China’s industrial sector reported a stronger rebound in April, as state data revealed that profits among large manufacturers rose 3.0 percent year-on-year that month, accelerating from a 2.6 percent gain in March. For the January-April period overall, industrial profits increased by 1.4 percent compared with the same stretch last year—up from a mere 0.8 percent growth recorded in the first quarter. At face value, these figures suggest that authorities’ targeted stimulus efforts—deployed gradually since last September—may be helping to stabilize corporate earnings and support a broader economic recovery. Yet with trade frictions flaring again on multiple fronts, some analysts caution that the current profit uptick could prove ephemeral. The core question now facing Beijing is whether the backdrop of monetary and fiscal support can sustain robust industrial earnings growth in an environment where export risks remain exceptionally high.

Industrial Profits Show Green Shoots, but Underlying Weakness Persists

According to data released by the National Bureau of Statistics (NBS) on Tuesday, profits at firms with annual revenue of 20 million yuan or more jumped 3.0 percent in April compared with the same month last year. Over the January-April span, profits reached a 1.4 percent rise—roughly twice the 0.8 percent recorded during the first quarter, indicating a gradual recovery that some policymakers have cheered as evidence of the efficacy of stimulus measures. Still, beneath these headline numbers lies a more nuanced story. While private-sector companies saw profits expand 4.3 percent year-on-year in the first four months, and foreign-invested firms chalked up a 2.5 percent increase, state-owned enterprises (SOEs) recorded a 4.4 percent decline in profits. In other words, the growth in overall industrial earnings is skewed toward nimble private players and export-oriented foreign ventures, while large, capital-intensive SOEs—long considered the bedrock of China’s industrial complex—continue to struggle.

“The rebound in the overall profit figure is encouraging, especially considering the challenges of weak domestic demand and lingering deflationary pressure,” said Yu Weining, an NBS statistician, in an accompanying note. “However, we must acknowledge that the foundation for stable profit growth still needs to be strengthened, particularly as external headwinds persist.” Indeed, many of the companies that have led the recent improvement operate in sectors that benefit directly from Beijing’s “new growth drivers” policies, such as advanced manufacturing, new-energy supply chains and high-value-added chemicals. By contrast, heavy industries tied to traditional commodity cycles—steel, shipbuilding and basic chemicals—are still contending with overcapacity and thin margins. As a result, observers caution that the current profit uptick, while welcome, may not be broad-based enough to endure protracted external pressures.

Stimulus Measures: A Drip-Feed Approach to Boost Domestic Demand

In response to slower growth and tighter global conditions, Chinese policymakers have rolled out a succession of stimulus measures since late 2023, aiming to shore up confidence, increase liquidity and spur consumption. Key among these has been a series of cuts to benchmark interest rates: the one-year loan prime rate (LPR) has been trimmed twice since September, bringing financing costs for manufacturers down to their lowest levels in years. In early May, the People’s Bank of China (PBOC) reduced the reserve requirement ratio (RRR) for large banks by 25 basis points, releasing nearly 500 billion yuan of long-term liquidity into the financial system. Meanwhile, the Ministry of Finance has accelerated fiscal transfers to local governments, allowing provincial and municipal authorities to issue special-purpose bonds for infrastructure projects—a move intended to sustain public investment in energy, transportation and technology parks.

These targeted measures have been accompanied by looser micro-lending guidelines, designed to facilitate easier access to credit for small and medium-sized enterprises (SMEs). As a result, new aggregate financing—an indicator that includes bank loans, bond issuance and trust lending—edged higher in April, suggesting that companies are at least partially tapping the credit expansion. To support consumer demand, Beijing has also extended temporary tax exemptions for vehicle purchases in select regions, encouraged municipalities to roll out digital consumption vouchers, and subsidized home appliance upgrades in less-developed provinces. Taken together, these moves constitute a patient, piecemeal approach that seeks to avoid abrupt policy shifts while shoring up the economy against downside risks. Yet the question remains: will this measured stimulus be enough to offset the damage inflicted by escalating trade tensions?

Trade Tensions Resurface, Undermining Export-Led Recovery

For much of the past decade, China’s industrial recovery has hinged on a resurgence of exports—particularly to the United States and Europe—where global demand for electronics, machinery and high-value goods remained comparatively resilient. That dynamic began to unravel, however, when U.S. President Donald Trump’s administration amplified tariffs on Chinese imports starting in 2018. Although a partial truce was reached in early 2020, tensions flared anew when Washington imposed additional duties on Chinese steel, aluminium and industrial machinery in late 2023. In turn, Beijing responded with reciprocal levies on U.S. agricultural products, automotive goods and chemical exports. Since then, the two sides have remained locked in a precarious tug-of-war, punctuated by intermittent negotiations in Geneva but lacking any durable, comprehensive agreement.

In April, as U.S. and Chinese officials agreed to roll back most of the newly imposed tariffs, trade observers hailed the brief easing as a potential turning point. Yet by mid-May, both governments signalled that the wartime stance could resume: Washington announced plans to review tariff exclusions on certain battery components, while Beijing threatened to impose extra duties on U.S. semiconductors. The net effect is that many Chinese exporters continue to operate under a cloud of uncertainty: factories that produce subcomponents for U.S-bound electronics orders, for instance, are reluctant to commit to large-scale production runs because of the risk that duties could spike again with little notice.

“The once-robust export rebound that China relied on has become much more volatile,” said Dan Wang, China director at Eurasia Group. “Commodities involved in new-energy supply chains and high-end manufacturing are faring reasonably well, but any sudden shift in U.S. trade policy could quickly cool demand for those very same products. That makes it difficult for industrial firms to plan investment or capacity utilization effectively.” Data for April exports posted better-than-expected growth after tariff reductions, yet that rebound masked a 5 percent year-on-year contraction in imports—suggesting that domestic demand remains tepid and that overseas sales gains may not translate into higher factory activity on a sustained basis.

SOEs Underperform, Private and Foreign Firms Drive Profits

A closer examination of the profit data reveals a bifurcated landscape. State-owned enterprises, which account for roughly 30 percent of industrial output by value, saw profits slump by 4.4 percent over the first four months of the year. In contrast, private-sector companies—fuelled in part by e-commerce expansion and agile production models—enjoyed a 4.3 percent profit rise, while foreign-invested firms recorded a 2.5 percent gain. The underperformance of SOEs points to a deeper structural challenge: many of these state-backed entities operate in sectors with endemic overcapacity, low pricing power and heavy debt burdens. China’s efforts to reform SOEs have made incremental progress, but managers are often reluctant to shut down loss-making facilities because of employment considerations and local government pressure.

By contrast, private manufacturers, many of which have pivoted toward higher-value products—such as precision machinery, advanced photovoltaic panels and electric-vehicle subcomponents—have harnessed both stimulus-related credit loosening and niche export opportunities. “The private sector is capturing the upside from policy support and consumer trends,” said Lynn Song, chief economist for Greater China at ING. “Auto components, new-energy battery materials and semiconductor equipment are all examples of industries where private firms have moved rapidly to fill gaps left by overleveraged SOEs.” Foreign firms operating in China, moreover, benefit from their global supply-chain integration; many maintain diversified sales channels, allowing them to compensate for weakness in U.S. markets by pivoting to Europe or emerging economies.

Domestic Demand Remains Weak: Consumption and Investment Lag

Even as industrial profits show tentative signs of life, indicators of domestic demand have remained muted. Retail sales growth decelerated to a 2.1 percent year-on-year increase in April, down from 3.4 percent in March. Auto sales, a key barometer of consumer confidence, fell 5.5 percent in the first four months of 2024 compared with the same period in 2023, as incentives expired and households grew cautious amid rising property-sector pressures. Home sales in major cities, having recovered briefly on the back of favorable mortgage rates, began stagnating again in April, with transaction volumes down 8 percent month-on-month across the ten largest housing markets. With roughly one-third of urban middle-class wealth tied up in real estate, the weakness in housing has weighed on overall consumption sentiment, leaving many manufacturers without a robust domestic absorption channel for their products.

On the investment side, infrastructure spending has held up—largely due to the bond-financed projects of local governments—but private business investment has remained lackluster. In the first quarter, fixed-asset investment in the manufacturing sector slowed to a 1.6 percent year-on-year gain, compared with 2.8 percent in the prior quarter. High levels of corporate debt and uncertainty over future demand have dissuaded many companies from expanding capacity, despite cheaper credit. Indeed, some analysts argue that the incremental stimulus—while necessary to avert a sharper downturn—has not yet translated into a virtuous cycle of spending. Instead, much of the new lending has been directed toward local government infrastructure vehicles, leaving manufacturing firms still in need of stronger revenue prospects before they commit to significant capital expenditures.

Financial Risks and Local Government Debt Pressure

Complicating the policy calculus is the heavy debt burden carried by local governments and their financing vehicles. Over the past decade, municipal authorities have relied on local government financing vehicles (LGFVs) to channel funds into roads, railways, water treatment facilities and other public projects. These off-budget entities have amassed an estimated 60 trillion yuan (roughly \$8.5 trillion) of debt, much of which is scheduled to roll over in the next two years. Although the central government has taken steps to address this risk—most notably by authorizing local governments to issue special-purpose bonds and by capping new LGFV borrowing—many analysts worry that sticky debt servicing costs could crowd out future fiscal stimulus.

For industrial firms, rising credit risk in the LGFV sector translates into tighter bank sentiment and potentially higher financing costs. Although benchmark lending rates have fallen, many smaller manufacturers still face effective borrowing rates north of 5 percent, especially if their collateral values are tied to volatile property prices or if they lack a track record of profitability. Meanwhile, as the authorities channel more funds into the social safety net—addressing labor-market concerns and deflationary wage pressures—the discretionary budget available for manufacturing subsidies and targeted tax rebates could be constrained. In other words, the fiscal room for prolonged stimulus may be narrower than official pronouncements suggest, highlighting the risk that industrial profits could slip again once the current wave of support—credit easing, infrastructure bonds and tax waivers—ebbs.

China’s policymakers must also contend with rising interest rates and volatility in global capital markets. Last week, yields on longer-dated government bonds in the United States spiked as investors worried about the size of U.S. federal debt and the prospects of further rate hikes by the Federal Reserve. Similar moves were seen in the United Kingdom and Japan, as markets anticipated that central banks would remain vigilant against persistent inflation. For China, the repricing of global yields has two major implications. First, a stronger U.S. dollar and higher U.S. rates tend to put downward pressure on the yuan, which can amplify imported inflation. Given that many Chinese industrial enterprises rely on imported intermediate goods—such as industrial gases, precision machinery and petrochemical inputs—a depreciating currency could squeeze profit margins even if nominal revenue rises in local currency terms. Second, as benchmark yields in advanced economies climb, Chinese bond yields have risen in tandem, raising the cost of financing for corporations and local governments alike.

Although the PBOC has intervened to smooth sharp fluctuations in bond markets, it has refrained from aggressive yield-curve control in recent months, preferring to keep the one-year and five-year loan prime rates on a downward trajectory without capping longer-maturity yields. By allowing ten-year government bond yields to rise toward 3.4 percent in April—up from 2.8 percent six months earlier—the PBOC signaled that it is unwilling to replicate Japan’s long-standing negative-yield approach. But the result is that Chinese corporates face higher long-term borrowing costs and less convincing yield stability, thereby reducing the incentive to embark on new capital projects. At the same time, higher yields deepen the cost of rolling over existing debt, further testing the ability of heavily indebted firms—particularly in cyclical sectors such as real estate and steel—to service obligations without additional state support.

Trade Risks, Export Dependency and Potential Job Losses

China’s export sector remains a key driver of industrial profits—but it is the same sector most exposed to geopolitical volatility. In 2023, exports as a share of GDP edged toward 20 percent, down from highs of roughly 35 percent a decade ago but still historically elevated for a major economy. Even small changes in foreign demand can ripple through complex supply chains. For example, if U.S. growth slows by one percentage point, Chinese electronics producers could see a 3 percent to 5 percent drop in orders, given the high proportion of consumer electronics destined for American households. In response to the prospect of renewed tariff escalations, some large exporters have begun to diversify production to Southeast Asia, Mexico and Eastern Europe. Yet those shifts require time, capital and skilled labor—commodities not always readily available for smaller manufacturers.

Last month, Nomura analysts warned that as many as 16 million jobs in China could be at risk if U.S. demand for Chinese exports were to fall by 50 percent. Much of those job risks would concentrate in labor-intensive industries such as apparel, footwear and consumer electronics assembly. Although large, state-owned export champions might absorb short-term shocks through their existing liquidity buffers, countless small and medium enterprises—many of which operate on razor-thin margins—lack the resilience to endure a sudden export collapse. “The sustainability of profit recovery hinges not just on domestic stimulus but on whether global demand remains stable,” observed Lynn Song of ING. “If the U.S. and Europe reimpose tariffs, or if trade talks break down entirely, private factories could face canceled orders overnight, triggering a fresh round of closures and layoffs.”

That risk is amplified by the fact that, even after the partial rollback of new-tariff measures earlier this spring, the U.S. has not fully rescinded its Section 301 tariffs on a wide swath of Chinese industrial products. During the thaw, Beijing agreed to purchase additional American soybeans and LNG, but those purchases represent a fraction of China’s energy needs and far smaller in dollar terms than the tariffs on industrial machinery—duties that range from 10 percent to 25 percent. In response, Chinese officials have pressed the European Union and other trading partners to deepen cooperation on technology standards and supply-chain security. Yet these diplomatic overtures may have limited impact if Washington remains set on using trade policy as leverage on issues ranging from intellectual property protection to national security. In late May, a U.S. Senate delegation visiting Beijing raised the prospect of new restrictions on semiconductor equipment exports, a move that would further complicate China’s ambitions to upgrade its manufacturing base.

Amid the broader uncertainty, some pockets of industry have thrived. Producers of solar photovoltaic (PV) panels, for instance, have benefited both from domestic subsidies and strong overseas demand in Europe and Latin America. In the January-April period, leading PV firms reported year-on-year profit increases of 10 percent to 15 percent, outpacing the national average. Similarly, companies specializing in electric-vehicle batteries and related chemicals—such as lithium carbonate, nickel sulfate and high-purity graphite—posted double-digit profit growth, buoyed by the government’s goal of having 40 percent of all new passenger vehicles be electric by 2025. High-end CNC machine tool manufacturers, too, enjoyed better margins as large state firms sought to upgrade capacity with domestically produced equipment rather than imported alternatives.

By contrast, traditional heavy industries have seen profits remain in the red or barely above breakeven. Steelmakers, for instance, reported a 6 percent year-on-year decline in combined profits over the first four months, as property-sector pullbacks and cautious infrastructure spending continue to subdue demand. Shipbuilders—once a global powerhouse—have similarly struggled; although new orders rose 12 percent in April, margins remain under pressure because of intense global price competition and overcapacity in dry-bulk and liquefied-natural-gas tanker segments. Even the temperatures in petrochemical facilities bear watching: margins on ethylene-glycol and polypropylene plunged by nearly 20 percent in April compared with the same month last year, reflecting lower overseas demand and softer downstream consumption.

The divergence between booming “new economy” segments and challenged old-economy ones has two key implications. First, a small handful of industries—particularly those linked to renewable energy, advanced electronics and high-end machinery—are shouldering much of the overall profit improvement. If trade frictions disrupt demand for any of those products, the impact on national profit figures could be disproportionately large. Second, the pain in traditional sectors underscores the unevenness of the recovery and raises questions about whether stimulus alone can genuinely address structural overcapacity issues. Directing credit toward new-energy firms may bolster headline profits today, but it does little to resolve legacy problems in steel and shipbuilding—problems that could resurge if state banks pivot back toward supporting local champions in infrastructure and property.

Monetary Policy Ambivalence: Balancing Inflation Risks and Growth Targets

The People’s Bank of China faces a delicate balancing act. On one hand, macroeconomic indicators—retail deflation, light inflation in producer prices, and tepid wage gains—suggest that more monetary easing could help reignite demand. Consumer-price inflation edged down to just 0.9 percent year-on-year in April, leaving retail sales growth vulnerable to further deceleration. Meanwhile, industrial producer prices have drifted negative for three consecutive months, signaling that many factories continue to feel the pinch of excess capacity and lackluster global demand. Against this backdrop, a modest cut in the one-year LPR in early May sought to reduce financing costs for households and smaller firms, while the RRR reduction for larger banks released a sliver of extra liquidity to support the corporate bond market.

On the other hand, any further rate cuts risk weakening the yuan and stoking capital outflows, which could, in turn, amplify pressure on bond markets. With U.S. yields flirting with multi-year highs, the gap between Chinese and U.S. ten-year yields narrowed to under 80 basis points in late May—its smallest margin since mid-2023. A smaller interest-rate differential reduces China’s capacity to attract foreign investment into its bond market, potentially accelerating yuan depreciation if outflows mount. A weaker yuan would have mixed effects: it might bolster export competitiveness in the short term, but it would also increase the cost of imported energy and raw materials, compressing profit margins for manufacturers reliant on gasoline, coal, steel scrap and key electronics components. Moreover, China’s large holdings of U.S. Treasury securities—over \$1 trillion as of March 2024—make it vulnerable to fluctuations in U.S. rates and dollar value, complicating the PBOC’s foreign exchange management.

Thus, Beijing appears to be adopting a cautious monetary stance: providing incremental support while avoiding large renminbi devaluation or a significant steepening of the yield curve. The PBOC’s reluctance to cut the one-year mortgage rate in early May—a move widely anticipated by market participants—underscores this ambivalence. Although policymakers have signaled readiness to deploy further “precise” easing for critical sectors, they have stopped short of broad-based rate cuts that might risk financial stability or currency turbulence. In effect, China is choosing to lean on fiscal stimulus—via infrastructure bonds and tax refunds—rather than rely exclusively on monetary policy to underpin industrial profits.

Beyond U.S. trade risks, China confronts a host of broader geopolitical uncertainties that could weigh on industrial earnings. Tensions in the Taiwan Strait, disputes over South China Sea shipping lanes, and escalating U.S. export controls on semiconductors all introduce layers of risk for Chinese manufacturers. In late April, Washington expanded export restrictions on cutting-edge chip design software, targeting companies that supply advanced processors for data centers and artificial-intelligence applications. That move triggered immediate price spikes for high-end chipsets, as domestic producers scrambled to source alternative tooling or modify existing designs. For Chinese firms producing smartphones, servers and edge-computing devices, the increased cost and limited availability of semiconductors could erode product competitiveness—particularly if foreign buyers shift toward non-Chinese suppliers to minimize compliance headaches.

Meanwhile, global supply-chain fragmentation continues apace. Many multinational companies have accelerated “China plus one” strategies, relocating parts of their production to Vietnam, India, Mexico and Eastern Europe to diversify risk. While China remains the world’s largest manufacturing hub—accounting for nearly a third of global output—the share of value-added components produced domestically for export is slowly shrinking. In 2023, exports of electronic components from China fell 4 percent from the prior year, even as exports of finished electronics devices rose modestly, reflecting a shift in the composition of trade. This dynamic poses a challenge for larger producers of industrial machinery and specialized equipment: if their oversea customers source more locally, the demand for high-end tool sets and automation solutions from Chinese suppliers may slacken.

At the same time, the global energy transition is reshaping industrial trade flows. As Europe and North America move to decarbonize, demand for electric-vehicle batteries, solar panels and wind-turbine components has surged. China, having staked major policy emphasis on clean-energy manufacturing—supported by generous local and central subsidies—has swiftly become the top exporter of photovoltaic modules, wind turbine blades and lithium-ion cells. Yet competition is intensifying: Vietnam, Thailand and Malaysia are scaling up their own PV and battery ecosystems, aiming to integrate upstream materials with assembly operations. U.S. tax credits for clean-energy manufacturing—introduced under the Inflation Reduction Act—provide substantial incentives for companies to build battery gigafactories on American soil, reducing some foreign buyers’ reliance on Chinese suppliers. If these incentives further accelerate localization, Chinese producers will face downward pressure on export volumes and margins, potentially undercutting part of the recent improvement in industrial profits.

Outlook: Uncertain Road Ahead for Profit Expansion

The trajectory of China’s industrial profits in the coming months will hinge on a delicate interplay of factors. On one side, the targeted stimulus measures—lower interest rates for manufacturing loans, RRR cuts, local government bond issuances and tax refunds—should continue to inject liquidity and shore up confidence among private firms. Additionally, pillars of the “new economy,” such as high-end manufacturing, renewable energy supply chains, and advanced electronics, appear to have robust global momentum that could sustain earnings growth even as traditional sectors languish.

On the other side, trade risks and geopolitical headwinds could reassert themselves suddenly. If tariffs on Chinese machinery, electronics or strategic materials are reinstated or escalated, export orders could evaporate, forcing factories to slash operating rates. Even absent direct tariff actions, the prospect of renewed U.S. export controls on semiconductor equipment, or broader sanctions on Chinese technology companies, could undermine industrial profit margins. Meanwhile, the fragility of domestic demand—reflected in sluggish retail sales, faltering auto purchases and uneven home sales—means that manufacturers cannot rest assured that local consumption will pick up the slack if exports fall. Under these conditions, heavy reliance on infrastructure-driven growth may create pockets of overinvestment that eventually weigh on profitability.

China’s leadership has signaled awareness of these risks. In late May, the State Council convened a high-level conference to review industrial support policies, emphasizing the need to “deepen supply-side structural reforms” alongside continued demand support. In practice, this means Beijing will likely place greater emphasis on capacity cuts in overbuilt sectors, accelerate restructuring of troubled SOEs, and press banks to reallocate credit toward “pillar industries” with sustainable profit potential. Authorities have also called for accelerating the rollout of high-speed rail, 5G networks and digital infrastructure—projects designed to underpin long-term growth but not necessarily to produce immediate profit spikes for heavy-industry firms.

For now, China’s industrial profit rebound, modest as it may be, offers a glimmer of hope that the stimulus drip-feed is working. But sustainability will depend on whether the underlying economy can shift from cyclical reliance on cheap credit and infrastructure spending to a more durable model driven by innovation, private consumption and global competitiveness. If trade uncertainties escalate or global financing conditions tighten further, the gains in industrial profits may prove too narrow to forestall a sharper downturn. As one senior economist in Beijing put it, “Stimulus can paper over the cracks in the near term—but if geopolitical headwinds intensify, we could see profits contract once more, even as factories remain well-sourced with cheap loans.”

In the weeks ahead, market participants will closely watch a slew of data points—May industrial profits, China’s June export numbers, municipal bond issuances, and PBOC interest rate guidance—to discern whether the current profit uptick represents a sustainable trend or merely a temporary lull before the next round of trade-driven turbulence. For policymakers, the challenge will be to calibrate stimulus measures so that they support the nascent recovery in private-sector profitability without creating fresh imbalances in debt or overcapacity. How deftly Beijing manages that balancing act may well determine whether China’s industrial sector can navigate the shoals of international trade risk and deliver the stable profit growth that the wider economy so desperately needs.

(Adapted from MarketScreener.com)

Categories: Economy & Finance, Geopolitics, Regulations & Legal, Strategy