China’s economy expanded more strongly than anticipated in the first quarter of the year, despite growing global concerns over the impact of the US-Israel conflict with Iran. According to official data, gross domestic product (GDP) increased by 5% year-on-year during the period, surpassing economists’ expectations of around 4.8%. It also represents the first publication of official GDP data since Beijing lowered its annual economic growth target last month to 4.5%–5%, marking its weakest expansion goal since 1991. Compared to the final three months of 2025, the country’s gross domestic product increased by 1.3% as per the China National Bureau of Statistics. If maintained throughout the year, that growth rate would translate into annual expansion of approximately 5.3%. All this occurred despite the conflict in the Middle East, which began on 28 February and significantly disrupted global energy supplies, with Asian countries being especially affected.
What drives the growth and what constrains it?
The recovery from slower growth in the second half of 2025 was propelled by the manufacturing sector, although the world’s second-largest economy continues to face pressure from declining property investment. Industrial production increased by 6.1%, with high-tech manufacturing standing out as a strong performer, growing by 12.5%. Manufacturing of products such as semiconductors, industrial robots, lithium batteries, and 3D printers performed particularly strongly, recording double-digit growth between 24% and 54%. Demand for manufactured goods was boosted by a 14.1% increase in exports during the first three months of 2026, according to earlier released data. In addition, fixed asset investment, which had contracted in the second half of 2025, increased by 1.7% in the first quarter.
However, China’s consumer services industry has been facing difficulties, with restaurants shutting down across the country and those that remain open often having noticeably empty dining areas. A prolonged and sharp decline in apartment prices has reduced Chinese household wealth, leading many consumers to rein in spending. Residential construction has slowed significantly over the past four years, but apartment sales have fallen at an even quicker pace, resulting in a rising surplus of unsold properties and making potential buyers hesitant to invest their savings in real estate. Meanwhile, retail sales grew by only 2.4% year-on-year in the first quarter and just 1.7% in March, falling well short of most economists’ expectations. Furthermore, car sales dropped by 17% over the quarter after the government reduced subsidies that had previously fuelled a surge in demand last year. Exports have supported the Chinese economy through much of its housing downturn since 2021. However, this time they were unable to offset wider weakness, following a sharp increase in China’s largest import category—computer chips.
What could risk China’s economic blossom moving forward?
China opened the year with stronger-than-expected growth, but analysts say this does not yet indicate resilience to the economic impact of the Iran war, which is clouding the global outlook and may still raise costs and weaken demand for the world’s second-largest economy. External demand helped sustain growth in the first quarter. However, this dependence also raises questions about how long it can last. Meanwhile, China’s factory-gate prices turned positive last month for the first time in more than three years, as surging commodity costs particularly oil—began to impact the country’s vast industrial sector. In recent years, major Chinese industries have been affected by excess capacity, leading to intense price competition and sustained deflationary pressure across the economy. According to data from the National Bureau of Statistics (NBS), the producer price index (PPI), which measures factory-gate inflation, rose 0.5% year-on-year, returning to positive territory for the first time since September 2022. Chinese policymakers have long sought to end deflation as they work to revive an economy burdened by oversupply and weak consumer demand. However, analysts caution that this “cost-push inflation,” driven by rising input costs rather than stronger demand, is not the ideal form of recovery. Instead, higher production costs passed on to already cautious consumers could further weigh on the economy by reducing household disposable income and dampening spending. Some economists caution that a prolonged Middle East conflict could drive up costs and squeeze producer profits, while also weakening consumer demand including from abroad, as rising prices reduce overall spending power.
China has traditionally depended on infrastructure development such as roads, bridges, ports, and other large-scale projects to stimulate its slowing economy. However, increasing debt levels, particularly among local and provincial authorities, are making this approach more difficult to maintain. Weak domestic demand has prompted Chinese firms to look overseas for growth. Exports rose in the first three months of this year at their fastest quarterly pace in over four years, driven mainly by electric vehicle and lithium battery shipments. Economists say these overseas sales have helped keep factories operating at high capacity across the country. However, the durability of this export strength remains uncertain. Tariffs and higher raw material costs linked to the Iran conflict appeared to weigh on the Chinese economy in March. Although China is relatively well positioned compared to other major economies to withstand disruptions to oil and gas supplies thanks to large fossil fuel reserves and its leadership in renewables, recent trade data points to unexpected changes that significantly narrowed its trade surplus. A key shift has been a sharp increase in semiconductor imports, despite a a weak Renminbi, as China rapidly expands data centre infrastructure to support artificial intelligence development. At the same time, exports of toys and footwear, once strong sectors—declined as rising plastic costs from the Middle East conflict squeezed manufacturers.
How will Sri Lanka be impacted from this?
As a key trading partner, Sri Lanka is likely to feel both direct and indirect effects from these developments in China. Slower and uneven Chinese growth could weaken demand for Sri Lankan exports such as tea, rubber, apparel inputs, and other commodities, while reduced Chinese outbound investment may delay infrastructure or development projects linked to Sri Lanka. The growing reluctance to spend amongst Chinese households, amid global uncertainties can also have an impact on Sri Lanka’s tourism sector.
At the same time, if Chinese manufacturers face higher costs and weaker global demand associated with the conflict in the Middle East, competition in export markets could intensify, placing pressure on Sri Lankan producers. Rising energy prices caused by Middle East tensions would also be significant for Sri Lanka, as a net fuel importer, increasing import costs, inflationary pressures, and pressure on the trade balance.