China’s already “tortuous” recovery from the Covid pandemic continued to stall today as fresh data indicated that domestic demand remained depressed.
Figures out this morning showed that the world’s second largest economy slid into deflation in July for the first time since February 2021, with the consumer price index (CPI) falling 0.3 percent year-on-year. CPI had been hovering around zero for months before.
Deflation refers to falling prices for goods and services. It can be hugely damaging for an economy as it encourages consumers to delay spending, putting further downward pressure on prices.
Innes McFee, managing director at Oxford Economics said the current bout of deflation is “altogether more worrying than previous Chinese deflationary episodes” for the government.
He highlighted weak consumer sentiment and a deteriorating property market as signs that deflation could prove more persistent than previous episodes, which were driven by excess supply.
Producer prices meanwhile, which measures the price of goods at the factory gate, was down 4.4 percent in July, falling for the tenth consecutive month.
Today’s figures reinforce an already bleak picture for the Chinese economy, which has struggled to resuscitate domestic demand after a series of draconian Covid-19 lockdowns.
Earlier this week figures showed that exports contracted 14.5 percent in July – the fastest rate of decline in three years – while imports dropped 12.4 percent, reflecting the weakness of domestic demand.
Some analysts have raised the prospect that China is entering a period of ‘lost growth’ similar to what Japan went through in the 1990s when a debt-fuelled property bubble burst, forcing consumers to deleverage rather than spend.
China’s heavily indebted real estate market has been engulfed in crisis for months after the near collapse of its largest property developer, Evergrande in 2021. Just yesterday, one of the largest property developers – Country Garden – defaulted on its bond payments, saying it had experienced “liquidity pressures”.
Weak demand will raise the likelihood of a major stimulus measure to boost demand.
So far policymakers have shunned major stimulus measures like those implemented post-financial crisis, which helped to fuel the real estate bubble. Instead they have opted for interventions “in a precise and forceful manner” which will help aid what even policymakers have dubbed a “tortuous recovery”.
McFee said he expects a targeted response aimed at limiting the build-up of leverage.
“Beyond the post-pandemic recovery, structural overhangs – including rising fiscal constraints given China’s higher debt burdens – will limit the extent to which an investment-led growth model can be sustained,” he said.
While the news will worry policymakers in China, there are some reasons to be cheerful for the rest of the world. Falling prices in China, which produces a large proportion of the world’s goods, could ease inflationary pressure on economies around the world.
Analysts at JP Morgan pointed out that the fall in Chinese exports mainly reflected lower prices rather than volume. “This could have facilitated the disinflation process in major trading partners,” they wrote.
Ding Shuang, chief economist for Greater China and North Asia at Standard Chartered, said deflation in China “should help inflation in the US and Europe to moderate”.
Faltering demand should also help to keep key commodity prices lower.
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