By Zhu Tian

After years of subdued prices, weak domestic demand and a prolonged property downturn, China’s economy may be showing signs of improvement. In the first three quarters of 2026, key price indices turned positive and industrial profits rebounded sharply.

Could this mean China has finally escaped deflationary pressure? And is the broader economy really turning a corner? In this article, CEIBS Vice President, Co-Dean, and Professor of Economics Zhu Tian examines what is driving the latest data, and questions whether it signals a genuine economic recovery.

According to data released by China’s National Bureau of Statistics (NBS), GDP grew by 4.6% in the first three quarters of 2026. This figure represents real GDP growth, which excludes the effects of price changes. Based on GDP measured at current prices, nominal GDP grew by approximately 5.5%, around 0.9 percentage points higher than real growth.

This marks an important shift. It suggests that the GDP deflator, a broad measure of price changes across the economy, rose by approximately 0.9% year-on-year. This means that, after three consecutive years of decline from 2023 to 2025, the GDP deflator has finally returned to positive territory.

The turnaround began in the second quarter of this year and continued into the third. Other price indicators have also shown signs of recovery compared with the previous three years. The Consumer Price Index (CPI) rose by 0.9% year-on-year in the first three quarters, compared with an average annual increase of just 0.1% between 2023 and 2025. Meanwhile, after 41 consecutive months of year-on-year declines, the Producer Price Index (PPI) turned positive in March. Its growth subsequently accelerated, reaching 5.0% in September, the highest level in four years. For the first three quarters as a whole, the PPI rose by 2.3% year-on-year.

Industrial profit figures also appear encouraging. In the first eight months of 2026, total profits at major industrial enterprises rose by 15.7% year-on-year. This represents a marked improvement following three consecutive years of declines in 2022, 2023 and 2024, when profits fell by 4.0%, 2.3% and 3.3%, respectively. Profits began to recover modestly in 2025, growing by just 0.6% for the full year, before accelerating significantly in 2026.

Taken at face value, these figures naturally raise two questions: Has China finally escaped deflationary pressure? And has the economy reached a positive turning point?

From the perspective of the price index, one could argue that deflation has ended. However, rising prices can have several distinct causes, with equally divergent implications for the economy. When prices rise because demand is strengthening, it generally signals an improving economy. But when higher prices are driven by supply-side shocks, they can actually make economic conditions more difficult.

To determine whether China's economy is genuinely recovering, we must first understand what is driving the rise in prices.

Rising prices do not necessarily mean stronger demand

Let’s begin with consumer demand. In the first three quarters, total retail sales of consumer goods grew by just 1.1%, while per capita household consumption expenditure increased by 3.6% in nominal terms, below the 5.3% growth in per capita disposable income.

When consumption growth is slower than income growth, it suggests that households remain cautious about spending and continue to favour saving.

Investment paints an even weaker picture. National fixed-asset investment fell by 7.2% year-on-year in the first three quarters, among which property development investment declined by 20.6%. Manufacturing investment fell by 2.1%. Both declines were steeper than those recorded in the first half of the year.

External demand, by contrast, remained strong. Exports rose by 16.4% in the first three quarters, an impressive performance. However, imports grew even faster, increasing by 22.3%.

China's merchandise trade surplus, a major component of net exports, reached approximately RMB 6.46 trillion. Although substantial in absolute terms, this represented an increase of only around RMB 200 billion compared with the same period last year.

The rapid growth in imports was largely driven by purchases related to the AI computing infrastructure supply chain and rising international commodity price, and therefore doesn’t indicate a broad-based recovery in domestic demand.

Taken together, consumption, investment and trade figures tell a clear story: external demand remains robust, but consumer spending is growing slowly and fixed-asset investment continues to contract. Domestic demand, in other words, remains weak.

This raises an important question: If domestic demand is still subdued, why are prices rising?

Higher prices are being driven by upstream industries and global markets

The answer lies in the composition of price increases.

In September, the PPI rose by 5.0% year-on-year. Prices of production materials increased by 6.5%, with particularly sharp rises in the mining and quarrying (25.4%) and raw materials industries (9.4%). Prices in processing industries rose by only 3.4%, while those of consumer goods produced by manufacturers actually fell by 0.1%.

A closer look at individual industries reveals an even more pronounced divergence. Producer prices rose by 35.3% in coal mining, 24.5% in oil and natural gas extraction, 21.4% in non-ferrous metal smelting, and 5.8% in computer, communications and other electronic equipment manufacturing.

By contrast, producer prices fell by 2% in automobile manufacturing, 3.3% in pharmaceuticals, and 5.3% in alcohol and other beverages.

The CPI shows a similar pattern. In September, energy prices rose by 7.3%, gold jewellery prices increased by 22.5%, and mobile phone prices climbed by 14.9%. Yet food prices fell by 1.7%, while service prices, which offer a more direct indication of domestic demand conditions, increased by just 0.8%.

These figures suggest that the rebound in China's price indices this year has been driven largely by rising international commodity and electronic product prices, rather than a broad-based recovery in domestic end-user demand.

China is a net importer of commodities and semiconductor chips, meaning that rising global prices translate into higher import costs. While some domestic upstream producers benefit from these price increases, businesses further down the supply chain face mounting cost pressures.

When domestic demand remains weak, such cost shocks can have negative consequences for the broader economy.

Profit growth is concentrated in a few industries

The sharp increase in industrial profits also deserves closer examination.

Beyond the effect of a low comparison base, what stands out is how heavily profit growth is concentrated in a small number of industries.

There are two main drivers: the electronics industry has benefited from surging global demand for computing power, boosting both sales volumes and prices; and upstream raw materials producers have gained from higher prices.

Based on total profit figures and comparable growth rates published by the NBS, profits at major industrial enterprises increased by approximately RMB 710 billion year-on-year in the first eight months of 2026, among which the electronics industry alone accounted for around RMB 440 billion.

Together with five upstream industries—non-ferrous metal smelting, coal mining, chemical raw materials, oil and natural gas extraction, and petroleum processing— the electronics industry accounted for approximately RMB 950 billion in additional profit, more than the total increase in industrial profits across the entire economy.

Put differently, the combined profits in all other industrial sectors actually fell by approximately 7%. The declines were particularly pronounced in several important industries. Profits fell by 16.0% in automobile manufacturing, 5.2% in electrical machinery, 46.7% in non-metallic mineral products, 17.4% in agricultural and food processing, and 14.4% in textiles and apparel.

The underlying mechanism is relatively straightforward.

As prices of upstream raw materials and semiconductor chips rise, manufacturers further down the supply chain face higher production costs. Yet weak demand limits their ability to raise selling prices, leaving profit margins squeezed from both sides.

Price data provide further evidence of this pressure.

In the first three quarters, industrial producers' purchasing prices rose by an average of 3.6% year-on-year, while their selling prices increased by only 2.3%. Moreover, increases in selling prices were concentrated mainly in upstream industries. Prices rose by 9.7% in mining and quarrying and 4.9% in raw materials, compared with just 1.9% in processing. Prices of consumer goods produced by manufacturers, meanwhile, declined by 1%.

In simple terms, this means that businesses are paying more for their inputs but struggling to charge more for their products. This is precisely the dilemma facing many midstream and downstream manufacturers.

These businesses, together with the service sector, are also major sources of employment.

When profit improvements are concentrated in just a handful of industries, they are unlikely to translate into widespread gains in employment and household income. Without improvements taking place more broadly across the economy, a meaningful recovery in consumer spending will remain difficult.

Stronger demand-side policies are still needed

China continues to face a serious shortfall in aggregate demand. Property investment is still falling at a rate of around 20%, consumer spending remains sluggish, and both private-sector and manufacturing investment are contracting. The domestic demand gap may therefore be widening rather than narrowing.

Against this backdrop, demand-side policy support should be strengthened, with particular emphasis on consumption and the property market.

On the consumption side, the central government could issue government bonds to finance cash-based consumption vouchers distributed directly to households. Such support should be maintained until domestic demand is strong enough to drive prices and economic growth back towards their target levels.

In the property sector, the central government could provide funding to acquire existing unsold homes at discounted prices and convert them into affordable rental housing. This would help improve developers' cash flows, support the completion and delivery of housing projects, and reduce unsold housing inventories.

It would also send a clear signal of the government's determination to stabilise the property market, helping to arrest the decline in what has been one of the largest sources of contracting demand.

Most importantly, these measures must be implemented on a sufficiently large scale to close the substantial gap in aggregate demand.

So, has China finally escaped deflationary pressure?

From the perspective of headline price indices, deflation has ended. But the underlying demand shortfall remains substantial, and rising prices do not, in themselves, translate into a broader economic recovery.

In this sense, China has yet to escape the pressures associated with deflation. There remains considerable scope for improvement, and a pressing need for stronger demand-side policies.

Zhu Tian is Vice President, Co-Dean, and Santander Chair in Economics at CEIBS. He is an expert on the Chinese economy and the author of Catching Up to America: Culture, Institutions, and the Rise of China (Cambridge University Press, 2021).