While much of the world welcomes signs of slowing inflation after a period of record price hikes, China seems to be facing a different challenge: the possibility of entering a prolonged deflationary period.
This not only threatens China’s economy but could have far-reaching effects on the global economy, according to financial insights from Investing.com.
Consumer and Producer Inflation in Decline
In August, China’s consumer inflation rate rose by 0.6% compared to the same month last year, marking the highest growth in six months.
However, this slight increase was primarily driven by rising food prices due to adverse summer weather, not by a significant improvement in domestic demand.
Excluding volatile items like food and fuel, core inflation slowed to 0.3% in August, down from 0.4% in July—the lowest rate in over three and a half years. On the industrial side, producer prices fell by 1.8% year-on-year, a sharper decline than the 0.8% drop in the previous month, indicating a slump in industrial economic activity.
Persistent Deflationary Pressures
Analysts at Morgan Stanley warn that continued deflation in China poses a serious risk to its economy, with falling wages cited as a major threat.
This downward trend could trigger a chain of negative effects, from reduced consumer spending and lower corporate revenues to higher unemployment rates.
An example can be drawn from Japan in the 1990s, where deflation led to the so-called "lost decades" of economic stagnation after a period of rapid growth in the 1980s. China seems to be teetering on a similar path, with youth unemployment hitting 18.8% in August—its highest rate this year—according to Agence France-Presse.
Beijing's Efforts to Combat Deflation
The Chinese government is striving to avoid Japan’s fate by injecting loans into the industrial sector to stimulate economic activity. However, these efforts have led to an increase in the production of goods without a corresponding rise in demand, exacerbating the deflation problem.
According to Morgan Stanley analysts, these measures have only marginally boosted employment and income levels, which in turn have failed to sufficiently stimulate domestic spending.
China has set a target for 5% real GDP growth in 2024, but ongoing deflationary pressures may hinder this goal. Some analysts suggest the government may need to consider fiscal measures, such as supporting the housing sector and expanding social welfare programs, to revitalize the economy and boost national savings.
Global Economic Implications of China’s Deflation
China's deflationary pressures are not confined within its borders but are being exported to the global economy. Morgan Stanley analysts reveal that China’s situation has contributed to lowering core inflation by about 0.1 percentage points in both the U.S. and the Eurozone—significant as central banks in these regions are contemplating lowering interest rates.
Although there are some early signs of policy shifts in Beijing, analysts caution that a real turnaround in China’s economic and political trajectory may take time, raising concerns about future global economic challenges.
