Upgrade China to 3.0 Stars 'Attractive' Rating Amid Private Sector Resurgence

• Consistent policy support for the private sector since early 2025 signals a meaningful softening of structural risks in China. Private businesses are positioned to drive more sustainable and broad-based economic growth moving forward.

• Reviving the private economy is key to addressing structural challenges including rising youth unemployment, weak consumer demand, and fragile confidence by enabling private enterprises to expand and innovate.

• As China prioritises semiconductor self-sufficiency and transitions toward a consumption-led growth model, policy tailwinds are most favourable for the technology and consumption sectors.

• We are upgrading China’s star rating from 2.5 “Neutral” to 3.0 “Attractive” and revising our PE multiple from 10X to 12X. This implies a target price of HKD 96 for the MSCI China Index by FY2027, representing a potential upside of 26.4%.

Over the past few years, China’s economic trajectory has increasingly drawn negative sentiment. One of the most significant concerns has been the country’s pivot toward a more centralised, top-down economic model. This shift has been characterised by a series of regulatory crackdowns across various sectors, most notably within the technology industry. Leading private enterprises, once seen as flag bearers of China’s economic dynamism, were subjected to stringent oversight, resulting in a chilling effect on innovation and investment. These actions led to prolonged periods of depressed valuations for some of China’s most prominent technology firms.

Compounding the structural shifts were several economic crises: sluggish consumer spending, surging youth unemployment, a deepening property sector meltdown, and rising geopolitical tensions. These factors collectively eroded investor confidence and raised questions about whether China’s economy was entering a period of systemic decline.

While many of these challenges remain unresolved and will take significant time to unwind, the past six months have brought encouraging signs of policy recalibration. Targeted support measures for private businesses suggest a renewed recognition among Chinese leaders that the private sector is not a threat to control, but a necessary engine for sustainable growth.

A Turning Point: The Re-Emergence of China's Private Sector

While initial signs of policy support for China’s private sector began to surface in 2024, the true inflection point arrived in January 2025 with the meteoric rise of DeepSeek. Its rapid ascent served as a wake-up call for policymakers: in order to break through the technology chokepoints impeding China’s artificial intelligence ambition, the private sector must play a central role. DeepSeek’s success highlighted the untapped potential that lies within China’s entrepreneurial ecosystem and underscored the urgency of creating an environment conducive to innovation-driven growth.

In February, a symbolic policy shift took place as President Xi convened a high-profile symposium with top tech entrepreneurs, including the long-absent Jack Ma. His reappearance—after years on the sidelines—sent a clear signal of political recalibration. Xi’s message, encouraging entrepreneurs to contribute to national innovation, signals a strategic recognition that private enterprise is essential to advancing China’s tech ambitions. The move also serves as a measure aimed at rebuilding trust with the business community and investors.

This rhetorical shift was quickly followed by tangible policy action. During the annual “Two Sessions” in March, policymakers unveiled a series of measures aimed at institutionalising support for the private sector. These included commitments to expand financial access for private firms, enable their participation in major infrastructure projects, and foster involvement in advanced manufacturing and the digital economy through a new public-private partnership (PPP) framework. These moves are intended to diversify capital channels and re-anchor private enterprise within the national development agenda.

A further milestone came with the implementation of the Private Economy Promotion Law on 20 May 2025, the first law explicitly dedicated to supporting private businesses. The legislation aims to ensure fair competition, equal access to market resources, and legal protections for private enterprises. Its passage marks a significant shift, signalling that private sector growth is now supported by a robust legal framework.

These developments collectively suggest a strategic rebalancing of China’s economic model. Looking ahead, we believe that China’s economic growth will become increasingly diversified, driven by both the scale and stability of state-owned enterprises and the agility and innovation of the private sector, laying the groundwork for a more resilient and competitive Chinese economy.

Table 1: Timeline of the policy shift in 2025

Jan 2025	DeepSeek served as a wake-up call for policymakers that the private sector plays a central role to break through technology chokepoints.
Feb 2025	President Xi held a high-profile symposium with leading entrepreneurs in tech space, including Jack Ma.
Mar 2025	The “two sessions” unveiled plans to support the private sector, allowing private capital’s participation in major infrastructure projects and AI via PPP framework.
May 2025	Introduction of the Private Economy Promotion Law, the first law explicitly dedicated to supporting private businesses.

Private Sector Expansion Holds The Key To Economic Growth

According to Qiu Xiaoping, Vice-Chairman of the All-China Federation of Industry and Commerce, the private sector is a cornerstone of China's economy—contributing over 50% of tax revenue, 60% of GDP, and more than 80% of urban employment. Its vitality is essential to tackling core challenges.

China’s bleak labour market has been a focal point of criticism in recent years. The downturn began in 2022, when regulatory crackdowns on the technology and education sectors led to widespread layoffs. This abrupt policy shift not only disrupted employment but also severely eroded investor confidence, triggering an equity market slump. By mid-2023, youth unemployment had soared to over 23%. The resulting labour market fragility weighed heavily on household sentiment and dampened consumption demand.

Recent signs, however, point to a gradual reversal. With the government now signalling stronger support for high-tech sectors, job creation is beginning to show green shoots. A notable example is Tencent’s announcement of its largest internship recruitment program, which plans to onboard 28,000 interns over the next three years, with a strong focus on full-time conversion. As leading technology firms expand, they are likely to absorb a significant portion of China’s educated youth, who will be a key demographic for long-term productivity.

A more stable labour market is fundamental to China’s strategic shift toward consumption-driven growth. In 2025, retail sales have shown encouraging resilience, with year-on-year growth surpassing 5% since March (Figure 1). While short-term stimulus measures, such as consumption vouchers, have contributed to the rebound, their impact is inherently limited, as seen in the fading effects of similar efforts in 2024. As such, a healthier labour market, anchored by private sector expansion, would provide the structural support needed to maintain momentum, especially in the face of external trade headwinds.

Figure 1: Consumption growth rebounds with increased resilience in 2025

Investor sentiment has been among the hardest-hit area since the onset of regulatory tightening. Domestic private investment shrank to near-zero growth in 2022, while foreign direct investment (FDI) turned negative in 2023. While FDI began to recover modestly from September 2024, following the rollout of sweeping stimulus, domestic private investment remained in contraction throughout the second half of 2024 (Figure 2). This divergence highlighted a key issue: policy stimulus alone is not enough as investors need structural, long-term assurances.

The first signs of a turnaround came in Q1 2025, with private fixed asset investment posting a modest 0.4% year-on-year increase. This recovery, though nascent, coincided with the introduction of landmark measures, including legislation promoting private sector participation in infrastructure and manufacturing via new public-private partnership frameworks.

Figure 2: Investment activity shows early signs of recovery

Rebuilding investor and consumer confidence will be a gradual process. However, the recent policy recalibration marks a meaningful shift in China’s growth narrative. If consistently implemented, these structural changes could lay the foundation for a more sustainable recovery in sentiment. A revitalised private sector, backed by stronger legal safeguards and improved access to capital, offers a more credible and sustainable pathway to meeting the government’s 5% GDP growth target.

Consumption and AI Momentum Drive Private Sector Growth

As China’s policy direction increasingly leans toward stimulating consumption and accelerating AI adoption, the positive impact is becoming visible in corporate earnings. The MSCI China Index has shown a notable rebound, with 1Q25 earnings growth gaining strong momentum. Information technology led the pack with nearly 40% year-on-year earnings growth, followed by communications services at 21%, while consumer staples and consumer discretionary also posted robust double-digit gains (Figure 3).

Figure 3: Technology-related sectors posted strong earnings rebounds in 1Q2025

China’s emerging AI wave is at the heart of this rebound. In 1Q25, companies deeply integrated into the digital economy and AI development saw substantial revenue uplifts. Alibaba, Tencent, and JD.com all reported double-digit growth in marketing revenues, powered by AI-driven advertisement targeting tools that improved customer segmentation and conversion efficiency. Meanwhile, cloud revenue surged by 18% for Alibaba and 42% for Baidu, as AI workloads drove greater demand for scalable infrastructure.

While AI software innovation in China is accelerating, hardware remains a strategic bottleneck. US export controls have effectively blocked access to cutting-edge AI chips, such as Nvidia’s A100 and H100, creating a critical gap in China’s AI development stack. In response, Chinese tech leaders are intensifying efforts in domestic chip design. Huawei’s Ascend series, though still behind Nvidia’s chips in raw computing power, are capable of supporting inference tasks for models like DeepSeek’s R1, underscoring progress in localised solutions.

Notable strides are also being made in consumer-grade chips. Huawei’s Kirin 9000 and Xiaomi’s recently launched XRing O1, the first Chinese-designed smartphone System-on-Chip (SoC) built on a 3nm process, represent significant advancements. While these chips have yet to match the performance of Western-designed counterparts in AI training, they function as important commercial enablers. By improving product margins, enhancing ecosystem control, and laying the foundation for vertical integration, they help China’s tech ecosystem build resilience amid tightening geopolitical constraints.

For instance, Xiaomi’s shift toward using its own SoC architecture could significantly reshape its cost structure and strategic positioning. As of 2024, Qualcomm supplied the majority of chips for Xiaomi’s premium smartphones (Figure 4). By transitioning to in-house SoCs, Xiaomi can reduce licensing and component costs while achieving tighter ecosystem integration. This move supports a premium pricing strategy via margin expansion and brand differentiation. Over time, Xiaomi’s chip capabilities could extend into adjacent markets such as electric vehicles and other Android-based hardware, reinforcing vertical integration and long-term competitiveness.

Figure 4: Xiaomi’s premium model used mainly foreign SoC

China’s drive for domestic chip production has also spurred growth for its leading foundries, notably SMIC and Hua Hong. However, Chinese foundries lack access to ASML’s cutting-edge EUV lithography tools, limiting them to 7nm processes using older DUV technology—with yield rates reportedly still below 50%. This creates a cost-efficiency trade-off: while chip demand is climbing, foundries face heavy capital expenditures for R&D and equipment upgrades, putting pressure on short-term profitability.

Despite these headwinds, the broader push underscores China’s long-term commitment to semiconductor self-reliance. Foundry investments are increasingly viewed not just as commercial endeavours but as strategic imperatives. Even at the expense of near-term margins, sustained policy support suggests these efforts will remain a national priority amid rising geopolitical and technological competition.

Upgrading China’s Valuation: Structural Reforms Set the Stage for Growth

The recent structural reforms supporting China’s private sector represent a pivotal shift in the country’s economic trajectory. By creating a more favourable environment for private enterprises, these changes are expected to boost earnings growth, innovation capacity, and productivity, especially in the technology sector, which sits at the nexus of AI advancement and rising domestic consumption.

A robust private sector also provides a critical buffer against external headwinds, such as ongoing US tariff disputes and slowing global growth, by anchoring expansion more firmly in domestic demand and innovation. Amid escalating trade uncertainties under the Trump administration, 2025 is shaping up to be a year where non-US markets take the lead. China’s structural transformation enhances its appeal as a compelling investment opportunity, particularly in light of our recent downgrade of US equities.

Related article: US: Downgrading to 2.5 stars “Neutral” amid an escalating trade war

We are raising our star rating on China from 2.5 “Neutral” to 3.0 stars “Attractive” and revising the market’s fair P/E from 10X to 12X, reflecting improved earnings visibility and a more constructive investment climate due to policy support. The MSCI China Index is projected to reach HKD 96 as of FY2027, offering a potential upside of 26.4%.

Investors may find China’s technology sector a promising source of growth. To capitalise on these opportunities, we recommend the iShares Hang Seng Tech ETF (HKEX: 3067 / 9067), which offers targeted exposure to leading Chinese tech companies. For those seeking broader market exposure, the iShares Core MSCI China ETF (HKEX: 2801) and the iShares MSCI China ETF (NASDAQ: MCHI) provide diversified access to China’s equity market. Alternatively, the Fidelity China Focus A-SGD Fund offers active management and has historically demonstrated resilience during periods of economic volatility.

Table 2: MSCI China’s earnings projections till FY2027

	2024	2025E	2026E	2027E
PE Ratio	12.7	11.7	10.6	9.5
Earnings Growth	24.2%	8.0%	10.4%	11.3%
EPS	6.01	6.49	7.16	7.97
Projected Fair Price (Based on fair PE ratio of 12X)				96
Upside				26.4%
Source: Bloomberg Finance L.P., iFAST Compilations. Data as of 18 June 2025.

Figure 5: MSCI China Index vs. EPS

Declaration:

For specific disclosure, at the time of publication of this report, the analyst who produced this report holds positions in iShares Core MSCI China ETF (HKEX: 2801). IFPL (via its connected and associated entities) holds a NIL position in the abovementioned securities.