CHINA’S slide into deflation is proving hard to fix. Prices in the world’s second-biggest economy have fallen for three consecutive quarters, the longest deflationary streak since the Asian Financial Crisis in the late 1990s. The trend appears set to continue, adding to the challenge for policymakers as they try to kick-start the country’s growth engine and defuse a simmering debt crisis.
1. What is deflation?
The term describes a situation in which prices for goods and services fall across the economy. It’s not to be confused with disinflation, which signifies prices are still rising, though more slowly. That’s what’s happening in the US.
2. Why is China in deflation?
Prices rocketed in the US and other big economies when they reopened after the Covid-19 pandemic, as pent-up demand coincided with shortages in the supply of many goods. Predictions that the same would happen in China proved to be wrong.
Consumer spending power is weak and a real estate slump has dented confidence, holding people back from buying big-ticket items. Manufacturing is leading the price drops. Officials are channeling credit to manufacturers to boost output, but the weak demand at home and sluggish exports are forcing businesses to mark down their products.
Energy prices have also been falling as global supply recovers from the shock caused by Russia’s invasion of Ukraine two years ago.
3. What’s so bad about falling prices?
Cheaper prices look good for consumers at first glance, but that doesn’t necessarily mean people will start spending again. In fact, they might hold off from buying expensive items in the hope they’ll fall further. That would depress economic activity even more, putting pressure on incomes, which could then result in less spending and further price cuts in a downward spiral.
Deflation also raises the level of “real,” or inflation-adjusted, interest rates in the economy. Higher debt servicing costs make it harder for businesses to invest, which in turn crimps demand, inducing more deflation. Some economists believe such “debt deflation” can trigger recessions or depressions as people default on their loans and banks are undermined.
4. Why is China’s deflation hard to fix?
Beijing responded to past bouts of deflation with forceful monetary easing and big fiscal stimulus measures. China is expected to boost fiscal stimulus again this year, but its plans won’t be clear until a national budget is released in March. While it’s vowed to accelerate some infrastructure projects and increase support for a slumping housing market, many economists aren’t expecting a large-scale building boom as in the past.
President Xi Jinping is determined to shift the economy toward new growth drivers, such as advanced technologies. One other reason the government may be reluctant to fire the stimulus big guns is concern that more borrowing will add to risks in the financial system.
5. So what are the government’s options?
Economists generally see a need to boost demand for goods and services, with the government either directly channeling more money into the economy or encouraging banks to lend more to businesses and households.
Calls are growing for the authorities to adopt more aggressive policies than rate cuts and trims to the amount of money banks must hold in reserve with the central bank — steps already taken in 2023, to modest effect. To durably boost consumer confidence and get people spending, the government will need to end the slump in the property market. Authorities have provided cheaper long-term cash to policy banks to support lending to the housing sector, but more help is needed.
6. How does China measure deflation?
There are three main gauges. Most-cited is the consumer price index, which reflects changes across a range of goods and services bought by households, and which in January recorded its deepest pace of decline since 2009.
The producer price index measures changes in industrial products sold by manufacturers and has been in contraction for more than a year. They’re both published by the statistics bureau. A gross domestic product deflator is calculated using the difference between the economy’s nominal and inflation-adjusted growth. It provides the broadest measure of prices across the economy, and is in its longest deflationary streak in nearly a quarter of a century.
7. What products are seeing the biggest price falls?
Falling food prices are the biggest contributor, according to a Bloomberg Economics analysis of the CPI. Within food, the decline is particularly pronounced in pork prices, As the most-consumed meat in China, it has a large weighting in the index. Large pork producers ramped up production expecting a consumption boom in 2023, but appetite for pork remained much more muted than expected.
Transport is another drag, driven mostly by falling car prices. A price war broke out among carmakers including Tesla and BYD in 2023, with prices of almost 900 car variants slashed by more than 5 per cent at one point. Prices aren’t falling across the board, however. Spending on services, such as travel and restaurants, has surged since pandemic restrictions ended, with prices continuing to rise in those sectors.
8. Will deflation ease in 2024?
Economists polled by Bloomberg expect deflation pressures to continue for at least the first half of 2024. Beyond that, government stimulus measures and a gradual rise in household confidence are expected to push consumer price growth for the full year to 1 per cent, with producer prices rising 0.2 per cent.
China’s central bank predicts consumer prices to “rebound moderately,” while economists at ING Groep NV said on Feb 8 that the latest price data could mark the low point for the CPI. But inflation forecasts for China have been unreliable, with few analysts foreseeing persistent deflation at the start of last year.
9. What does it all mean for foreign investors?
As Chinese manufacturers cut prices to shed excess supply, that may ripple through to places like the US and Europe, providing some help for central banks there as they work to tame inflation. While consumers around the world may benefit from cheaper Chinese goods, it could raise trade tensions if domestic manufacturers are being undercut. The clearest impact on foreign investors may be a hit to the earnings of Chinese companies.
There’s potential upside in bonds, which protect investors better during times of trouble. Concerns about growth and curbed investment usually prompt governments to deploy looser monetary policy, making a country’s bonds more attractive. BLOOMBERG
