial resources available to support consumers will be limited.

That said, there is still a great deal China can do to gradually rebalance the economy, but this will take time and the risks of a deflationary trap may need to become more fully recognised.

We believe more aggressive central government fiscal policy is needed – with a larger deficit aimed at supporting demand and consumption.

US government debt continues to breach successive ceilings, triggering significant sell-offs that have driven up borrowing costs. What are the implications? What lessons should China, as a major holder of US Treasuries (see SCMP Plus factsheet), draw from these developments?

If we look at how the US uses government borrowing, the majority is on welfare-related spending, including healthcare. By contrast in China, it’s more on capital formation, capex and investment.

These are two very different approaches. In my view, both economies need some form of rebalancing.

For the US, the priority should probably be gradual fiscal consolidation, reducing the deficit over time while redirecting spending towards reinvestment. For China, given its large manufacturing base and extensive infrastructure, fiscal policy may be more effective if it is directed towards consumption, household welfare and social support.

For investors, the near-term uncertainties are clear. There is still debate over the path of US monetary policy, including where the Fed’s terminal rate will settle, as well as how the US government may respond to pressure on Treasury yields.

But my sense is that most global investors still view corporate America as profitable and innovative. While concerns about US government debt exposure may lead to some hedging, confidence in US assets remains broadly intact.

A key reason is fundamentals: US companies continue to be seen as strong, profitable and innovation-driven, which helps support the broader appeal of American assets.

In this part of the world, many still argue that US government debt is too high and without fiscal consolidation, sovereign credit risks could eventually emerge.

When you speak with global investors, the picture is more nuanced. Many may adjust their exposure to US government debt or demand a higher long-term risk premium on Treasuries. Yet they remain broadly confident in corporate America. Thus, there are almost “two Americas”.

China faces a different challenge. Global investors generally view the central government’s fiscal position and the state-owned financial system as quite robust, largely because China has prioritised financial sector resilience, especially the profitability and stability of state-owned financial institutions.

Few investors are seriously concerned about Chinese sovereign risks, systemic financial risk or China’s long-term national competitiveness.

If anything, China’s industrial strength and supply-chain advantages remain clear. The bigger concern is corporate profitability. Foreign investors are less certain whether Chinese companies can deliver sustainable earnings growth.

This is also a challenge for China to attract more foreign capital and FDI. Yes, China’s supply chain advantages and geopolitical competitiveness are all well recognised, but the key question is whether these strengths can be translated into visible, predictable and sustainable improvements in corporate profitability.

The yuan has been on a steady path upwards, despite Beijing reiterating it has neither the need nor the intention for competitive trade advantages through currency depreciation. What is your take?

There are market voices talking up the possibility of further yuan appreciation, with some even predicting significant strengthening in the next few years. Their argument is largely based on China’s trade surplus. Given the sheer scale of that surplus, they argue that the yuan is likely undervalued.

I am not fully convinced. If we look at other East Asian economies, such as Japan and South Korea, large trade surpluses have not automatically translated into sustained currency appreciation.

A trade surplus is just one side of the story. The other side is the capital account. The key question is what happens to the surplus – is it reinvested domestically or deployed offshore in search of better returns?

In the cases of South Korea and Japan, a sizeable portion of their trade surplus has been reinvested overseas – usually in US assets, like bonds or the stock market, because their domestic yields are lower than offshore ones.

China is facing a similar challenge. Yes, China does run a large trade surplus, but persistent deflationary pressure means domestic yields and assets remain relatively unattractive. Government bond yields have been hovering below 2 per cent, while the stock market has recovered from two years ago but is largely muddling through.

Against this backdrop, it’s natural that many exporters, after receiving their export proceeds, may prefer to park their funds offshore and invest in overseas assets instead.

If we look at the broader balance-of-payments picture, it does not clearly support the view that the yuan is undervalued.

What would support a much stronger, sustainable yuan appreciation would be a genuine rebalancing of China’s economy, driven by faster and more effective domestic reflation.

When nominal GDP growth recovers, corporate revenue and profit growth should also improve. In turn, bond yield and equity earnings will likely be higher too, making Chinese assets more attractive, which will provide a more durable foundation for yuan strength.

This year, the yuan may even break 6.7 against the US dollar, but we don’t believe China is actively seeking a significantly stronger currency at this stage.

In our previous interview in March 2025, you highlighted “green shoots” in the tech sector. With China’s AI boom and the rise of new players, from robotics to chipmaking, can green shoots evolve into a new growth driver? Can technology alone sustain – or even accelerate – growth?

I think what we’re seeing now is more than just “green shoots”. In a K-shaped economy, the upper arm of the K is becoming stronger, supported by a profound structural transformation taking place underneath the surface of deflation, something we call the Industrial Revolution 5.0.

Historically, there have been four major industrial revolutions: mechanisation; then electrification; then automation; and fourth, digitalisation, which broadly unfolded from the 1970s through the early 2000s.

Now, China may be among the first economies to move meaningfully into a fifth industrial revolution, one enabled by industrial intelligence and the large-scale deployment of physical AI.

This is not limited to humanoid robots. It is about the broader integration of AI-native operating systems into the physical economy – drones, EVs and robotics in different forms.

Right now, China has 8 million such systems deployed across factories, transport and logistics. That number could rise tenfold to roughly 80 million by 2035. This large-scale deployment of next-generation AI in the real economy could help address China’s labour constraints.

China’s population is ageing and shrinking, but the deployment of physical AI may be sufficient to offset much of the resulting labour shortage. That’s the first key enabler; we call it intelligence.

The second enabler is resilience. Under the 15th five-year plan, China is trying to address all key chokepoints across its domestic technology stack, including areas such as semiconductor equipment, industrial design software and very high-end computer numerical control machines.

China has historically relied on foreign technology in several of these critical areas, and it is now trying to reduce that dependence with localisation.

Finally, there is leadership. China is moving beyond just exporting finished goods assembled domestically to exporting a full-stack industrial ecosystem, including global standards.

Taken together, intelligence, resilience and leadership suggest that China is entering this next industrial revolution from an unmatched starting point.

China already accounts for 28 per cent of global manufacturing value added and the country covers all of the 666 industrial categories and subcategories defined by the United Nations. That breadth gives China extraordinary scale, depth and flexibility across the industrial system.

China also has a large and expanding base of smart manufacturing capacity, including tens of thousands of smart factories supported by 5G and Internet of Things infrastructure. That’s why it can move away from just [being] a factory country to something broader – an industrial operating system for the world.

In conversations with international investors, China’s industrial story is often too quickly dismissed simply as a narrative of overcapacity, low margins or even trade-war-induced decline.

These narratives do not fully capture what is happening. We believe a more important story lies in what’s coming next: China transitioning from being the world’s factory to the world’s industrial operating system.

This could help China address key chokepoints across supply chains. This is also a story about leadership.

A lot of sectors could benefit, such as industrial automation, semiconductor equipment, robotics components, industrial ecosystem software and so on.

If China can accelerate this technology revolution while adopting a more effective approach to economic rebalancing, for example, by using government financial resources to support consumption and welfare, its growth model could become much more sustainable.

Importantly, the capex cycle associated with embodied AI does not have to be value-destructive. It could drive fundamental improvements in productivity, margins and potential GDP growth, creating a more durable foundation for long-term economic expansion.

Through deeper reform and rebalancing, China could also break the deflation trap, which in turn will reinforce its technological progress. Stronger domestic demand is essential because firms need the ability to sell products and services at healthy prices in the home market.

Ultimately, China would benefit from a demand-driven ecosystem, one that gives companies the confidence to invest, hire and spend more on research and development. If policymakers continue to deepen their understanding of this dynamic and deliver the reforms required, China’s Industrial Revolution 5.0 could become not only a technological transformation but also a more sustainable growth model.