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China’s Slide Into Deflation Raises Concerns About Economic Future

After months of concern that the Chinese economy was teetering on the brink of potentially damaging deflation, Beijing’s National Bureau of Statistics this week made it official, reporting that overall prices had declined in July by 0.3% compared to a year earlier.

As much of the world struggles with the difficult phenomenon of price inflation, the news about deflation in China comes after months of reports showing stagnating price levels there, rising unemployment and slowing domestic production.

Chinese officials characterized the decline in prices as transitory and said the year-over-year comparison is somewhat skewed by higher-than-usual levels of price appreciation in 2022. NBS chief statistician Dong Lijuan said, “With the impact of a high base from last year gradually fading, the CPI [consumer price index] is likely to rebound gradually.”

Economic struggles

The Chinese economy has been struggling for more than a year as officials have tried to navigate a way out of a downturn caused by multiple problems. The most prominent was a heavy-handed zero-COVID policy that saw entire cities shut down, sometimes for weeks at a time, in an effort to prevent the spread of the coronavirus.

However, the Chinese economy has also been enduring other difficulties. The property sector, which in recent years accounted for between 20% and 30% of GDP, has suffered a severe slowdown, with a number of major developers unable to service their debts, and many projects left incomplete. The banking sector is also burdened by bad loans, many of which were made to local government agencies that have experienced sharp declines in revenue.

Increasing unemployment among younger workers is also a problem, with the official jobless rate for people ages 16 to 24 at 21%, and some experts expressing concern that the real number is significantly higher.

One data point

Loren Brandt, the Noranda chair professor of economics at the University of Toronto, told VOA in an email exchange that it’s important to be careful about extrapolating from a single month’s data.

However, he added, “It is a signal of continued weakness in the economy that has deeper roots. The drop in external demand and exports only adds to these problems. We tell all kinds of stories of how deflation adversely affects the economy by itself, but at the core are a deeper set of issues. We learned this in the case of Japan.”

Japan, China’s neighbor to the east, has endured decades of price deflation that experts attribute to a wide variety of economic and societal factors, including a low birth rate and high rates of personal savings.

Global impact

William T. Dickens, a professor of economics and social policy at Northeastern University, told VOA he is concerned that deflation is likely to persist in China.

“The Chinese economy appears ripe for continuing deflation,” he wrote in an email exchange. “Both internal and external demand is weak, and inflation has been low even before this slip into deflation. The situation looks bad to me, and a lot will depend on what the Chinese government is able to accomplish to restore demand. I’m not optimistic.”

As the world’s second-largest economy, China’s troubles could have a global impact if deflation persists, Dickens said.

“My biggest worry is for developing countries that depend on China to purchase their raw materials,” he wrote. “A lot of these countries are already stressed by the debts they owe — to China in particular. As China falters, these countries will see a falloff in their demand exports. This will make it hard for them to keep paying their creditors.”

Widespread defaults, he added, could trigger “financial instability” that extends beyond China and heavily indebted countries.

Impacts of deflation

Consumers might initially see price deflation as a positive development, as it makes it cheaper to purchase goods and services. However, it also has serious potential negative effects.

Lower prices drive down business revenues, leading to lower profits, less investment, and potentially higher unemployment as companies pare back on production in the face of decreased demand.

Deflation can also make it relatively more expensive for consumers and businesses to service debt — especially debt incurred at interest rates prevalent before deflation sets in. In times of deflation, the relative purchasing power of every dollar spent on debt repayment is higher than it was before prices began falling.

‘Deflationary spiral’

Economists also warn of a possible “deflationary spiral,” in which expectations of future price declines influence consumer behavior.

When inflation began rising in the U.S. in 2021, economists warned that if consumers came to expect prices to keep rising, they might lead to an inflationary spiral, in which consumers concerned about rising prices accelerated their timetable for major purchases, driving up demand and inadvertently triggering even higher inflation.

A deflationary spiral in China would have the opposite effect. If Chinese consumers believe prices may keep falling, they could delay major purchases in the expectation of better deals in the future. The resulting slowdown in demand could exacerbate deflationary pressure.

Source: VOA