China's Big Test: Vacillating Economy, Complex Geopolitics, and Xi's Control Under Scrutiny

Beijing, June 24, 2025 – China, once seen as an unstoppable rising power, faces what appears to be one of the most complex and precarious periods in its recent history. The government's ambitious target of 5% economic growth by 2025 looks increasingly like a mirage, overshadowed by a lethal combination of deep structural internal economic weaknesses, a less incisive geopolitical presence than expected, growing shadows over Xi Jinping's absolute control of the military, the persistent specter of the Taiwan issue, and, increasingly, the high uncertainties and severe legal and operational risks for foreign companies operating in the country. China seems trapped in a perfect storm, where each crisis fuels the others, creating a context of great instability and unpredictability for the Dragon's future.

China's economic difficulties are evident on multiple fronts. Sluggish consumer spending remains anemic, a worrying sign of low confidence and widespread caution among the populace. This weak domestic demand is compounded by a perceived global boycott against Chinese products allegedly being dumped, a phenomenon indicating the sale of goods at prices below production cost to gain market share.

At the heart of these concerns is the real estate crisis, which continues to rage without improvement. The sector, once a driving force, now acts as a significant drag, with consequences reverberating throughout the financial system and investor confidence.

The Deflationary Spiral and Overcapacity

Recent economic data confirm this grim picture. May figures for the Consumer Price Index (CPI) and Producer Price Index (PPI), released on June 9, showed consumer deflation continuing for the fourth consecutive month, while the PPI recorded its largest drop in almost two years. This indicates profound deflationary pressure, which economists predict won't subside anytime soon. Even increased consumption during two national holidays failed to offset overall weak domestic demand, highlighting the severity of the problem.

Since the pandemic, the Chinese economy has continued to weaken. Consumers are more cautious due to the prolonged real estate market downturn, and many companies are trapped in a fierce price war driven by industrial overcapacity. US tariffs, further aggravating this overcapacity, will reduce US demand for Chinese goods and intensify the price war, creating a vicious cycle.

Ten Crucial Challenges Identified by Experts

Alicia García Herrero, a senior fellow at the independent European think tank Bruegel, outlined ten critical challenges China faces:

1. Lack of Fiscal Space and Local Debt: Unlike 2008, when China could implement massive stimulus, public debt now stands at about 100% of GDP, a very high level for a country with similar per capita income. This limit stems largely from large fiscal deficits, including astronomical loans taken by local governments, often for unproductive real estate and infrastructure projects. The crisis of these local debts threatens financial stability and the central government's ability to provide further stimulus.

2. Monetary Policy Constraints: Although the People's Bank of China (PBoC) still has room to cut interest rates or implement quantitative easing, monetary policy's real impact is limited. This is due both to high real interest rates caused by deflation and to obstacles in the money supply. The weak renminbi restricts the PBoC's maneuverability, and Chinese banks, already suffering from low profitability, would struggle to absorb further profit declines from additional interest rate cuts.

3. Insufficient Domestic Demand: China's production scale far exceeds its domestic market's consumption capacity. Investment growth in manufacturing capital goods significantly outpaces GDP growth, while real estate investment has drastically declined. Sectors like green technologies show massive investments, with China accounting for almost 90% of total global investments (e.g., solar panels), highlighting potential overcapacity even in these areas.

4. External Demand and Geopolitical Challenges: Chinese imports have stagnated, leading to a large trade surplus, crucial for economic growth. However, with rising manufactured goods exports and increasing global protectionism, China's share of global manufacturing output has risen to 18%, a trend that may be difficult to sustain long-term. The United States has already reduced imports from China, and the impact of global tariffs under a potential Trump administration makes it difficult for China to continue relying on foreign markets as in the past.

5. Overcapacity and Deflationary Pressure: Manufacturing capacity utilization in China has fallen from its 2021 peak to near pandemic levels. The collapse in manufacturing goods prices compresses manufacturers' profit margins. Without a significant increase in domestic consumption, rising protectionism from various countries will lead to high tariff barriers, intensifying deflationary pressure in China.

6. Lack of Policy Support and Slow Private Consumption: While increased private consumption is generally believed to correct China's economic imbalances, it's easier said than done. Chinese private consumption as a percentage of GDP remains low, especially compared to fixed capital investment. High investment and even higher domestic savings, among the world's highest, reflect a lack of confidence in the Chinese people's future. Changing this would require radical reforms, like strengthening the pension system and providing better unemployment and public healthcare benefits, but these don't appear to be on the Chinese government's agenda.

7. Real Estate Sector Still in Recession: The real estate sector, which for years accounted for a third of China's total economic growth and fixed asset investment, began to decline in 2021 with Evergrande's collapse. Its contribution to growth is now negative, and house prices and transaction volumes continue to decrease.

8. Excessive Investment Leading to Diminishing Returns: China's high savings have fueled a huge investment boom that has been the primary growth driver for too long, now becoming excessive. Returns on assets for state-owned enterprises are low, and even those for private enterprises (POEs) are now too low.

9. Demographic Decline and Youth Unemployment: The one-child policy left its mark on China's demographic structure, but the fertility rate has rapidly declined since 2019, likely due to economic uncertainty. Urbanization is estimated to be completed by 2035, when a decline in the urban workforce will begin, negatively impacting social productivity and potentially reducing annual economic growth by approximately 1.3 percentage points. Adding to this is the dramatic problem of youth unemployment, which has reached record levels and risks generating social instability and frustration among younger generations.

10. US Technology Restrictions and Challenges in Self-Sufficiency: China and the United States compete in innovation. US spending on R&D as a percentage of GDP exceeds China's, making it difficult for China to surpass the US in global technological dominance. The US has also sought to curb Chinese tech development through various means, including export controls on advanced technologies, to prevent their use for military and surveillance purposes. Despite massive investments, China is encountering significant difficulties in achieving full technological self-sufficiency, particularly in critical sectors like advanced semiconductors, which leaves it vulnerable to external pressures.

High Legal and Operational Risks When Doing Business with Beijing

Doing business in China has always been challenging, but today it has become an endeavor fraught with dangers, extending far beyond the purely economic arena. For foreign companies, operating in the Dragon means navigating an increasingly opaque legal labyrinth, where understanding regulations isn't just a precaution but a vital necessity to avoid draconian sanctions or, at worst, the detention of personnel.

Since 2015, under Xi Jinping's leadership, the Chinese Communist Party has erected an imposing legislative architecture focused on national security, cybersecurity, and data privacy. This regulatory framework has a dual purpose: to strengthen government control over all information flows within China's borders and, simultaneously, to extend surveillance over all entities, domestic and foreign. Beijing doesn't hesitate to consider any insufficient control or data leakage a direct threat to its security, transforming companies into potential targets.

The implications for foreign businesses are dramatic:

• The Digital Big Brother: New laws provide the government with an expansive legal basis to access and control data held by foreign companies in China. No corner is hidden when the state deems its interests at stake.

• The Espionage Trap: Commercial activities once considered ordinary can now be labeled as espionage. Companies risk heavy penalties not only for alleged illegal activities but also for indirectly facilitating international sanctions against China, putting them in an untenable position between two fires.

• The Obligation to Cooperate: Perhaps the most unsettling aspect is that Chinese employees of foreign companies can be legally compelled to assist the CCP's intelligence efforts. This creates an unsustainable ethical and practical dilemma for multinationals, who see local staff transformed into potential state instruments.

Laws like the amended Counter-Espionage Law (effective July 2023) have broadened the definition of "espionage" to include "any document, data, material, or object related to national security interests," without providing precise details. This regulatory ambiguity leaves companies, journalists, and academics in a limbo of legal uncertainty, where almost any piece of data can become a potential accusation.

Similarly, the 2021 Cybersecurity Vulnerability Reporting Regulation obliges companies to disclose any "bugs" discovered in their systems or software to Chinese authorities, preventing public disclosure or international sharing until Beijing completes its assessment. This clause paves the way for unethical exploitation of security flaws. Finally, the 2021 Personal Information Protection Law (PIPL), while seemingly similar to Europe's GDPR, harbors ambiguities that could make it one of the world's strictest data privacy laws, generating a high level of implementation uncertainty.

In this scenario, foreign investor confidence can only falter, fueling a quiet disinvestment that further aggravates China's already precarious economic conditions.

Shadows Over Xi Jinping's Control of the People's Liberation Army

Despite a decade of meticulous power consolidation, Xi Jinping's grip on the People's Liberation Army (PLA) now appears less monolithic than previously believed. Recent dynamics within the Chinese Communist Party (CCP) and the PLA suggest a phase of profound realignment and a potential erosion of Xi's unconditional authority over the Party's armed wing.

The anti-corruption campaign, while presented as a tool for internal cleansing, is now perceived by some as an operation to reassert Xi's authority, which paradoxically might also reveal his power's fragility. Key indicators of this uncertainty include:

• Dramatic Events at the Military Apex: On June 2, the sudden disappearance of Xu Qiliang, former Vice Chairman of the Central Military Commission (CMC), was reported. This follows the prolonged public absence since March 11 of He Weidong, the other CMC Vice Chairman and a figure considered highly trusted by Xi, amid rumors of an investigation. These incidents follow earlier removals of key CMC members like Li Shangfu and Miao Hua. Should He's absence be officially confirmed, the effective number of CMC members would drop from seven to just four, highlighting a leadership vacuum and a potential crisis of confidence.

• Large-Scale Purges and Signs of Distrust: The sheer scale of the purges is striking, with estimates indicating over 100 high-ranking officers, nearly a hundred of whom hold general rank, incarcerated in the last year alone. The use of establishing or expanding hundreds of specialized detention centers nationwide underscores these operations' systemic nature.

• Striking at Xi's Inner Circle: A particularly telling aspect is that many high-ranking officials removed in the past year were previously promoted by Xi himself. Furthermore, the latest wave of purges appears to have largely targeted figures considered "loyalists" to the leader, with vacant positions presumably filled by elements close to Zhang Youxia, the other CMC Vice Chairman. This dynamic has fueled serious speculation that Zhang has gained significant control over the armed forces, with some observers even hypothesizing that Xi, while nominally retaining his position, may have become a mere "rubber stamp," having lost effective control over the CCP's highest power base – the military.

• Internal Contradiction on Corruption: In his third term, Xi himself acknowledged in January 2025 that corruption, despite years of intense efforts, remains pervasive and is even on the rise. This admission undermines the perception of monolithic control and reveals a continuous struggle for loyalty and power, indicating that drastic reforms and purges haven't eliminated the root causes or internal resistance.

Historically, Xi Jinping built a vast control apparatus, reforming the Central Military Commission to centralize command and subordinating paramilitary forces (PAP) directly to Party control. The principle of "The Party Commands the Gun" has been consistently reasserted, and military promotions now strictly emphasize "political standards." However, recent events suggest that, despite these efforts, his authority may be increasingly questioned.

Military appointments expected around August 1, and especially the outcome of the Fourth Plenary Session of the CCP Central Committee (slated for late August to mid-October), will be decisive tests. The nature of these decisions and the figures who emerge will clarify whether Xi Jinping has managed to re-establish undisputed power over the PLA, or if his authority over the CCP's armed wing remains a terrain of continuous negotiation and consolidation amidst heightened surveillance and control.

The military parade in September 2025, commemorating the 80th anniversary of the end of World War II, will be a clear projection of force and cohesion on the international stage. However, staging such a grand display amidst deep internal purges might also serve domestic purposes: to project an image of unwavering stability and control to reassure the population and Party elites themselves, seeking to mask or counterbalance narratives of internal friction and a potential weakening of Xi's power.

Geopolitical Weakness in the Middle East and the Crucial Taiwan Knot

In addition to economic challenges and internal power struggles, China is encountering significant limitations in its power projection capabilities in the geopolitical arena, particularly in the Middle East. Beijing has attempted to establish itself as a mediator in the region, facilitating a rapprochement between Saudi Arabia and Iran in 2023 and presenting itself as a more neutral actor in the Israeli-Palestinian conflict compared to the United States. Its position as the largest buyer of Iranian oil has been a vital lifeline for Tehran, which is under crippling international sanctions.

However, recent events have exposed the fragility of Chinese influence. While Israel and Iran engaged in an unprecedented exchange of attacks, and the United States struck key targets on Iranian soil, Beijing's response was limited to generic calls for de-escalation. According to analysts like Craig Singleton of the Foundation for Defense of Democracies, Beijing offered no concrete help to Tehran, merely rhetoric that paints China as a principled alternative, while it quietly remains on the sidelines.

This behavior suggests that China adheres to statements and condemnations at the UN, avoiding promising more than it can deliver, which would highlight the limits of its power projection. The result is a patently weak response that underscores how little real leverage China has over Iran when armed conflicts begin.

Despite China, along with Russia, being a key supporter of Iran, strengthening ties after the US withdrawal from the nuclear deal in 2018, and even with President Xi Jinping calling relations "strategic" with Tehran in 2023, the reality on the ground reveals a different capacity for action. A retired Chinese colonel, Liu Qiang, even stated that "Iran's survival is a matter of China's national security," but this has not translated into decisive intervention in the face of escalation.

Adding to this geopolitical weakness is the crucial issue of Taiwan, which represents the greatest and most volatile threat to regional and global stability for China. Beijing's increasingly aggressive rhetoric regarding unification and growing military exercises around the island keep the international community on constant alert. Any potential decision to take military action on Taiwan would entail incalculable economic and human costs for China, triggering unprecedented sanctions and a likely international military reaction, which would exponentially worsen all the internal and external crises described so far.

Conclusions: A Distant Goal, Amidst Unknowns and Fears

In summary, the 5% growth target for 2025 increasingly appears to be a statement of intent rather than a realistic forecast. The cracks in the Chinese economic model are deep and require bold reforms, not just temporary stimuli. The unknown factor of Trump, with his threat of a new trade war, could not only nullify Beijing's efforts but also push the Chinese economy into uncharted territory of recession and turbulence. Added to this is a geopolitical influence in the Middle East that appears, at present, limited and insufficient to support its key allies, the high legal risks for foreign companies, and, perhaps the most critical factor, the growing uncertainties about Xi Jinping's absolute control over the powerful Chinese military machine, with the persistent and dangerous Taiwan scenario at the forefront.

The stakes are incredibly high, not just for China, but for the entire global economy. As Beijing scrambles to project an image of stability, the Asian giant is navigating increasingly turbulent waters, with a storm on the horizon that could test its resilience like never before.