Tariffs, Stimulus, and the Yuan: China’s Economic Path Forward
As the trade war between the United States and China intensifies, Beijing faces a delicate balancing act in maintaining its economic growth while navigating a series of complex challenges. The trade dispute, which began in earnest during President Donald Trump’s administration, has led to a series of tariff increases that threaten to undermine China’s export-driven economy. Despite these pressures, President Xi Jinping’s government has committed to ambitious growth targets, with the announcement of a 5% economic expansion goal for 2025, marking the first time in over a decade that China has set the same target for three consecutive years.
However, achieving this goal is fraught with difficulties. U.S. tariffs, which have been steadily rising, are expected to hurt China’s exports and slow down economic activity. If the tariffs continue to rise, China may need to resort to stimulus measures, devaluing its currency, or a combination of both to offset the impact. Yet, each of these strategies comes with significant risks that could affect long-term stability.
The Growth Target and Trade War Context
During the annual parliamentary session in March 2025, China’s leadership unveiled a growth target of about 5% for the year. While this may seem modest by China’s previous standards, it reflects a careful approach to managing the country’s economic future amid ongoing external pressures. The target marks the third consecutive year China has set the same growth goal, signaling stability in its economic planning.
However, the timing of this announcement was significant. Just hours earlier, U.S. President Donald Trump escalated the trade war by raising tariffs on Chinese goods to a blanket 20%. The trade war, which began in 2018, has already led to a series of tariffs that have affected hundreds of billions of dollars’ worth of trade. As the U.S. imposes higher tariffs, Chinese goods become more expensive on the U.S. market, reducing demand for Chinese exports. This creates a serious challenge for an economy heavily reliant on trade.
The growing tensions have prompted concerns that China might need to deploy significant stimulus to counteract the damage from falling trade revenues. However, a stimulus package that goes too far could exacerbate China’s existing debt problems and undermine Xi Jinping’s long-standing efforts to rein in rising debt levels.
Stimulus and Financial Risks
China’s leadership faces a difficult choice. On the one hand, stimulus measures—such as increased infrastructure spending, tax cuts, or subsidies to key industries—could help drive economic activity and ensure that China meets its growth target. On the other hand, excessive stimulus would increase debt levels, which have already reached high levels in China. The country’s local governments, corporations, and banks are all deeply indebted, and additional borrowing could worsen financial stability.
Since the onset of the COVID-19 pandemic, Beijing has been more cautious with its stimulus approach. Unlike in previous economic slowdowns, when the government unleashed large-scale “bazooka” stimulus measures, China has largely resisted such aggressive tactics in recent years. This restraint is driven by a desire to avoid triggering a financial crisis like the one that followed the 2008 global financial crisis, when massive government spending and lending led to a sharp rise in debt.
However, analysts suggest that if the trade war intensifies and tariffs continue to rise, China may have little choice but to introduce more substantial stimulus measures to offset the economic damage. Economists have varied views on the scale of stimulus required. Some, like Carlos Casanova of Union Bancaire Privée, estimate that China may need to inject “tens of trillions of yuan” to address the fallout from tariffs and stabilize key sectors such as real estate and local government debt. Others, like Tommy Xie of Oversea-Chinese Banking Corp., suggest that a more moderate stimulus of 1 to 2 trillion yuan could suffice.
Regardless of the amount, increasing stimulus comes with significant risks. China has made significant progress in reducing its debt levels in recent years, and expanding credit further could undermine these efforts. If the Chinese government resorts to a large-scale stimulus package, it could face the dilemma of balancing short-term growth objectives with the need to manage long-term financial risks.
The Yuan: A Tool for Stimulus or a Double-Edged Sword?
Another tool that China could use to mitigate the economic impact of rising tariffs is devaluing its currency, the yuan. During the first phase of the trade war in 2018 and 2019, China allowed the yuan to depreciate by 11.5% against the U.S. dollar. According to Morgan Stanley economists, this move helped offset about two-thirds of the tariff hike by making Chinese goods cheaper and more competitive on global markets.
However, this time around, devaluing the yuan is a far more complicated option. The yuan is already near the lower bound of a range that the People’s Bank of China (PBoC) is willing to allow the currency to fluctuate within. A sharp devaluation now could risk triggering significant capital outflows, as investors might pull their funds out of China in anticipation of further depreciation. This could place additional strain on China’s foreign exchange reserves and create volatility in the financial markets.
A weaker yuan could also exacerbate inflationary pressures within China, especially for imports, making everyday goods more expensive for consumers. Moreover, any aggressive devaluation could raise concerns among trading partners, particularly the U.S., which has frequently accused China of currency manipulation. If Beijing were to pursue this route, it could provoke even harsher retaliation from Washington, potentially escalating the trade war even further.
Thus, while currency devaluation could provide short-term relief by boosting exports, it also carries significant risks that China may be unwilling to take, particularly given the fragility of its financial system and the global scrutiny it would face.
China’s Firm Stance: Rhetoric and Reality
Despite the ongoing pressures, President Xi Jinping’s government has responded to the trade war with relative calm and moderation. The Chinese government has so far resisted making dramatic economic decisions such as large-scale currency devaluation or excessive stimulus measures. Instead, it has adopted a more measured response, focusing on managing the immediate impact of tariffs through moderate economic measures and ensuring long-term growth through structural reforms.
However, the rhetoric coming from China has become increasingly combative. Hours after the growth target for 2025 was announced, the Chinese embassy in the U.S. issued a statement on social media platform X (formerly Twitter), declaring, “If war is what the U.S. wants, be it a tariff war, a trade war or any other type of war, we’re ready to fight till the end.” This statement underscores China’s resolve to stand its ground in the face of escalating tensions with the U.S.
While China’s leadership remains committed to achieving steady growth, there are no guarantees that the situation will remain stable if the trade war continues to worsen. If tariff levels rise significantly, China may find itself with fewer options to avoid a slowdown. The government’s current strategy focuses on balancing economic stability with long-term reforms, but this approach could be tested if the trade war intensifies further.
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The Bottom Line
China is facing a complex set of economic challenges as it navigates the ongoing trade war with the U.S. While the government has set an ambitious 5% growth target for 2025, achieving this goal will require careful management of both domestic and external pressures. Stimulus measures, currency devaluation, and other economic interventions could provide temporary relief, but each carries significant risks.
With the yuan already near its weaker limits and debt levels remaining a concern, China may have to consider additional measures to ensure continued growth. However, any drastic actions—such as large-scale stimulus or aggressive currency devaluation—could destabilize the economy in the long run. The road ahead remains uncertain, and the outcomes of the ongoing trade war will play a significant role in shaping China’s economic trajectory for years to come.
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