China's Bull Market: Navigating Macroeconomic Imbalances and Capital Outflow Risks

China's equity market has surged in 2025, buoyed by a record trade surplus and robust performance in high-growth sectors like semiconductors and AI. However, beneath this optimism lie deepening macroeconomic imbalances and capital outflow risks that threaten the sustainability of the bull market.

The Trade Surplus: A Double-Edged Sword

China's current account surplus hit a record USD 135.1 billion in Q2 2025, driven by a 5.7% rise in exports and a 1.3% decline in importsTrading Economics, ^[2]. This surplus has fueled corporate revenues and investor confidence, particularly in export-linked industries. Yet, the IMF warns that such imbalances—exacerbated by global overcapacity and U.S. tariff threats—risk prolonging divergence in trade dynamicsIMF, ^[1]. A potential 60% tariff hike on Chinese goods, as modeled by UBS and J.P. Morgan, could shave over 150 basis points off China's 2025 GDP growthUBS and J.P. Morgan, ^[3], directly undermining corporate earnings and market valuations.

Capital Flight and Debt Overhang

Capital outflows have intensified, with China recording a Q1 2025 capital and financial account deficit of USD 1,656 billion, reflecting persistent flight amid trade tensionsIMF, ^[1]. This exodus is compounded by a debt-to-GDP ratio exceeding 300%, driven by non-productive investment in property and infrastructureCarnegie China, ^[4]. The property sector's deleveraging, which began in 2021, has already reduced GDP growth by 3 percentage points, while local governments grapple with hidden debt refinancingEast Asia Forum, ^[5]. A prolonged balance sheet recession—marked by weak debt productivity and declining private demand—could entrench low growth and amplify real debt burdensEast Asia Forum, ^[5].

The Consumption-Investment Gap: A Structural Challenge

China's consumption-to-GDP ratio remains at 38%, far below the U.S. 68% and EU 52% averagesOECD, ^[6]. Despite government-led initiatives like consumption vouchers and trade-in programs, structural issues such as high precautionary savings and weak labor markets persistMcKinsey, ^[7]. Fiscal stimulus, including social transfers and infrastructure spending, aims to bridge this gap, but its efficacy is clouded by low consumer sentiment and aging demographicsMcKinsey, ^[7]. Meanwhile, fixed asset investment by private enterprises has stagnated, deepening the imbalance between consumption and investmentReuters, ^[8].

Policy Responses and Market Implications

The Chinese government has signaled a shift toward consumption-driven growth, with fiscal expansion, interest rate cuts, and structural reforms to stabilize the economyUBS and J.P. Morgan, ^[3]. However, these measures face headwinds. For instance, a weaker yuan—potentially used to offset tariff impacts—could erode purchasing power and dampen domestic consumptionReuters, ^[8]. Similarly, aggressive fiscal deficits to support growth risk inflating debt further, creating a vicious cycle of low productivity and rising leverageCarnegie China, ^[4].

For investors, the bull market's sustainability hinges on whether these policies can rebalance the economy without triggering financial instability. While sectors like EVs and AI may benefit from domestic demand, overvalued stocks in semiconductors and real estate face margin pressures as global demand softensIMF, ^[1].

Conclusion

China's bull market is underpinned by short-term trade strength but faces long-term risks from capital outflows, debt overhang, and structural imbalances. Policymakers must navigate a delicate balance between stimulating consumption and managing debt, while investors should remain cautious of sector-specific vulnerabilities. As U.S.-China trade tensions loom, the path to a sustainable bull market will require disciplined reforms and a shift away from export-driven growth.