China, once a global economic powerhouse, has faced a significant setback as it slipped into deflation in July, a troubling development that underscores the challenges of its post-Covid economic recovery. The Consumer Price Index (CPI), a crucial measure of inflation, declined by 0.3 percent in July, according to official data released by the National Bureau of Statistics. This marks the first instance of deflation in over two years, raising concerns about the country’s economic stability and placing pressure on authorities to intervene and stimulate growth.
The recent deflationary trend follows closely on the heels of another disheartening report: China recorded its sharpest decline in exports since the initial days of the Covid-19 pandemic. Additionally, imports took a significant hit as both domestic and global demand experienced a substantial drop.
Deflation, characterized by a sustained decrease in the prices of goods and services, is influenced by several factors, with weakening consumer spending playing a crucial role. While lower prices might seem beneficial for consumers in the short term, this phenomenon can have dire consequences for the broader economy. Consumers often delay purchases in the hopes of securing even lower prices in the future, leading to reduced demand. Consequently, companies scale back production, curtail hiring or even implement layoffs, while also resorting to discounts to clear existing inventory. This not only dampens profitability but also exacerbates economic challenges.
China faced a brief period of deflation at the end of 2020 and the start of 2021, mainly attributed to a sharp decline in pork prices, a staple in the country. The previous episode of deflation occurred in 2009 during the global financial crisis. However, the current circumstances are notably different, raising concerns of a more prolonged deflationary period. With key growth drivers faltering and youth unemployment soaring above 20 percent, analysts worry about the potential long-term impact.
The ongoing turmoil in the real estate sector, which has traditionally accounted for a significant portion of China’s economic activity, stands out as a primary contributor to this current “deflationary shock.” According to Andrew Batson, an economist at Gavekal Dragonomics, declining property prices are a key driver of deflation. Furthermore, the weakening exports, historically a cornerstone of China’s growth, are also contributing to the deflationary pressures.
The recent disappointing data, particularly the worse-than-expected export decline, directly affects the operations of numerous export-oriented Chinese companies, causing a notable slowdown in their activities. As Tim Waterer, Chief Market Analyst at KCM Trade, notes, the inflation data suggests a lack of confidence in the prospect of an imminent economic turnaround. This data further highlights China’s status as a global economic concern.
Meanwhile, the producer price index (PPI), which measures the cost of goods at the factory gate, fell by 4.4 percent in July. Although a slight improvement from June’s 5.4 percent decline, this marks the tenth consecutive month of contraction. The declining producer prices not only affect corporate profit margins but also provide insights into the overall health of the economy.
The persistent deflationary trend threatens to thwart China’s target of achieving five percent growth this year. The official figures for the first and second quarters of 2023 indicated a meager growth of 0.8 percent. Economists are now advocating for a comprehensive recovery plan to reinvigorate economic activity. However, the government appears to be adopting a more measured approach, focusing on targeted measures and declarations of support for the private sector.
As China grapples with the challenges posed by deflation and economic stagnation, the road to recovery appears uncertain. The nation’s policymakers will need to carefully navigate these difficulties, balancing short-term interventions with sustainable strategies for long-term growth.