According to research by a well-known international investment bank, if policies do not timely support domestic demand, the risk of deflation in China is increasing. Xie Jinhe, Chairman of Caixin Media Group, believes that the most profound experience for China in the next 10 years will be deflation.
In the second quarter, China’s GDP reached the weakest growth rate in over three years, with industry insiders noting a further cooling of economic activities. Despite the boost in exports from the artificial intelligence (AI) boom, it has not been able to offset declines in other sectors.
A research report from Morgan Stanley, a renowned international investment bank, shows that the risk of deflation in China is on the rise. While exports provide some cushion, they may not be enough to offset weak domestic demand. Since last year, China’s overall exports have grown by an average of about 10.5%, but the export structure deserves attention. Technology-related products have contributed the most to export growth, but their spillover effects on the overall economy are relatively limited.
The report suggests that ideally, expanding exports could boost profit margins in non-commodity industrial sectors, further driving wages and consumption, forming a positive cycle between exports, income, and domestic demand. However, if the residential sector continues to deleverage significantly at the current pace while fiscal policy remains tight, export growth may still not be sufficient to fully offset weak domestic demand.
The report points out that a key reason why the current deleveraging process feels particularly “painful” is that the real estate market has not been able to provide support as it did in the past. The share of real estate fixed asset investment in GDP has been steadily decreasing compared to China’s historical trend, currently even lower than the level in 2004. The Chinese property market may still remain in a downturn for some time. On one hand, past real estate activities have been prolonged at levels above what is sustainable, meaning adjustments may need more time; on the other hand, demographic structures continue to suppress housing demand, with the declining total population posing a long-term structural challenge for the real estate market.
Another key change is the noticeable acceleration in the deleveraging speed of the residential sector. Between 2022 and 2024, the ratio of household debt to GDP in China remained relatively stable, while leverage continued to rise in the corporate and government sectors. However, a turning point emerged in 2025 when households began reducing their debt-to-GDP ratio. In 2026, the deleveraging efforts have further strengthened, with this year estimated to potentially mark the first year of a decrease in Chinese household debt. The other end of the household balance sheet reflects this trend as well, with China’s household savings rate reaching a new high since 2022 after seasonally adjusted in the second quarter of 2026.
The report indicates that in a deflationary environment, pressure on household income growth, coupled with limited policy support for consumption, leads families to cut spending and increase savings. With the current deleveraging efforts by the household sector in China and the economy facing deflationary pressures, there is a greater need for fiscal policy support. With insufficient demand, the issue of overcapacity persists, putting the economy at risk of falling into a deflationary cycle. Even with strong exports, the Chinese economy may still face a tug-of-war between “exports supporting external demand while households deleverage impacting domestic demand.” If fiscal support is not increased in a timely manner, the risk of China falling back into a deflationary zone will further rise.
Xie Jinhe, Chairman of Caixin Media Group, posted on Facebook on September 7, entitled “China is gradually moving towards the Japanese trap!” Since 2017, the bursting of the real estate bubble in China has caused consumers to be the first hit. This is because after the decline in real estate prices, people are pessimistic about the future and prefer to hold onto more cash.
Xie Jinhe analyzed that the most difficult aspect for the next 10 years will be the turmoil of deflation. Taking Japan after the bursting of the real estate bubble as an example, people are even more hesitant to consume. “This is what Mr. Gu Chaoming calls the repair of the balance sheet. Even with lower interest rates in Japan, people are not willing to borrow, but are striving to repay debts! After thirty years, Japan has finally overcome its bubble economy.”
Xie Jinhe stated that currently, the Chinese yuan is appreciating significantly, and interest rates in China continue to decrease. During times of declining interest rates and currency appreciation, this is the most difficult period of deflation. At this time, China should be more open to attract global funds for investment. However, with current strict regulations and increased taxation and fines on businesses, money flows in the opposite direction, and internal efforts are made to move money abroad. Central supervision is becoming stricter. “If these phenomena do not change? The next decade in China will be even harder than the previous one!”