China’s humming factories threw a lifeline to an economy struggling with weak demand in the second quarter. That’s also given policymakers space to fight deflation — if they choose to do more than just hitting their growth target.

Gross domestic product beat expectations to grow 5.2% between April and June, bringing the official 5% expansion goal for the year within reach. But while strong exports made up for sluggish consumption at home, they also masked a worsening decline in prices that threatens to drag the world’s second-largest economy into a prolonged slowdown.

Nominal GDP, which accounts for price changes, grew only 3.9%, the least outside the pandemic since the quarterly data began in 1993. The GDP deflator, a measure of economywide prices, extended the longest streak of decline on record.

This persistent deflation fuels a dangerous cycle: As consumers withhold purchases in anticipation of further price drops, business profits and wages will suffer, further dampening the appetite to spend.

"I worry that policymakers will be complacent because of the good GDP numbers,” said Raymond Yeung, chief economist for Greater China at Australia & New Zealand Banking Group. "They shouldn’t ignore that deflation is the most urgent problem now.”

A delay in further stimulus risks exacerbating sluggish consumer confidence, which remains weighed down by a worsening property market. Continued reliance on exports, which made up almost a third of growth in the first half of the year, also leaves the economy vulnerable to external shocks.

While the outcome of tariff talks with the U.S. remains unclear, exports are already expected to slow in the coming months as the effect of front-loading fades, with economists forecasting growth to decline sharply to 2% for the year. A drop in overseas shipments would not just hurt growth but also worsen the oversupply at home and put even more pressure on prices.

With expansion in the first six months now standing at 5.3%, banks including Nomura Holdings and Goldman Sachs Group have revised up their forecasts for the economy. The improved outlook offers leader Xi Jinping a rare opportunity to tackle sticky deflation before real growth starts to falter.

The Chinese president signaled his intent to do so earlier this month, when he and other top officials offered their bluntest assessment yet of the cutthroat competition that’s been dragging down prices and profits across industries. Reining in overcapacity may also ease China’s tensions with trading partners, who have increasingly complained of a flood of Chinese products drowning out local competition.

"Curbing excessive competition could have a negative impact on the economy in the short term, so it needs to be pushed forward when the economy is relatively stable,” said Ding Shuang, chief economist for Greater China and North Asia at Standard Chartered.

But such a pivot won’t be easy. As Chinese consumers remain reluctant to spend, tackling deflation means cutting supply and production capacity — effectively allowing less efficient or unprofitable companies to fail.

To curb price wars, authorities will likely prevent local governments from supporting companies trapped in chronic losses, encourage mergers and tighten competition rules, Ding said.

A key challenge lies in the nature of industries suffering from price wars. Many are emerging sectors where significant production capacity was built only in recent years, said Jacqueline Rong, chief China economist at BNP Paribas. That makes it difficult to identify outdated capacity for shutdown, unlike a 2015 supply-side reform targeting traditional heavy industries.

"Unless we see significant progress in production or capacity cuts across industries, the problem of low prices is bound to persist in the second half the year,” Rong said.

Other than industrial capacity, economists believe authorities will focus on supporting the ailing property sector in the coming months. Home prices fell at a faster pace in June, in a yearslong slump that erodes homeowner wealth and make them less inclined to spend.

In a sign of policy in the works, Xi this week called for the acceleration of a "new model” for property development, advocating a more measured approach to urban planning and upgrades. While falling short of some investors’ expectations for more aggressive measures, it’s not uncommon for China’s top leaders to set a general policy direction and task lower-level officials with working out specifics.

Goldman Sachs economists including Lisheng Wang expect modest easing steps including further cuts to mortgage rates and greater policy support for urban village renovation and some urban infrastructure, they wrote in a Tuesday note.

Despite signals of policy actions on the supply side, some economists are worried that a lack of direct stimulus for domestic demand will ultimately hobble China’s efforts to ease deflation.

The People’s Bank of China appears comfortable keeping its current policy stance without further easing moves in the near term. Deputy Gov. Zou Lan said in a Monday briefing the central bank will monitor the impact of measures already implemented while repeating its vow to maintain a moderately loose monetary policy.

Economists generally expect the monetary authority to deliver another round of moderate interest rate cut between 10 and 20 basis points in the fourth quarter, when growth may slow. The impact of government subsidies, which drove consumption and investment growth, could weaken then due to a higher base late last year.

Authorities may also step up fiscal stimulus modestly once the economy loses steam. Policymakers planned a 500 billion yuan ($70 billion) program for infrastructure investment via policy bank financing as well as a nationwide child subsidy.

Larry Hu, chief China economist at Macquarie Group, said policymakers will have little motivation to boost domestic demand, given the strong export and manufacturing performance.

"Ideally, China would do more to boost demand even if it hits 5% growth,” said Hu, adding that it will make the economy more balanced. "The Chinese government will just do enough to hit 5% growth.”