HSBC AM | China’s underestimated innovation capability – AI and beyond

April 16 2025

DeepSeek’s breakthrough in artificial intelligence (AI) has gained a considerable amount of investor attention, lifting sentiment towards Chinese assets. China tech stocks have outperformed since the start of the year, defying ongoing worries about mainland China’s economic recovery. Despite uncertainties over US trade policies, we believe that AI advancements have an important role to play in key technology segments, which could contribute to the country’s long-term growth outlook.

While China has already been recognised for its existing open source large language model (LLM) ecosystem, what DeepSeek demonstrated was the ability to achieve comparable performance relative to other existing popular LLMs, such as Open AI’s GPT-4. In addition, with significantly reduced costs, it also presented transformative opportunities for other companies to cut costs and increase their productivity as well as demonstrate how China can still make significant progress.

At this stage, we believe the following segments in the technology sector should benefit from the expected accelerated adoption of AI:

• Cloud platforms – AI has become a significant driver of cloud adoption for enterprises. We expect cloud service providers to deliver improving revenue contribution from AI-driven cloud revenue growth

• Semiconductors – AI development will likely speed up China’s AI computation hardware localisation. The reduction in AI costs may lead to increased demand for advanced chips that enable faster processing and enhanced capabilities, benefiting semiconductor manufacturers

• Application software – With lower computation costs, app developers are enabled to process more complex applications with high reasoning requirements. This could improve software companies’ research and development (R&D) efficiency, saving costs and driving earnings growth

• Devices – The greater availability of AI applications will likely shorten device replacement cycles as hardware upgrades are needed to accommodate new functions. This should benefit smartphone and PC makers, as well as related supply chains

We believe China’s innovation ability is not limited to AI. DeepSeek is amongst the top six Chinese tech startups, nicknamed the “six little dragons”, all based in Hangzhou, a city that has cultivated a diverse range of cutting-edge products and services and emerging industries. These rising companies’ innovative capabilities in the AI space and beyond – including in gaming, humanoid robots, brain-computer interface and spatial intelligence – are now catapulting the city to a tech powerhouse status.

AI advancements are also likely to have positive implications for robotics, especially in humanoid robots, which are slowly becoming a reality. The global shipment of humanoid robots from major players in the US and China are expected to be more than 10,000 units in 2025, and this is estimated to exceed 5 million by 2030 as AI developments could significantly lower manufacturing costs and support wider adoption¹. We are already seeing investment opportunities in this space in mainland China, such as in robotic manufacturers and component makers that benefit from established supply chains and cost control advantages.

Other innovative segments include China’s electric vehicles (EVs). Chinese EV brands are accounting for more than 70% of global market share at present. Adoption has also significantly increased locally, where about 50% of cars sold in China in 2024 were EVs or plug-in hybrids versus only 5% in 2019². We expect Chinese EV makers to maintain this leadership both globally and domestically, especially as advanced driver assistance systems (ADAS) continue to develop. Domestic manufacturers are expected to adopt more higher level ADAS functions, thanks to recent AI breakthroughs, with major domestic car makers announcing plans to roll out more of these functions in future.

In addition, the country’s healthcare sector has become more competitive globally in our view, particularly in the field of innovative drugs. Mainland China’s presence in the global innovative drug market has grown, with innovative drug out-licensing activities rising in the past few years as the country produces more high-quality medicines that meet international standards. While the number of Chinese-made first-in-class (FIC) innovative drugs still lag those of developed markets, we do expect China to narrow the gap in the next few years, supported by the generally lower labour and research & developments costs in the country, as well as ongoing government support.

 

China vs developed markets – China catching up in FIC oncology innovative drugs

Source: Pharmcube, Bernstein analysis, as of December 2024. FIC: first-in-class or potentially first-in-class.

 

Given these latest developments in mainland China, we believe there is potentially an attractive re-rating opportunity for the Chinese equity market. Valuations remain attractive relative to other markets, with discounts remaining high despite the recent rally. Coupled with the light positioning of foreign investors, we expect further inflows into the market.

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[1] Source is Citic Securities report, 13 February 2025

[2] HSBC Global Research, January 2025

 

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