Why is China threatened with deflation and what does this mean?

Why is China threatened with deflation and what does this mean?

Lianhe Zaobao 2023-08-16 08:48

Morning Mist / Repost

Source: Bloomberg

Written by Jill Elaine Disis

The July consumer price (CPI) data leave no doubt that China is clearly threatened by deflation right now. Consumer prices and industrial producer ex-factory prices fell together for the first time since 2020, heightening concerns about the state of China's second-largest economy. Given that many other parts of the world are facing inflationary pressures, the news of lower prices in China may seem a bit offbeat. However, the factors that have led to these problems in China are special and deep-rooted, and solving them may not be easy.

1. Inflation in other countries, why is China deflationary?

The United States and other major economies have seen inflation spike following the reopening of the pandemic, and earlier this year, some economists expected that to happen in China after the lifting of anti-epidemic policies. However, this is not the case. Growth in consumer spending in China remains subdued, and a prolonged decline in real estate has dampened confidence and people's reluctance to buy big-ticket items, which in turn has affected furniture and appliance prices. Energy prices have also been falling due to sluggish global commodity prices and China's long-standing grip on the power sector. Price wars between automakers have exacerbated deflationary pressures, and many companies are also cutting prices to clear excess inventory that has accumulated during the pandemic. Spending on services such as tourism and catering has rebounded sharply since the end of the epidemic, and prices in these areas have continued to rise.

2. If everything is cheaper, isn't that good for consumers?

Not really. Cheap prices may seem like a good thing for consumers at first glance, but that doesn't necessarily mean consumers will start spending money. When the prices of various goods fall for a long time, people will begin to think that prices will continue to fall, and it is better to postpone the purchase of expensive goods such as home appliances. This further dampens economic activity, which in turn forces companies to cut prices. For consumers, this usually translates into reduced incomes or job losses, which in turn leads to less spending and a dangerous downward spiral.

3. What is the impact on the business?

Falling prices often lead to lower revenues and profits, which then discourages investment and hiring. Deflation also pushes up "real," or inflation-adjusted interest rates, in the economy. Rising borrowing costs reduce their ability to invest, which in turn dampens demand and leads to increased deflation. Some economists believe that "debt-based deflation" can trigger a recession or depression as people default on their loans and banks take a hit. In Japan, for example, the long period of economic stagnation that led to a prolonged period of economic stagnation remained a problem in the 1990s, and the Government was still dealing with how to stimulate economic growth in a sustainable way. The Bank of Japan's negative interest rate policy has had little effect, and monetary policy may usher in a new adjustment this year.

4. How long will this deflation last?

Lower food and energy costs put significant downward pressure on the July data, and some economists expect the drag on CPI data to wane for the rest of the year. PPI deflation has been going on for a long time since October 2022. However, July's figures improved slightly from the previous month, suggesting that the PPI had stabilized. Overall, China's inflation rate has been low for a decade, which economists attribute to high household savings rates and rapid growth in industrial capacity due to high investment.

5. What might China do?

China's central bank may cut interest rates or lower the RRR further. The problem is that the central bank faces several constraints, such as the depreciation of the renminbi and already high levels of debt, especially local government debt. Fiscal support (or stimulus) has also been muted given fiscal pressures, meaning that governments are less inclined to rely on large-scale spending measures than in the past, and are instead shifting to targeted strategies. China is also encouraging local governments to find ways to stimulate consumption.

6. What about foreign investors?

Given that companies face price cutter pressures in times of deflation, the most obvious impact may be corporate earnings. Bonds still have some room to rise, and these assets can be relatively better protected for investors in times of economic downturn. Fears of subdued economic growth and investment often prompt governments to deploy looser monetary policy, which would make a country's bonds more attractive. However, Ken Cheung, chief Asian FX strategist at Mizuho Bank, said China's sovereign bond yields are too low compared to major markets to attract foreign traders.

7. What does this mean for the global economy?

There may be some benefits for developed countries, at least in the short term. As Chinese manufacturers cut prices to absorb excess supply, that could affect places like the United States and Europe, helping local central banks as they curb high inflation. But there are some limitations: Europe and the United States have become more protectionist in recent years and have tried to limit their dependence on China. And Chinese-made goods account for a relatively small share of consumer spending in developed countries. For example, the CPI basket in the United States, which consists mainly of housing, food, energy, and health care, has little to do with imports from China. Emerging markets may welcome the price drop, but there are some caveats, and analysts say they may be wary of overwelcoming competing Chinese goods, which would weaken local industries.

8. Has this happened before?

Yes. In 2009, 2015, and 2020, the Chinese government responded with strong monetary easing and massive fiscal stimulus each time. While Beijing has promised to accelerate some infrastructure projects and step up support for the property market, many economists don't expect a massive infrastructure boom like in the past, as China pushes its economy to rely on new growth drivers, such as advanced technology. This would make the government's response more similar to what it did during the 1998 deflation. Before joining the World Trade Organization, China restructured the assets of underperforming banks and reduced the size of its state-owned sector.

Source: 2023-08-16 Lianhe Zaobao

https://www.zaobao.com/wencui/political/story20230816-1424101

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