While the world fights inflation, China’s problem is deflation

From a real estate crisis to strict Covid controls to its lowest growth target in three decades, China’s economy faces many problems. But inflation is not one of them.

Data released last week showed consumer prices rose 2.1% year-on-year in October – the kind of moderate gain that Western policymakers can only dream of. Producer prices, a measure of the prices of goods leaving factories, entered negative territory for the first time since 2020.

There are caveats. Producer prices fell from a high base last year, China’s National Bureau of Statistics noted, as prices in the metals and coal mining industry fell significantly. But without food or energy, underlying inflation was 0.6%: consumer prices are heavily dependent on pork, which accounts for a tenth of the basket and whose price increased by 52% in October after the decimation of herds linked to swine fever.

While other major economies have struggled to get inflation under control during the pandemic, China, where Covid-19 still dominates a languid economy and authorities continue to impose lockdowns and mass testing, is at risk. grappling with the threat of deflation. In addition to causing consumers to delay purchases in the hope that prices will fall further, deflation is a problem for borrowers because it increases the real value of their debts, making them harder to repay relative to current incomes. .

“Deflation is certainly worse than inflation in China, as it drives up the cost of borrowing for consumers and businesses,” said Dan Wang, chief China economist at Hang Seng Bank China. Corporate and local government debt remains the country’s “highest financial risks”, she added.

China’s high debt risk is encapsulated in its real estate crisis, which last year saw waves of defaults among highly leveraged property developers and a slump in deals. Deflation is expected to increase pressure on household mortgage payments, Wang added, and a slower housing market is indirectly putting “downward pressure” on consumption.

“If people don’t buy an apartment, there will be virtually no consumption of durable goods.”

The future of inflation in China is linked to its zero Covid policy. Although cases hit a six-month high this week, the government’s approach so far means only a tiny fraction of the population has been infected nearly three years after it emerged. The government slightly relaxed inbound quarantine and contact tracing rules last week, but the timing of any reopening remains unclear.

Erin Xin, Greater China Economist at HSBC, notes that the government has “refined” its Covid policies and that a possible “gradual recovery in consumption” could help on the demand side of inflation.

One of the few signs of inflation in China is the price of food in major cities, which Wang said could be the result of the higher cost of transporting food between provinces, given the strict travel restrictions. below zero-Covid.

Otherwise, she notes that household savings have increased rapidly this year. This echoes faintly what happened in Western economies, which in 2020 also grappled with the threat of deflation and saw higher savings, before prices started to rise sharply in 2021.

In China, the government has over the past year sought to gently ease monetary policy rather than unleash broad stimulus measures like those seen in the United States and Europe. But Beijing could be forced to provide such a boost to its local governments, which bear much of the zero-Covid costs and can no longer rely on land sales to developers.

A rapid reopening in China combined with a change in the government’s approach to stimulus could tip the inflation pendulum, with profound implications for the world given the country’s energy demand and output. Goods.

But for now, this is not a central scenario. China, in its Covid policy framework, is approaching deflation. For the rest of the world, this could be an unexpected source of relief.

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