China’s Economy Faces Deflation Risk as Prices Fall

China’s Economy

China is facing a growing threat of deflation as the economy slows down and consumers delay spending. The country’s consumer price index (CPI) fell 0.1% year-on-year in July, the first decline since January 2021, according to data released by the National Bureau of Statistics on Wednesday. The producer price index (PPI), which measures the cost of goods at the factory gate, also dropped 0.4% year-on-year, extending the contraction for the 10th consecutive month.

The falling prices reflect the weak demand and excess capacity in many sectors of the Chinese economy, which has been hit hard by the Covid-19 pandemic and its aftermath. China was the first country to impose strict lockdown measures to contain the virus outbreak in early 2020, and also the first to lift them later that year. However, the recovery has been uneven and fragile, as domestic consumption remains sluggish and external demand fluctuates amid global uncertainties.

The deflationary pressure poses a challenge for Beijing’s stimulus plans, which aim to boost growth and employment while avoiding excessive debt and financial risks. If consumers expect prices to keep falling, they may postpone their purchases, further dampening economic activity and forcing businesses to cut prices more. That would erode corporate profits and revenues, leading to lower investment and wages, and creating a vicious cycle of stagnation.

China’s Economy

China’s deflation is different from other countries’

China’s deflation is different from the inflation surge that has followed the reopening of the US and other major economies, where massive fiscal and monetary stimulus have fueled consumer spending and pushed up commodity prices. China has adopted a more cautious and targeted approach to stimulus, relying more on infrastructure investment and credit support than direct cash transfers or interest rate cuts.

China’s deflation is also different from the chronic deflation that plagued Japan for decades, which was caused by structural factors such as an aging population, a shrinking labor force, low productivity growth, and a strong currency. China still has a large and young population, a growing middle class, a competitive export sector, and a relatively weak currency.

However, China does face some long-term challenges that could increase the risk of deflation in the future, such as a slowing demographic transition, a declining potential growth rate, a rising debt burden, and a shrinking policy space. Moreover, China has to deal with some short-term shocks that could exacerbate the deflationary pressure in the near term, such as the recent Covid-19 outbreaks in several provinces, the regulatory crackdown on some industries such as technology and education, and the geopolitical tensions with the US and other countries.

How China can cope with deflation?

To cope with deflation, China needs to adopt a combination of policies that can stimulate demand, support supply, and enhance resilience. On the demand side, China could increase fiscal spending on social welfare, health care, education, and environmental protection, which could boost household income and consumption while improving social equity and sustainability. China could also ease monetary policy by lowering interest rates or reserve requirements for banks, which could lower borrowing costs and increase credit availability for businesses and consumers.

On the supply side, China could accelerate structural reforms that can improve productivity, innovation, and competitiveness. These include opening up more sectors to private and foreign investment, enhancing market competition and regulation, strengthening intellectual property rights protection and enforcement, promoting green development and digital transformation, and fostering new growth drivers such as high-end manufacturing and modern services.

On the resilience side, China could enhance its ability to cope with external shocks and uncertainties by diversifying its trade partners and markets, expanding its domestic demand and supply chains, strengthening its financial stability and risk management systems, and improving its international cooperation and communication.

By adopting these policies, China can avoid falling into a deflation trap and achieve its goals of high-quality development and common prosperity.

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