Awaiting Policy Fine-tuning: Capital-Expenditure-Led Fiscal Support May Accelerate in the Third Quarter
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Awaiting Policy Fine-tuning: Capital-Expenditure-Led Fiscal Support May Accelerate in the Third Quarter
Morgan Stanley expects Beijing to strengthen fiscal implementation from the third quarter onward, focusing on strategic infrastructure such as AI and power grids rather than directly stimulating consumption.
- Second-quarter GDP tracking remains at 4.4% YoY, and the report expects a mild recovery in the second half supported by faster fiscal implementation and lower energy prices.
- The fiscal impulse still has not caught up: fiscal revenue rose 6.8% YoY in May, but expenditure fell 1.6% YoY; issuance of government bonds and policy bank bonds in June also showed no meaningful acceleration.
- Domestic demand remains soft, secondary-home transactions weakened again, Dragon Boat Festival travel showed "strong traffic but weak wallet conversion," and YoY auto and online home appliance retail sales continued to be weighed down by high bases.
- Exports remain resilient, with EPMI new orders stable at 53.1, above the year-to-date average of 52.1; container throughput growth slowed to about 3% YoY, but the higher share of air freight in tech exports does not necessarily imply weaker exports.
- Monetary policy continues transitioning toward an interest-rate-based framework, with the PBOC introducing new overnight reverse repos to ease end-quarter short-term liquidity mismatches, alongside a narrower interest-rate corridor.
Report interpretation
Overview
This report is Morgan Stanley's China sentiment and policy tracker. Its core view is that the economy and policy execution remained weak in the second quarter, but policy fine-tuning is being prepared. The report expects Beijing to accelerate capital-expenditure-centered fiscal spending from the third quarter onward, mainly focusing on strategic infrastructure such as AI and power grids, to stabilize short-term growth while serving long-term goals such as energy security, technological self-reliance, and supply chain resilience.
Core views
The report maintains its second-quarter GDP tracking estimate of 4.4% YoY and notes that an end-quarter push in industrial production may bring short-term inventory accumulation. On the export side, conditions remain relatively solid, with advanced manufacturing PMI and EPMI new orders still in expansion territory; on the domestic demand side, weakness continues, with real estate, holiday consumption conversion, auto sales, and home appliance retail sales all under pressure in YoY terms. On the policy side, stronger fiscal support has not yet clearly materialized but may accelerate in the third quarter; monetary policy, meanwhile, continues transitioning toward a framework centered on short-end interest rates through tools such as newly added overnight reverse repos.
Analysis framework
The report cross-validates high-frequency activity indicators with policy execution indicators: it uses EPMI, new orders, container throughput, secondary-home transactions, holiday travel, auto and home appliance retail sales, and construction activity to observe demand and production; it tracks the fiscal impulse through fiscal revenue and expenditure, government bond and policy bank bond issuance, and quasi-fiscal fund usage; and it judges the monetary policy framework through PBOC open market operations and changes in the interest-rate corridor.
Methodology notes
Synchronized observation of activity and sentiment
High-frequency indicators across manufacturing, exports, real estate, consumption, and construction are used to judge whether China's economic momentum is improving.
Speed of fiscal implementation
By combining on-budget fiscal revenue and expenditure, government bond issuance, policy bank bond issuance, and quasi-fiscal fund usage, it evaluates whether fiscal expansion is truly being converted into economic support.
Interest-rate-based policy framework
Through newly added overnight reverse repos, short-end liquidity management, and a narrower interest-rate corridor, it observes the transition of monetary policy from quantity-based tools toward a framework centered on short-term interest rates.
Quarterly GDP tracking
The report maintains its second-quarter GDP tracking estimate at 4.4% YoY and incorporates the end-quarter industrial production push and inventory changes into its assessment.
Asset mapping & comparison
Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).
- China macro assetsPolicy fine-tuning and fiscal implementation are the core variables for second-half growth expectations.
- Strengths
- Capital-expenditure-led fiscal support in the third quarter may underpin growth, while lower energy prices also help improve the terms of trade.
- Weaknesses
- Fiscal execution in the second quarter was slow, and domestic demand and real estate remain weak.
- Comparison
- Compared with the delayed policy execution in the second quarter, the report is more optimistic about marginal improvement in the second half driven by faster fiscal implementation.
- Risks
- If project returns, funding support details, and the pace of bond issuance fall short of expectations, the growth recovery may be delayed.
- Real estate chainWeakening secondary-home transactions show that real estate remains one of the drags on domestic demand.
- Strengths
- Marginal improvement in construction activity provides a small positive signal.
- Weaknesses
- The earlier rebound in transactions proved unsustainable, and household demand and market activity have weakened again.
- Comparison
- Real estate is performing worse than advanced manufacturing and the export chain.
- Risks
- If home transactions continue to decline, this will weigh on household confidence, local government finances, and related consumption.
- Advanced manufacturing, AI, and power grid infrastructureExpected to become the main destinations of third-quarter fiscal capital expenditure.
- Strengths
- EPMI remains in expansion territory, and policy goals are aligned with energy security, technological self-reliance, and supply chain resilience.
- Weaknesses
- Short-term demand still needs validation from actual fiscal project implementation.
- Comparison
- Compared with direct consumption stimulus, the report believes policy is more tilted toward strategic infrastructure investment.
- Risks
- Unclear project returns, financing support, and implementation details may affect the speed of investment execution.
- Exports and technology manufacturingExport resilience is a relatively positive growth support in the report.
- Strengths
- EPMI new orders remain stable at 53.1, and the higher share of air freight in tech exports helps offset the signal from slowing container throughput.
- Weaknesses
- Container throughput growth has slowed to about 3% YoY.
- Comparison
- External demand is relatively stronger than domestic consumption and real estate.
- Risks
- Weaker global demand, a cooling tech export cycle, or trade frictions may weaken export resilience.
- RMB interest rates and liquidityThe PBOC's newly added overnight reverse repos reflect more refined end-quarter liquidity management.
- Strengths
- The overnight tool can ease the maturity mismatch between previous 7-day reverse repos and the 2-3 day end-quarter funding squeeze.
- Weaknesses
- The easing signal from monetary policy is more about framework fine-tuning than large-scale stimulus.
- Comparison
- The policy focus is shifting further from quantity-based tools toward short-end interest-rate management.
- Risks
- If liquidity volatility persists or the transmission of the interest-rate corridor is not smooth, market funding conditions may still face periodic disturbances.
Key data
- Second-quarter GDP tracking4.4%同比The report maintains this tracking estimate and notes that the end-quarter industrial production push may bring short-term inventory accumulation.
- EPMI new orders53.1Above the year-to-date average of 52.1 and also above the 2024-25 average of 51.1, supporting the view of export resilience.
- Advanced manufacturing EPMI52.2Slightly down from the previous period, but still above the 2024-25 average of 51.0.
- Container throughput growth约3%同比Growth slowed in May and June, but the report believes that the higher share of air freight in tech exports means this does not necessarily represent weaker exports.
- May fiscal revenue6.8%同比Lower than April's 8.2%, but still maintaining relatively steady growth.
- May fiscal expenditure-1.6%同比Improved from April's -3.2%, but overall spending remains weak.
- Unused bond quota约60%Fiscal implementation was slow in the second quarter, with about 60% of the bond quota still unused.
- Quasi-fiscal infrastructure funds人民币8000亿元The report says that quasi-fiscal funds allocated for infrastructure have barely been used so far.
Impact & implications
If fiscal spending accelerates as expected in the third quarter, the likely beneficiaries will be strategic infrastructure areas related to AI, power grids, energy security, technological self-reliance, and supply chain resilience, rather than traditional consumption stimulus. For markets, the implication is that domestic demand and real estate remain drags in the near term, but policy support and falling energy prices may improve the growth trajectory in the second half; on the monetary side, the emphasis is increasingly on short-end interest rates and refined liquidity management.
Risks
- The pace of fiscal support may fall short of expectations, with government bonds, policy bank bonds, or quasi-fiscal fund usage continuing to be slow.
- If project returns and funding support details for the "six major networks" construction plan remain unclear for too long, infrastructure implementation may be delayed.
- Real estate transactions may continue to weaken, putting pressure on domestic demand, household confidence, and related industry chains.
- Holiday travel flows may fail to convert into consumer spending, with the quality of the services consumption recovery weaker than surface traffic data suggests.
- Export resilience may be weakened by slower global demand, a downturn in the tech export cycle, or trade frictions.
- If the end-quarter industrial production push results in inventory accumulation, it may front-load and weaken subsequent production momentum.
- If energy prices rebound, they may again intensify constraints on the domestic petrochemical sector and worsen the terms of trade.
What to watch
- Whether fiscal spending truly accelerates in the third quarter, especially in AI, power grids, and strategic infrastructure projects.
- The pace of government bond and policy bank bond issuance, as well as the usage of RMB 800 billion in quasi-fiscal infrastructure funds.
- Implementation details of the "six major networks" construction plan, project return arrangements, and funding support schemes.
- Whether EPMI new orders, container throughput, and tech-export-related air freight indicators continue to support export resilience.
- Whether secondary-home transactions, construction activity, auto sales, and online home appliance retail sales show sustained improvement.
- PBOC overnight reverse repo operations, end-quarter liquidity volatility, and changes in the short-end interest-rate corridor.
- Second-quarter GDP, the industrial production push, and inventory data, to validate the 4.4% YoY tracking estimate.