China’s Economy Undergoing K-Shaped Differentiation: Strong Exports, Pressured Domestic Demand

Overview

In its latest market sentiment tracking report, Morgan Stanley notes that although April’s economic activity data fell short of expectations across the board, this largely reflects the impact of oil price shocks and a temporary slowdown in fiscal policy. The report underscores that broader second-quarter data support its structural narrative: China’s economy is increasingly exhibiting a pronounced “K-shaped” dual-speed growth pattern. On the one hand, domestic demand—particularly consumption and real estate‑related activity—remains subdued; on the other, bolstered by the global supercycle in AI and energy capital spending, exports and high‑value‑added manufacturing continue to hold strong. The firm maintains its baseline forecast of 4.8% real GDP growth for 2026 and views oil price dynamics as a key swing factor determining the trajectory of subsequent growth.

Core views

Dual Pressures Behind April’s Weak Data: The report attributes April’s subdued growth not to a single factor, but to the combined impact of oil price shocks and a waning fiscal stimulus. Rising oil prices have both eroded domestic income through deteriorating terms of trade—undermining already fragile consumer confidence—and directly driven a sharp decline in capacity utilization across sectors such as petrochemicals since March, imposing output constraints. Meanwhile, although first-quarter GDP outperformance may have sparked a brief sense of complacency at the policy level, general public budget spending fell year over year in April, while the pace of issuance for general government bonds and local government special-purpose bonds has slowed markedly after a robust first quarter. Domestic Demand Remains Lagging: High-frequency data indicate that domestic consumption momentum remains muted. Year-on-year growth in passenger car sales and online appliance sales has weakened further on a month-to-month cumulative basis, reflecting the drag of a high base and diminishing policy effects. Construction-related indicators are equally weak, with cement shipments and rebar demand hovering near multi-year lows—signaling a mechanical slowdown in housing construction due to insufficient new project starts earlier in the cycle, as well as tepid capital spending on traditional infrastructure. Upstream utilization rates are also under pressure, with low utilization of liquefied natural gas (LNG) and crude oil, and further deterioration in asphalt utilization. Exports and High-End Manufacturing Show Resilience: In stark contrast to the sluggish domestic demand, exports and high-end manufacturing sectors have demonstrated remarkable resilience. Despite the oil price shock, container throughput at major ports has remained stable. While the purchasing managers’ index (PMI) for emerging industries has softened slightly from April, it remains at a solid level, and export orders remain robust. This suggests that global demand for AI infrastructure and energy transition is supporting China’s high-value-added manufacturing segment. Policy Outlook: Fiscal Acceleration and Monetary Easing: Given April’s monthly GDP growth of around 4% and the tepid performance of May’s high-frequency indicators, the report concludes that Beijing may need to step up fiscal deployment starting in June to prevent second-quarter GDP from falling significantly below the 4.5% target and to lay the groundwork for a timely re-acceleration in the second half of the year. Currently, net issuance of both general and special-purpose bonds remains subdued, likely reflecting a transitional phase characterized by an insufficient pipeline of eligible projects. On the monetary front, the central bank is expected to maintain ample interbank liquidity via the DR007 rate. With loan demand weak and government bond issuance slowing, DR007 has remained below the policy rate since April; as bond issuance picks up, the rate may edge higher, though this should not be interpreted as an active tightening of liquidity. A New Direction for Infrastructure: “Six Networks” Development: Recent policy guidance underscores the need to accelerate planning and construction around the “Six Networks”—water management, next-generation power grids, computing‑power networks, next‑generation communications, urban underground utility networks, and logistics. The report views this approach as pragmatically aligned with both short-term growth stabilization and long-term structural priorities, including energy security, AI infrastructure, and supply-chain resilience.

Analysis framework

This report employs a “Two‑speed Economy” analytical framework to interpret China’s macroeconomic data. Rather than treating aggregate GDP or industrial output as a simple average, the analysis disaggregates the economy into two distinct components: the “domestic demand side,” driven by consumption, real estate, and traditional infrastructure; and the “export and high‑end manufacturing side,” propelled by global value‑chain specialization, technological upgrading, and external demand. By decomposing the economy in this way, analysts can explain why, despite seemingly weak headline indicators—such as April’s data—certain high‑frequency metrics, including container throughput and PMIs for emerging industries, remain robust. This methodological approach enables readers to appreciate that current economic vulnerabilities are primarily concentrated in domestic circulation, weighed down by oil prices and the property sector, while external demand and technology‑driven internal structural upgrades continue to provide support. Furthermore, the report incorporates “oil prices” as a key exogenous variable, examining their dual effects on domestic income distribution (terms of trade) and production costs (capacity utilization), thereby deriving a range of scenario assumptions.

Methodology notes

• Industry/ Sector Analysis FrameworkSupply-and-Demand Framework

  K-shaped growth divergence (two-speed economy)

  We divide the economy into two distinctly performing segments: on one end are the weaker sectors weighed down by domestic demand and the property market, while on the other are the stronger sectors driven by exports and high technology. This analytical approach better illuminates structural imbalances and opportunities than a mere aggregate‑level perspective.

• Macroeconomic frameworkOthers

  Oil prices as a key swing factor

  Under specific macroeconomic conditions, it is crucial to identify key external variables that exert a nonlinear amplification effect on economic growth. In this analysis, oil prices not only influence inflation but also, by compressing household incomes and constraining upstream capacity utilization, serve as the tipping point that determines whether the economy transitions to “resilient growth” or enters a sustained downturn.

Key data

• 2026 Real GDP Growth Forecast4.8%Under the baseline scenario, the forecast assumes that oil-price–related tail risks will be mitigated by the end of the quarter.
• April Monthly GDP Estimate~4.0%Reflecting the short-term trough following the oil price shock and fiscal slowdown
• Second-quarter GDP growth floor target~4.5%To prevent significant deviations from the annual targets, the threshold for fiscal support needs to be lowered.
• DR007 vs Policy RateDR007 < Policy RateSince April, money market rates have remained persistently below the policy rate, indicating ample interbank liquidity.

Impact & implications

For the market, this means that China’s economic outlook should not be painted in gloomy terms based solely on the weak data from April. Structural opportunities remain, particularly in export‑oriented high‑end manufacturing sectors tied to global AI capital spending and the energy transition. However, segments linked to the domestic real estate chain, traditional infrastructure, and mass consumption may continue to face headwinds until fiscal policy delivers a meaningful acceleration in implementation. On the policy front, investors should closely monitor the pace of government bond issuance starting in June, as well as the approval and commencement of projects under the “Six Networks” initiative. If oil prices fail to stabilize after June—or even rise further due to geopolitical factors such as disruptions in key shipping lanes—the downside risks to economic growth will intensify, potentially prompting calls for more aggressive monetary or fiscal easing. Conversely, should oil prices normalize, combined with fiscal catch‑up measures and a low base effect, the second half of the year could see a modest year‑over‑year rebound in growth.

Risks

• Further increases in oil prices, coupled with ongoing geopolitical disruptions—such as a Strait of Hormuz closure—beyond June, are tilting growth risks to the downside.
• Fiscal policy has fallen short of expectations, and a shortage of eligible projects has delayed the ramp-up of infrastructure investment.
• Domestic consumer demand remains sluggish, and the stimulative effects of policy measures are waning.

What to watch

• Since June, has the net issuance of general government bonds and local government special-purpose bonds accelerated significantly?
• The trajectory of international oil prices and the impact of geopolitical developments in the Middle East and other regions on supply chains.
• The specific planning and implementation of the “Six-Network” infrastructure projects, as well as their construction commencement progress.
• High-frequency data on container throughput, the PMI for emerging industries, and the persistence of export orders.