Concerns About Deflation in China Continue to Grow

In December, consumer prices in China experienced a decline for the third consecutive month, highlighting the difficulties that Beijing is encountering in its efforts to stimulate the economy while grappling with deflationary pressures.

The overall measure of prices imposed by Chinese manufacturers, on the other hand, continued to decline for the 15th consecutive month. This issue is causing increasing worry among officials in the United States and Europe as confident Chinese entrepreneurs seek to offload a more significant number of affordable products onto the global market, thereby posing a challenge to Western brands.

Chinese Authorities Are Constantly Looking For Ways to Revive the Economy

Chinese authorities have been grappling with the challenge of revitalizing domestic demand for several months, as their expectations of a robust economic recovery following the easing of Covid restrictions failed to materialize.

On the contrary, Chinese consumers are cutting back on spending due to concerns about the sluggish property market and the alarming rate of youth unemployment. Manufacturers are in a hurry to reduce prices due to declining domestic sales.

It’s becoming a complex predicament for the remainder of the globe. Until recently, Western economists viewed deflation in China as a positive development, as it resulted in reduced prices for imported products from the global manufacturing hub. That contributed to a decrease in inflation in the United States, which experienced a gradual decline throughout 2023, although it slightly increased in December.

However, the factors that contribute to deflationary trends in China are further intensifying trade tensions, as the decrease in domestic demand leads to a more significant surplus of Chinese goods being exported. Last autumn, the European Union raised concerns about China’s excessive supply of affordable electric vehicles, prompting an inquiry into the impact of state subsidies originating from China.

“Continued deflation or meager inflation in China may lead to an increase in trade surplus and potentially result in more trade conflicts with other countries,” stated Adam Wolfe, an economist specializing in emerging markets at Total Strategy Research.

China’s Central Bank Failed to Heed Economists’ Pleas

Last year, China’s central bank indicated its view that deflationary conditions in the nation’s economy are temporary. In spite of economists’ persistent pleas for more decisive measures to stimulate development and demand from consumers, Chinese policymakers have chosen to refrain from distributing cash or providing direct assistance to households.

The data released on Friday offered at least some validation for Beijing’s perspective. According to the national statistics bureau, there was a decrease of 0.3% in the consumer-price index compared to the same month last year. This is a slight improvement from the 0.5% drop observed in November. The reading, primarily influenced by the decline in oil and food prices, is in contrast to the 0.4% decrease anticipated by economists.

Excluding the unpredictable fluctuations in food and energy costs, the core inflation rate stood at 0.6% in the previous month.

However, numerous economists express their belief that reversing deflationary pressures will prove to be challenging.

According to Wei Yao, the chief Asia analyst at Société Générale, it is anticipated that China’s consumer prices will experience a gradual recovery and reach 1% by the end of 2024. However, the downward squeeze on prices is expected to persist for some time.

“According to her, the potential for deflationary tension in China due to sluggish domestic demand may endure for an extended period,” she stated.

Throughout the entire year, consumer inflation in 2023 amounted to 0.2%, significantly lower than Beijing’s target of around 3%. This outcome surprised those who had predicted a surge in inflation in China after senior leaders relaxed COVID-19 restrictions in late 2022.

In December, there was a 2.7% decrease in producer prices, which measures the wholesale prices at factory gates. This decline is slightly less than the 3% drop observed in November. The index has remained in the red for 15 consecutive months since October 2022.

What Was the Reason for the Price Drop, and What Could It Lead To?

Producer prices in China were impacted by the combination of declining oil prices and weak demand for certain industrial products, as reported by the country’s statistics bureau.

There is concern among economists that China may enter a dangerous cycle of debt deflation, where declining prices lead to wage cuts by companies and reduced consumer spending, resulting in a downward spiral of weakened demand and further price drops. Japan underwent a comparable ordeal in the 1990s, as the nation embarked on a prolonged era of economic stagnation accompanied by a declining population and high levels of debt.

The measures implemented by Chinese authorities in the past year have produced limited results thus far.

The country’s central bank has reduced interest rates on multiple occasions. Authorities additionally reduced expenses for individuals seeking mortgages and prolonged tax incentives for proprietors of private enterprises. In October, China released an extra $137 billion in unsecured debt to finance various infrastructure initiatives.

Despite those efforts, recent data indicate that the economy has slowed down following a period of accelerated expansion in the third quarter of the year. Surveys have shown a decline in productivity at manufacturing plants and in service sectors.

Sales of New Homes Have Continued to Show Sluggishness

Last week, Zhongzhi Enterprise Group, a prominent trust company in the country, announced its bankruptcy amidst the ongoing turbulence in China’s housing market.

Projections from international investment banks indicate that China’s economy is expected to experience a growth rate between 4% and 4.9% this year. Although this figure is relatively elevated compared to other countries, it represents a deceleration from previous periods of China’s rapid growth.

A number of economists anticipate that Beijing will uphold a marginally elevated target of approximately 5%, potentially indicating the likelihood of additional stimulus in the future.

Several economists anticipate a reduction in deflationary pressures by 2024 as the price of pork, a significant factor in China’s inflation calculation, and oil prices recover. In December, there was a 26.1% decrease in pork prices, which showed a slight improvement compared to the 31.8% decline seen in November.

“Economists from J.P. Morgan have expressed their belief that deflation will come to an end while emphasizing that low inflation will continue to persist,” stated the economists.

In a recent communication to clients, Citi economists expressed their expectation that China may reduce policy rates starting in the second quarter of this year, citing concerns about deflation.

“There is no room for indecisiveness in policy to avoid a possible dangerous cycle of deflation, loss of confidence, and economic stagnation,” they expressed.