China's GDP growth decelerated sharply to 4.3 per cent in the second quarter of 2025, as collapsing domestic demand exposed the deepening structural fault lines of the world's second-largest economy. According to analysis published by MERICS (Mercator Institute for China Studies), the slowdown reflects a worsening imbalance between an export-driven growth model and a persistently weak domestic economy.

Fixed-Asset Investment: The Primary Drag

The steepest blow came from fixed-asset investment (FAI), which contracted across multiple sectors. Real estate investment fell by 18.0 per cent — the largest contraction for a half-year on record, according to the MERICS report. Crucially, the decline was not limited to property: FAI also fell in road building, education, healthcare, and construction.

The analysis points to cash-strapped local governments as a key structural weakness. These governments typically shoulder a significant share of infrastructure spending, but their fiscal buffers appear to have run dry — removing a critical engine of domestic investment.

Consumer Confidence Remains Fragile

Weak household sentiment is compounding the investment slump. Domestic car sales collapsed by 16.1 per cent year-on-year in June, according to the MERICS report, serving as a barometer of broader consumer caution. Suppressed consumption is directly dragging on headline growth figures, and analysts see no near-term catalyst for a reversal.

Beijing has repeatedly stated its commitment to raising household spending, but the MERICS analysis notes that any meaningful shift would require difficult structural reforms — ones that could take several years to produce results even if implemented decisively. Serious steps in that direction, the report observes, are not currently on the cards.

Exports Surge, But Imbalances Deepen

While the domestic economy stagnates, China's external trade has surged. Exports grew 27.0 per cent in June on a US dollar value basis, and imports rose 36.0 per cent — though the import growth is largely attributed to rising prices for commodities and high-tech products rather than a genuine increase in import volumes. In effect, China is paying more for roughly the same quantity of goods from abroad.

High-tech products performed particularly strongly in the export mix, suggesting China's external competitiveness remains intact and its export boom retains room to grow. This dynamic, however, is precisely what is fuelling trade friction with major partners.

EU-China Trade Tensions Set to Escalate

The growing volume of Chinese goods flowing into Europe has prompted a review of the European Union's trade defence mechanisms. Notably, even the German government — historically cautious about publicly criticising Beijing's industrial policy — has begun speaking more candidly about what it characterises as unfair trade practices.

The MERICS report warns that EU policymakers should not expect concessions from Beijing in ongoing trade and investment discussions. Given the economic pressures China faces domestically, it is likely to maintain an intransigent position in negotiations, the analysis states. EU-China trade tensions, it concludes, will remain elevated as long as structural imbalances persist.

The Road Ahead for Beijing

Even with export strength providing a partial buffer, Beijing will need at least moderate growth in both consumption and investment to avoid a broad-based economic slowdown and meet its official growth targets. The challenge is structural: the levers required to boost consumption — income redistribution, social safety net expansion, property market stabilisation — are politically complex and fiscally demanding.

Whether Beijing can engineer a rebalancing without triggering a sharper near-term contraction remains the central question for China's economic trajectory in the second half of 2025.