China Enters Deflationary Territory as Consumer Prices Slip, Highlighting Deepening Economic Slump
China’s consumer prices have fallen into deflationary territory for the first time in two years, signaling a concerning phase in the ongoing economic downturn of the world‘s second-largest economy. Data released on Wednesday painted a bleak picture for China, as its economic recovery continues to weaken amidst a series of challenges, including declining exports, record-high youth unemployment, and a prolonged downturn in the real estate market.
What makes China’s situation unique is the unusual decline in commodity prices, including steel, coal, vegetables, and consumer goods. This stands in stark contrast to much of the rest of the world, where easing restrictions have led to struggles in keeping inflation in check.
In July, China’s consumer price index (CPI) fell by 0.3% year-on-year, marking a potential shift towards deflation. However, experts suggest that this may only be temporary, as core inflation, which excludes volatile food and energy prices, rose to 0.8% in July, the highest since January.
The danger lies in the possibility of expectations of lower prices becoming entrenched, which could further dampen demand, increase the debt burden, and potentially lead to an economic trap. This is especially risky for heavily indebted countries like China, as it raises borrowers’ debt-servicing costs and reduces consumption and investment.
China’s total debt is projected to reach nearly three times its gross domestic product (GDP) in 2022, a higher ratio than that of the United States, according to the Bank for International Settlements. Eswar Prasad, a Cornell University economist and former China chief at the International Monetary Fund, urges that the Chinese government’s attempt to downplay the risks of deflation and stagnant growth may backfire, further complicating the country’s economic recovery.
Despite the concerning data, Chinese policymakers maintain optimism about falling prices and downplay suggestions of persistent deflation. Statistician Dong Lijuan from the National Bureau of Statistics of China believes that the CPI is expected to gradually pick up as the impact of last year’s high base is eliminated.
The contrast between China and Western countries is stark, with the United States and others experiencing surging inflation prompting central banks to raise interest rates in an attempt to cool growth. As the global prices in China decline, it may help ease inflationary pressures worldwide but could also pose risks by flooding markets with low-priced Chinese-made goods that could outcompete foreign competitors and impact employment in developed countries.
China’s lack of inflation reflects an imbalance in domestic supply and demand, characterized by low domestic demand and insufficient government social security support for households, according to economists. This lack of consumer confidence, coupled with the uncertainties stemming from the COVID-19 pandemic, regulatory concerns, and a struggling real estate sector, dampens expectations for a sharp consumer inflation rebound this year.
As a result, Chinese manufacturers and exporters may struggle to gain pricing power, impacting profit margins and hindering expansion plans and job creation. July’s producer price index (PPI) decline of 4.4% was worse than expected, and businesses across various sectors are slashing prices to address excess inventory and weakened demand from the West.
The ultimate challenge for Chinese policymakers lies in preventing a self-reinforcing cycle of lower prices leading to reduced production, lower wages, and suppressed demand. While economists anticipate further interest rate cuts by the People’s Bank of China, doubts remain regarding their effectiveness in alleviating deflationary pressures.
Experts suggest that the Chinese government needs to take more significant steps to address deflation and support economic recovery. As businesses and households remain hesitant to increase investment and spending, modest stimulus measures may prove largely ineffective in this environment, warns Arthur Budaghyan, the chief emerging markets strategist at BCA Research.
As the Chinese economy navigates these challenges, the path to recovery remains uncertain, and the need for substantial measures becomes increasingly apparent.