China is experiencing a concerning trend as it enters a period of deflation, bringing forth the need for policymakers to consider additional monetary and fiscal measures. Although there are indications that the decline in prices may be temporary, the pressure to stimulate the economy remains.
The National Bureau of Statistics announced that the consumer price index (CPI) registered a 0.3% decrease in July compared to the same period last year, marking the first decline since February 2021. This decline is slightly better than the expected 0.4% decrease forecast by Bloomberg economists.
Furthermore, producer prices fell for the tenth consecutive month, contracting 4.4% in July from a year earlier. This is the first instance since November 2020 that both consumer and producer prices have experienced contractions.
The Bureau stated that the decline in consumer prices can be attributed to the high base of comparison from last year, indicating that it is likely to be a temporary phenomenon. Additionally, they mentioned that consumer demand continued to show signs of improvement in July.
Dong Lijuan, the chief statistician at the NBS, commented on the situation, stating, “With the impact of a high base from last year gradually fading, the CPI is likely to rebound gradually.” It is noteworthy that recently Chinese authorities have discouraged economists from discussing deflation in order to promote positive narratives about the economy.
China’s economy is currently grappling with falling prices, reflecting weakened consumer and business demand following the lifting of pandemic restrictions earlier this year. The economy’s recovery is being weighed down by a protracted slump in the property market, decreased demand for exports, and subdued consumer spending.
Robin Xing, the chief China economist at Morgan Stanley, affirmed China’s current deflationary state. He emphasized the pivotal role policymakers play in determining the duration of deflation, urging coordinated fiscal and monetary easing as a response.
The weak inflation data has prompted investors to anticipate further monetary stimuli, such as interest rate cuts, from the People’s Bank of China. However, the central bank faces constraints, including a weaker yuan and elevated debt levels in the economy, which require cautious decision-making. Fiscal support has also been limited due to financial pressures faced by local governments.
There are concerns about whether the monetary measures implemented by the PBOC are actually being utilized for productive purposes or if they remain locked within the banking system. The Economic Daily highlighted the reluctance of some companies to expand production due to softened profit expectations, leading them to deposit loans rather than investing them. It also noted that liquidity is ample within the financial system.
Authorities in Beijing have downplayed deflation risks in public discourse with Chinese-based analysts reportedly being instructed by regulators and companies to avoid discussing the matter. The PBOC officials have assured that China will avoid deflation in the second half of the year, projecting a closer-to-1% consumer-price growth by the year-end.
The falling prices not only indicate a rise in real financing costs within the economy but also add urgency for the PBOC to take action and prevent further weakening of growth momentum. Some experts argue that cutting the required reserve ratio (RRR) may be more necessary in the short term than interest rate reductions.
Although the core inflation measure, which excludes volatile food and energy costs, increased to 0.8% from 0.4%, suggesting some underlying demand in the economy, prices for household goods, food, and transport contracted. Conversely, prices for services spending, such as recreation and education, showed an upward trend.
Economists anticipate that the negative trend in the CPI will be short-lived, possibly lasting for one to two months. Food and energy prices are expected to rise rather than fall in the latter half of the year, relieving the drag on CPI caused by food and fuel in the first half.
While it is believed that the producer price index (PPI) has reached its lowest point, emerging from deflation for the remainder of the year may prove challenging.
China’s entry into deflation has raised concerns among policymakers who are now contemplating further monetary and fiscal measures to counteract the weakened economy. The possibility of a rebound in consumer prices and the need for coordinated action to stimulate growth remain key focus areas going forward.
Market Capital Research 