The rise of AI. AI is among few industries that aligns the government’s long-term growth plan and enterprises’ incentive to find new profit drivers, while accommodating external pressures and internal economic transition needs. Meanwhile, China possesses several advantages in supporting AI development. (1) The AI model training cost in China is visibly cheaper than many countries. (2) China has strong support in green power generation to accommodate increasing electricity demand of AI data centers. (3) China has many well-trained researchers, and its science and technology cluster rank No. 1 globally. (4) China has large population and netizen (internet citizens), which provides a significant size of data for training.

However, the unavailability of most edge-cutting chips and the government’s intention to pace AI development due to potential side effects on employment have constrained China’s AI capital expenditure (capex) growth especially compared to that of US. Chinese companies need to balance the risks among less efficient homegrown chips, more advanced overseas chips (but with supply uncertainty), and their compatibility to local systems. Meanwhile, AI shock to the labor market is a key risk that policy makers must consider especially when old growth engines are losing steam. Therefore, the positive spillover from AI models to commercial application is relatively small at the current stage. According to official estimates, the AI economy size (including the core AI sector and its downstream applications) only accounts for 0.8% of gross domestic product (GDP) in 2025, and we expect its contribution to grow to approximately 1% in 2026.

Continued struggle of the “olds”. The housing sector saw a visible sales and fixed asset investment (FAI) drop in 2025, and each round of housing policies just provided temporary support rather than lasting impact. As new sectors are growing and capital market sentiment pays less attention to housing sluggishness, we expect policy makers will focus less on real estate and any further arrangement will just try to slow the falling pace instead of changing the direction. Therefore, negative spillover to household income expectation via the wealth effect remains. 2025 saw meaningful fiscal impact transmission to consumption via goods trade-in; such support is likely to stay in 2026 and will diversify its coverage to tourism, catering, sport entertainment, elderly consumption and other services consumption.

Tariff concern is reduced but export’s GDP contribution may decrease in 2026. China’s 2025 exports outperformed most investors’ expectation and contributed approximately 1.5 percentage points to the GDP growth rate, which is mainly driven by strong transshipment, export front-loading and the expansion in non-US markets. Concerns around tariffs are largely reduced following the recent trade war truce. That said, we expect exports to moderate in 2026 due to weakening external demand, higher average global tariffs and the payback of 2025 front-loading. We expect net export contribution to GDP will be reduced by more than half compared to that of 2025.

Another year of cyclical support to buy time for “news” growth. We expect GDP growth to moderate to 4.5% in 2026, mainly due to the decreased contribution of net exports. Fiscal policy will continue to focus on FAI (technology upgrading not real estate) and consumption. We expect central government fiscal deficit of GDP will stay at 4% of GDP. Meanwhile, special Chinese Government Bonds (CGB) and local government (LG) special bonds will be upsized to CNY1.8 trillion (trn) and CNY4.4trn respectively. More flexibility can be seen in quasi-fiscal if economic momentum is weaker than expectation. We expect a 10-20 basis point (bp) policy rate cut in 2026, and we think a 50 bp Reserve Requirement Ratio (RRR) cut is possible to complement CGB purchase in liquidity management. However, in general, we don’t expect aggressive easing by the People's Bank of China (PBoC) as (1) the remaining room for both the policy rate and the RRR is small and (2) monetary policy is not the key handle when structural issues weigh on aggregate demand amid economic transition.

Investment implications. China growth is expected to moderate in 2026 and deflation to remain in place (with gradual normalization), which anchors rates downside. Rates upside is also capped by limited easing and PBoC curve management. We expect CGB to be in range trading in 2026 (use spikes in yield to receive).

20d74dd1-d492-11f0-ba96-cf4c2a01c0e9