China has entered a period of deflation as the country’s economy struggles to recover from the impact of zero-Covid policies. According to the National Bureau of Statistics (NBS), the consumer prices index in China fell by 0.3% in the year leading up to July. This represents the first year-on-year decline since February 2021, with inflation remaining unchanged in June.
Deflation, characterized by falling prices of goods and services, can be attributed to various factors, including a decline in consumption. In addition to this, China has also seen a continued decrease in factory gate prices. The producer prices index (PPI) has experienced a 10th consecutive month of decline, with a 4.4% drop from the previous year, following a 5.4% decrease the previous month. This is slightly higher than the forecasted 4.1% fall.
These figures have raised concerns about China’s economic growth, with fears of entering an era of slower growth similar to Japan’s “lost decades” in the 1990s. During this period, consumer prices and wages stagnated for a generation. This concern was further fueled by poor import and export data released by China on Tuesday, which resulted in a decline in Asian shares.
While cheaper goods may appear advantageous for purchasing power, economists are worried about the negative effects of falling prices on the broader economy. Deflation tends to lead consumers to delay their purchases in anticipation of further price reductions. Consequently, this lack of demand compels companies to cut back on production, freeze hiring or even lay off workers, and offer discounts to sell off their existing stock. This dampens profitability despite unchanged costs.
China previously experienced a brief period of deflation at the end of 2020 and early 2021 due to a significant decrease in the price of pork, which is the most commonly consumed meat in the country. The last deflationary period before that was in 2009. However, analysts are now concerned that the current deflationary trend may persist for a longer duration, given the challenges faced by China’s main growth engines and the record-high youth unemployment rate of over 20%.
Economist Andrew Batson of Gavekal Dragonomics believes that ongoing turmoil in the real estate sector, which has traditionally accounted for a quarter of China’s economy, is the primary driver of this “deflationary shock.” Additionally, flagging exports, historically a crucial source of growth for China, are also contributing to the deflationary trend.
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