China’s Deflation Battle and Its Global Implications

Investing.com reports that while many countries are experiencing signs of cooling inflation after a significant rise in prices, China is grappling with increasing worries about a potential phase of entrenched deflation.

In August, consumer price inflation in China reached its highest level in six months. However, this data did little to alleviate concerns about the demand in the world’s second-largest economy. The primary reason for this was that the increase in food prices, which drove a 0.6% rise in the consumer price index compared to the previous year, was largely attributed to unfavorable summer weather rather than a sustainable recovery in domestic demand.

Core consumer inflation, which excludes items such as food and fuel, was recorded at 0.3% in August, a decline from 0.4% in July. This represented the lowest reading in nearly three and a half years.

Simultaneously, producer prices decreased by 1.8% year-on-year, worsening from a 0.8% decline in the preceding month.

Prolonged deflation poses a serious risk to the economic outlook, according to analysts at Morgan Stanley. They pointed out that shrinking paycheck sizes could emerge as a significant threat, potentially triggering a chain reaction of decreasing spending, falling corporate revenues, and subsequent layoffs.

Japan experienced a similar episode of deflation during the 1990s, which led to what is now referred to as its “lost decades”—a period of economic stagnation following the country’s rapid growth in the post-World War II era.

The Morgan Stanley analysts noted, “[A]s decades in Japan have shown, deflation can lead to a cycle that becomes increasingly difficult to break.” To prevent a similar outcome, they argue that the Chinese government may need to implement comprehensive and possibly costly measures to counteract the deflationary cycle.

Beijing has already made efforts to stimulate the economy by channeling loans into the industrial sector. However, this assistance has resulted in an increased supply of consumer goods without boosting overall demand, further exacerbating deflation.

As a result, the immediate benefits to employment, income, and domestic spending have been quite limited, as per the analysts’ observations.

Currently, China has set a target of achieving 5% real GDP growth in 2024, but ongoing deflationary pressures may jeopardize this objective.

Lawmakers may soon consider providing fiscal support to the housing sector and social welfare programs, as predicted by the Morgan Stanley analysts. Such actions could support China’s vital real estate market and enhance savings.

However, they cautioned that despite the initial indications of a shift in tone from Beijing, meaningful changes in policy and subsequently the economy are unlikely in the near future.

The challenge of declining prices is not exclusive to China; the analysts highlighted that, given China’s significant role in global trade, the nation “continues to export disinflationary pressure worldwide.” They pointed out that China’s deflationary trends have already reduced core inflation in both the United States and the eurozone by roughly 0.1 percentage points—a significant impact as both regions’ central banks begin a new cycle of interest rate cuts.