China Economics: Austerity Now, Acceleration Later?

Research evidence excerpt

China Economics: Austerity Now, Acceleration Later?

China Economics

09 July 2026 Citi Research

An underappreciated driver of the sharp 26Q2 slowdown is a de facto fiscal

austerity. FAI growth slumped -5.7%YoY in Mar-May amid flattish subsidies for

“two key projects” (两重) and equipment upgrades. Retail sales growth turning

negative at -0.6%YoY in May is partly attributable to the scale-back of the trade-in

scheme and delays in fund disbursement. At the aggregate level, the broad fiscal

deficit (general budget + government funds)1 was 2.2% of GDP in Jan-May, below

the 2.4% recorded a year earlier. On a 12-month rolling basis, the deficit has

narrowed to 8.8% of GDP in May from 9.0% at end-2025. Central and local

governments are each contributing to this austerity, but through distinct

channels:

n Central government austerity is a less obvious but a meaningful contributor –

driven by revenue outperformance rather than spending restraint. Broad

central government spending is running ahead of the run-rate seen in recent

years, reaching a five-year high of 33.3% of the annual budget by May and

growing a solid 10.1%YoY in Jan-May. The tightening has stemmed entirely from

the revenue side. A combination of PPI reflation and stricter tax collection,

particularly for Personal Income Tax (PIT, up 12.2% YoY in Jan-May), has

bolstered tax receipts and resulted in a central surplus larger than last year.

n Local governments are the main and more visible source of fiscal drag –

pressured on both revenue and spending sides. In contrast to the central

government, broad local government spending contracted -1.7%YoY in the first

five months, and the spending progress decelerated to 34.8% of the annual

budget compared with 35.0% in the same period of 2025. On the revenue side,