China Insights
Market spotlight: Out with involution, in with innovation
China’s economy is navigating a complex structural transition, shaped by both cyclical pressures and longer-term policy priorities. One of the most persistent challenges in recent years has been deflationary pressure, which has compressed corporate profitability and weakened incentives for investment in productivity enhancing activity. A significant contributor has been the phenomenon often described as ‘involution’, which is a destructive price competition in oversupplied industries that erodes margins and discourages innovation.
In response, policymakers introduced an ‘anti-involution’ campaign in mid-2025, targeting sectors where excessive competition had intensified disinflationary pressures. The objective extends beyond short-term stabilisation. By discouraging race-to-the-bottom pricing, authorities are attempting to reshape corporate behaviour and redirect economic incentives toward productivity, technological upgrading and higher value creation.
Figure 1: Deflationary periods in China
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Figure 2: Forecasted impact of anti-involution on profit reflation
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Past performance does not predict future returns. Any forecast, projection or target where provided is indicative only and not guaranteed in any way. Source: Government websites, Goldman Sachs Global Investment Research, as of January 2026.
The policy direction was reinforced at the most recent National People’s Congress (NPC), where policymakers emphasised the transition toward higher quality, innovation-led growth rather than stimulus-driven expansion. The government set a moderate growth target and reiterated its commitment to developing ‘new quality productive forces’, signalling that technological capability, industrial upgrading and domestic demand will remain the central drivers of China’s next phase of economic development. Importantly, the NPC also signalled a more explicit focus on reflation, with policymakers prioritising a return to positive price dynamics and improved corporate pricing power – a key precondition for a sustained earnings recovery.
This document provides a high-level overview of the recent economic environment. It is for marketing purposes and does not constitute investment research, investment advice nor a recommendation to any reader of this content to buy or sell investments. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination.
For informational purposes only and should not be construed as a recommendation to invest in the specific country, product, strategy, sector or security. The views expressed above were held at the time of preparation and are subject to change without notice. Any forecast, projection or target where provided is indicative only and not guaranteed in any way. HSBC Asset Management accepts no liability for any failure to meet such forecast, projection or target.
While the anti-involution initiative remains in its early stages and measurable outcomes will take time to emerge, the broader direction of policy is clear. China’s growth model is gradually shifting away from cost-driven expansion toward innovation-led development. This transition is increasingly visible across sectors such as artificial intelligence, biotechnology and advanced manufacturing i.e. the industries that feature prominently in the country’s industrial strategy.
Rebalancing toward a more resilient domestic engine
The policy agenda reflects a wider effort to rebalance the economy toward a more resilient domestic growth engine. Geopolitical tensions and trade frictions have weighed on activity in recent years, yet structural resilience remains evident. Although investment growth has slowed amid tariffs and weaker external demand, the expansion of higher value export industries – particularly technology-linked sectors – has partially offset that weakness. At the same time, supply-side reforms and industrial upgrading are helping to improve the quality rather than just the quantity of growth, reinforcing the transition toward a more sustainable economic model.
Domestic financial dynamics reinforce this shift. Following the correction in the property market, Chinese households accumulated exceptionally large savings balances, with deposits exceeding USD 20tn, a figure larger than national GDP. As deposit rates decline, a gradual reallocation of these savings into financial assets – including equities and investment funds – could provide an important source of liquidity for capital markets. Recent trends already suggest early evidence of this rotation, with increasing flows into domestic equities and Hong Kong listed markets, supported by lower deposit rates and improving sentiment toward risk assets.
Consumption patterns also illustrate the scope for rebalancing. Spending on goods is already approaching levels observed in advanced economies, yet services consumption remains underdeveloped, at roughly one-third of US levels. Policies aimed at strengthening social safety nets and reducing precautionary savings could therefore unlock a significant source of domestic demand. Policy measures announced at the NPC, including targeted support for household consumption and services sectors, reinforce this shift toward a more consumption-led growth mix.
Fostering innovation
Innovation policy sits at the centre of this transition. China’s 15th five-year plan prioritises technological capability, productivity improvement and greater economic self-reliance. Historically, the country’s development model relied heavily on scale and cost efficiency; the emerging strategy seeks to complement these strengths with technological leadership and higher value creation.
Several sectors illustrate this shift. China has established itself as a major participant in artificial intelligence, with companies such as Alibaba, Tencent and ByteDance deploying AI applications at scale.
Although capital expenditure remains roughly one-fifth of US spending, Chinese firms have demonstrated notable efficiency in deploying resources and localising supply chains. Recent developments in LLMs and AI cost efficiencies have also reinforced perceptions of China's ability to compete on both performance and cost, supporting a reassessment of its innovation capabilities.
Figure 3: AI Capex for China versus major US CSP (USD bn)
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Any forecast, projection or target where provided is indicative only and not guaranteed in any way.
Source: Bernstein analysis and estimates, January 2026.
Figure 4: Chatbot arena scores for AI models
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Any forecast, projection or target where provided is indicative only and not guaranteed in any way.
Source: Morgan Stanley Research as of December 2025.
Biotechnology represents another area of rapid progress. Chinese firms increasingly develop early stage molecules and license them to multinational pharmaceutical companies, signalling a transition from manufacturing-led growth toward intellectual property driven innovation. Meanwhile, advanced manufacturing continues to evolve toward higher precision and technology intensive production, particularly in robotics where integrated domestic supply chains allow producers to operate at materially lower cost than international competitors.
Together, these developments point to a gradual but deliberate transformation of China’s economic model. The latest NPC discussions reinforced that this transition will be supported by measured fiscal policy, targeted industrial support and a continued emphasis on technological self-reliance rather than broad-based stimulus. The policy mix therefore suggests a more calibrated approach to growth by prioritising structural upgrades, reflation and risk control over short-term stimulus cycles.
For investors, the significance lies less in short-term cyclical acceleration and more in the structural evolution of China’s growth model. As the economy moves away from deflationary competition toward productivity-driven expansion, the implications are increasingly visible across financial markets where both equities and fixed income assets are beginning to reflect the structural evolution of the economy.
China equities
Earnings repair and a gradual recovery
Against this structural backdrop, China’s equity market is moving from a valuation-led stabilisation phase toward a more earnings-driven recovery. After several years of persistent downward revisions, corporate profitability is beginning to improve, supported by easing deflationary pressures, selective fiscal measures and tighter discipline in oversupplied industries. The recovery remains uneven, yet it represents an important inflection point: equity returns are increasingly dependent on earnings quality and sustainability rather than multiple expansion alone. A gradual reflationary backdrop, supported by policy efforts to stabilise prices and improve demand conditions, is likely to be a key driver of this earnings repair cycle.
Domestic liquidity conditions have also begun to support equity market stabilisation. The gradual reallocation of substantial household savings toward higher-yielding financial assets is providing incremental support for capital markets, while policymakers have adopted a measured approach to liquidity management in order to avoid excessive volatility. This combination has contributed to a more stable upward trajectory in equity markets. Strong southbound flows into Hong Kong equities and improving participation from domestic investors further reinforce this liquidity-driven support.
Figure 1: GDP contribution from China property sector and new industries
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Figure 2: Consensus EPS growth estimates
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Past performance does not predict future returns. Any forecast, projection or target where provided is indicative only and not guaranteed in any way. Source: MSCI, Bloomberg, RIMES, Factset, Morgan Stanley Research, November 2025.
At the same time, the composition of growth within the equity market is evolving. New industries – notably electric vehicles, advanced manufacturing and biotechnology – are progressively replacing real estate as the primary engine of economic expansion. This shift reflects the broader policy emphasis on innovation-driven growth and industrial upgrading.
Policy measures aimed at curbing destructive price competition have also helped stabilise corporate margins. Capacity rationalisation and regulatory intervention in sectors affected by price wars have begun to reduce margin erosion and support producer prices.
While these measures remain in the early stages of implementation, they help reduce downside risks to earnings and support a gradual rebuilding of investor confidence. Early signs of pricing discipline in upstream sectors suggest that supply-side adjustments are beginning to translate into improved profitability dynamics.
Technology and innovation-led industries remain central to the market outlook. Despite external constraints, China’s internet and technology companies continue investing heavily in artificial intelligence, automation and digital services. Monetisation pathways are gradually emerging across advertising, cloud computing, logistics optimisation and enterprise software. Although the earnings benefits of these investments are likely to be back-loaded, strong balance sheets allow companies to sustain capital expenditure without compromising financial stability.
In healthcare, rising research capability and increasing outbound licensing activity reinforce China’s growing role in global pharmaceutical development. These developments highlight the country’s increasing participation in innovation-driven industries rather than purely manufacturing-based value chains.
Consumer oriented sectors are recovering more slowly, reflecting cautious household behaviour and uneven income growth. Nevertheless, policy emphasis has shifted decisively toward supporting domestic demand, and targeted measures should gradually stabilise sentiment and moderate earnings volatility. Incremental policy support for services consumption and household income is likely to play an increasingly important role in sustaining this recovery.
Figure 3: MSCI China Forward P/E against 5-year average (x)
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Figure 4: MSCI China Forward P/E versus global peers (x)
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Past performance does not predict future returns. Any forecast, projection or target where provided is indicative only and not guaranteed in any way. Source: Datastream, MSCI, Morgan Stanley Research, as of January 2026.
Valuations across Chinese equities remain moderate relative to both historical averages and global peers. As a result, even incremental improvements in profitability could support medium-term returns. Combined with improving earnings visibility and policy support, this creates a more balanced risk-reward profile compared with recent years. In this environment, market performance is likely to depend less on broad macroeconomic acceleration and more on selective sectors aligned with policy priorities, margin normalisation and structural innovation.
China fixed income
Independence, diversification and the next phase
While China’s equity market reflects the country’s industrial transformation and innovation agenda, the fixed income market provides a distinct set of characteristics within global portfolios. Rather than positioning it in relative terms, its relevance lies in the specific diversification and stability properties it can offer within a multi-asset framework.
Over the past two decades, China’s bond market has undergone a remarkable transformation. What was once primarily a domestic financing channel has evolved into the second-largest bond market in the world, encompassing a broad range of sovereign, policy bank, corporate and local government issuers. The market’s development has been accompanied by gradual liberalisation, with programmes such as Bond Connect enabling foreign investors to access the domestic bond market without establishing onshore accounts.
Figure 1: Foreign holdings of China government bonds (RMB trillion)
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Past performance does not predict future returns.
Source: Bloomberg, CEIC, HSBC Asset Management January 2026.
Today, investors can allocate to Chinese fixed income through several channels, including the large onshore renminbi bond market, the offshore renminbi “dim sum” market and USD-denominated Chinese credit. Each segment offers different combinations of currency exposure, yield characteristics and credit risk, but the domestic government bond market remains the cornerstone of the asset class.
A distinctive feature of Chinese government bonds is the relative independence of their yield dynamics from global interest rate cycles. In recent years, yields in major developed markets have been driven largely by global inflation and monetary tightening cycles. Chinese government bond yields, by contrast, have been more closely linked to domestic liquidity conditions, policy objectives and growth dynamics. This reflects a policy framework that remains focused on domestic stabilisation and reflation, rather than tightly tracking global monetary cycles.
Figure 2: Yield of 10-year government bonds (per cent)
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Past performance does not predict future returns.
Source: Bloomberg, HSBC Asset Management, data as of January 2026.
Foreign participation in the market remains modest relative to other major sovereign bond markets. As a result, international capital flows exert limited influence on yield formation. Instead, yields are primarily determined by domestic economic conditions, supply-demand dynamics and monetary policy settings.
For global investors, this independence underpins the diversification case. Because Chinese bond yields respond predominantly to domestic macroeconomic factors, they have historically exhibited relatively low correlation with other major sovereign bond markets. In an environment where correlations between developed market equities and bonds have become less reliable, this feature has become increasingly valuable from a portfolio construction perspective.
Figure 3: Bond correlation in USD terms
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Past performance does not predict future returns. Source: Bloomberg, HSBC Asset Management; Correlation calculated in USD, using weekly data for the 5-year period as of 15 December 2025. Indices used are Markit iBoxx ALBI CNH Total Return, Markit iBoxx ALBI CNY Total Return, JACI China, Bloomberg Global Aggregate Index, Bloomberg US Aggregate Index, JPMorgan GBI-EM Global Comp, JPMorgan Asia Credit Index, ICE BofA US High Yield Index, JACI Non Investment Grade Index, Bloomberg US Treasury Index, ICE BofA Euro Government Index.
Performance data supports this perspective. Despite volatility in China’s equity market and concerns surrounding economic growth in recent years, Chinese government bonds have delivered stable returns with relatively low drawdowns compared with many global sovereign markets.
Figure 4: Total return performance (rebased to 100 on 31 December 2020)
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Past performance does not predict future returns.
Source: Markit, JPMorgan, FTSE, Bloomberg, 16 January 2026.
Indices used: China govt bonds (unhedged USD): Markit iBoxx ALBI China Onshore Government TRI Unhedged USD; Emerging market govt bonds (unhedged USD): J.P. Morgan GBI-EM Global Diversified Composite USD; Global bonds (hedged USD): Bloomberg Global Aggregate Total Return hedged USD Index; Global government bonds (hedged USD): FTSE World Government Bond Index hedged USD.
Macro fundamentals also contribute to this resilience. China continues to maintain relatively strong external balances and growth rates that remain higher than most advanced economies. In addition, diversified energy sourcing and substantial reserves help mitigate external shocks, including periods of elevated commodity price volatility.
For portfolio construction, the implication is increasingly clear. Chinese bonds may not offer the highest yields among emerging markets, but their combination of policy anchoring, structural independence from global rate cycles and improving accessibility positions them as a valuable diversifying allocation within global fixed income portfolios.
As China’s financial markets continue their gradual integration into the global investment system, the role of renminbi fixed income within institutional portfolios is likely to expand – not as a tactical allocation, but as a strategic source of stability, diversification and income within a more complex global macro environment.
Past performance does not predict future returns. For informational purposes only and should not be construed as a recommendation to invest in the specific country, product, strategy, sector or security. The views expressed above were held at the time of preparation and are subject to change without notice. Any forecast, projection or target where provided is indicative only and not guaranteed in any way. HSBC Asset Management accepts no liability for any failure to meet such forecast, projection or target.
Past performance does not predict future returns. Diversification does not ensure a profit or protect against loss. For informational purposes only and should not be construed as a recommendation to invest in the specific country, product, strategy, sector or security. The views expressed above were held at the time of preparation and are subject to change without notice. Any forecast, projection or target where provided is indicative only and not guaranteed in any way. HSBC Asset Management accepts no liability for any failure to meet such forecast, projection or target.
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