China's "two-speed" economy has a low GDP while it coexists with the end of three years of deflation.

China 's economy grew 4.3% year-on-year in the second quarter, the lowest rate in three decades — excluding only the exceptional period of Covid-19 restrictions.

The announcement made by the National Statistics Office indicates that Gross Domestic Product (GDP) growth is lower than the 5% recorded in the first quarter and below the official target of 4.5% to 5% for 2026.

The numbers reinforce the perception that the world's second-largest economy is going through a period marked by simultaneous signs of fragility and resilience, in a scenario where the historic fall in GDP coexists with the end of a three-year cycle of deflation .

In practice, this contradiction reinforces the two speeds of the Chinese economy: exports continue to grow strongly, while demand for consumer goods in the domestic market remains stagnant, confirming the structural imbalances that have become more evident over the past few months.

Domestically, the prolonged crisis in the real estate sector – with an 18% drop in investments in this segment compared to the previous year – shows that the domestic economy remains stalled, unable to transform industrial gains and technological advances into dynamism.

At the same time, the external sector is experiencing vigorous expansion. Chinese exports grew 27% in June, driven primarily by the global boom in artificial intelligence. Shipments of semiconductors abroad jumped more than 120%, and segments such as electric vehicles, industrial batteries, and solar panels continue to rise.

Industrial production grew 5.3% in the month, supported by international demand for high-tech products and the expansion of digital infrastructure in several countries. This contrast—strong industry, weak consumption—is cited by economists as evidence of a deepening structural imbalance.

Dan Wang, director of Eurasia Group in China, notes that the "stellar" export performance does not translate into benefits for consumers. "This becomes clear when you consider that the most dynamic sectors are highly automated and capital-intensive, generating few jobs and little income for families," she says.

The housing crisis, which drained savings and reduced household wealth, continues to limit consumption, even with occasional signs of improvement, such as the slight increase in retail sales and the drop in the youth unemployment rate to 15.6%.

Deflation defeated

The situation becomes even more complex with the end of the deflationary cycle that marked the last three years. The GDP deflator, a broad indicator of price variations in the economy, has turned positive for the first time since the beginning of 2023.

The reversal, however, does not stem from a robust domestic recovery, but rather from the increased cost of imported products—especially oil—following the start of the war in Iran. The energy shock raised prices of industrial inputs and helped China emerge from deflation, but did not eliminate domestic deflationary pressure, still fueled by oversupply in various sectors.

The cumulative downward price variation over the last three years – the longest period of deflation suffered by a major economy in decades – gives an idea of the complexity faced by the Chinese government. Since 2023, the average price drop has affected everything from real estate and cars (-27%) to food items such as pears (-31%), eggplants (-14%) and eggs (-8%).

Several factors contributed to this situation. In the case of the real estate sector, the persistent deflation over the past four and a half years, when a bubble burst with bankruptcies of construction and real estate companies, generated a crisis that affected consumer confidence, comparable to the 2008 crisis in the US.

Experts also cite the so-called "involution" factor, caused by excess production capacity generated by the state and weak domestic demand. As a result, Chinese companies entered a cycle of price and profit margin cuts to survive, leading to reduced wages and jobs and, consequently, a drop in consumption.

Despite the improvement in the deflator, consumer and business confidence remains low. The economy continues to depend on external stimulus, while trade tensions intensify. Europe and the United States have increased criticism of Chinese industrial dominance, arguing that the flow of exports harms local industries. In June, the US government proposed new tariffs of at least 10% on Chinese goods, citing concerns about forced labor.

Domestically, the Chinese government has adopted a cautious stance. The growth target for 2026, between 4.5% and 5% of GDP—the lowest in decades—indicates an official tolerance for a slower pace to deal with problems such as the indebtedness of local governments, which have reduced spending to contain high deficits.

The first signs of new stimulus emerged this week with the launch by the Chinese government of its first five-year plan focused on consumption, aiming to reach nearly US$9 trillion in annual retail sales by 2030 — a goal considered unambitious by experts.

In practice, the current scenario reveals a China with the "glass half full": despite the historic fall in GDP and persistent domestic weakness, the country benefits from a favorable external environment, which boosts exports and helps mitigate deflationary pressures.

But the "half-empty" glass remains evident. The growing dependence on foreign sales, the housing crisis, weak consumption, and geopolitical tensions create a vulnerable situation that challenges the government's ability to rebalance its economy.

The slowdown in the second quarter, coupled with the end of the deflation cycle, marks a turning point: China needs to decide whether to continue betting on the export model or finally move forward with the deep reforms that economists have been advocating for years.