China's consumer price index fell year-on-year last month at the sharpest pace since November 2020. At the same time, the decrease in the indicator has been observed for eight months in a row. Deflation in November was -0.5% (both compared to November 2022 and compared to October).
From the point of view of the average consumer, lower prices are a positive factor, because their costs are decreasing, but prolonged deflation can become a serious problem for the economy. Prolonged deflation leads to the development of a deflationary spiral, in which a prolonged drop in prices causes a decrease in production volumes and, as a result, an economic downturn in the country.
Is China's economy gradually sinking? What is the danger of deflation in China for the global economy? What is the reason for such price dynamics? Should we wait for the deterioration of the economic situation in China, or is a number of media outlets just scaring us?
Echoes of the past
Many investors and Chinese companies believed that after China's rejection of the harsh restrictive measures that had been in effect for three years due to the coronavirus pandemic, high demand would resume in the country, and sales of goods would rise sharply. But the reality did not match the expectations of the majority. According to Bloomberg, many companies in China are still trying to cope with the damage that COVID-19 has caused to their cash flow and profits. Some retailers, instead of placing new orders, try to sell all their accumulated stocks, expecting a sharp increase in sales.
Instead of the rapid price increases predicted by some economists at the beginning of the year, China is experiencing a prolonged period of decline, which clearly contrasts with what is happening in other global markets struggling with high inflation. There is a risk that Chinese consumers will continue to refrain from purchases, expecting prices to fall further, and enterprises unsure of future demand may reduce production and investment.
According to Bloomberg, unlike the temporary decline in late 2020 and early 2021, the drop in consumer prices is more of a concern this time. At that time, the main reason was the fall in pork prices, and the current trend is explained by a sharp decline in exports - consumers in some of China's largest markets, including the United States and Europe, are reducing their spending. At the same time, the prolonged recession in China's real estate sector has led to a drop in prices for rent, furniture and household appliances.
In addition, the real cost of borrowing in China is expected to remain high in 2024, as deflationary pressures still persist, posing an additional threat to the growth of the world's second largest economy.
The causes of deflation in China and its consequences for the global economy
Consumer price deflation in China (-0.5% MoM, -0.5% (YoY)) it became the deepest in three years and noticeably deviated down from the consensus forecast of minus 0.1%, emphasizes Olga Belenkaya, head of the Macroeconomic analysis Department at Finam. This is mainly due to a decrease in food prices (-4.2% (YoY)) due to the continued drop in pork prices, however, non-food inflation slowed down (to 0.4% versus 0.7% a month earlier) against the background of lower prices for transport services and a slowdown in the growth of prices for education services. In addition, according to Belenkaya, the cost of energy resources should have decreased in November, as world oil prices returned to lows in several months. Core inflation (excluding volatile components of food and energy resources) remained at the October level (0.6%). Deflation is even more challenging in the manufacturing sector (PPI), where the producer price index has been declining year-on-year for the 14th month in a row, falling (-3% (YoY)) it became the maximum since August. Here, prices are falling in almost all groups, especially strongly in the raw materials sector, Belenkaya emphasizes.
"Weak price dynamics may indicate an unstable recovery in domestic demand, despite the numerous measures taken by the government to stimulate consumption. The real estate crisis that has been going on for about two years and the high debt burden of regional administrations have a restraining effect on demand, these factors were recently referred to by Moody's, which lowered the forecast of China's sovereign credit rating from "stable" to "negative". Among other alarming data from China's latest statistics is an unexpected decrease in imports in November and the unstable dynamics of the PMI manufacturing activity indices," the Finam expert notes.
According to Belenkaya, the danger of sustained deflation is that consumers and businesses may postpone decisions about purchases (goods and services) or investments in the expectation that prices will continue to decline in the future – so the process of reducing economic activity and prices may become self-sustaining. Since China is the world's largest importer of raw materials, such a model of economic behavior could lead to a decrease in demand and prices for commodity exports, including Russian ones. Moreover, according to the expert, this may have a negative impact on the growth of the global economy next year, which is already expected to be low due to the restrictive monetary policy of world central banks, whereas for the government and the Central Bank of China, these data are an occasion to offer additional incentives.
Dimitri Rezepov, portfolio manager at General Invest, in turn, notes that the main problem inherent in the deflationary processes in China is the consumer's savings model. "During the periods of covid lockdowns, Chinese consumers seem to have finally lost faith in the "bright future" and switched to saving mode. The latest inflation data confirms this: prices for durable goods decreased by -2.2% year-on-year, while prices for everyday goods increased by 0.2% year-on-year. Restrained spending by the population is compounded by weak external demand. As a result, Chinese companies have an excess of production capacity, and producer prices have decreased by 3% year-on-year," he says.
At the same time, economist Nikita Mitrofanov emphasizes that the post-crisis situation in the Chinese economy still does not allow it to gain the necessary growth rate. "Yes, China will be able to grow by 4-5% this year, but statistics show that the old impulses of economic growth are fading, and new ones are not found," he says. The Chinese Communist Party, according to the expert, expects that in the conditions of capital outflow, trade wars with the United States and a possible military escalation of the conflict with Taiwan, it is the domestic consumer who will become the locomotive that will pull the economy forward, but statistics indicate that there is trouble with demand in China. "Chinese residents now prefer to postpone their demand for later, because then it will be cheaper. The number of transactions within the economy is decreasing, businesses are making fewer sales, financial results and tax revenues are deteriorating. So far, China is at the point where business can still tolerate all this and survive at the expense of internal reserves. But in the future, if the Chinese do not start spending money, they will have to cut jobs or close down en masse," Mitrofanov believes. At the same time, he also notes that such a situation is negative for Russia. "The less the average Chinese consumes goods, works and services, the less they need Russian gas and oil. And since China is the largest consumer of energy resources in the world, the drop in total demand affects the pockets of suppliers," the expert says.
Meanwhile, Freedom Finance Global analyst Roman Lukyanchikov believes that deflation in China is more dangerous for the China itself than for the global economy. According to him, in anticipation of further price reductions, Chinese consumers will restrain their consumption, which is fraught with a decrease in sales volumes by Chinese companies, which means that the latter will be forced to reduce production and investment in their development. As a result, this will result in a drop in expectations for further growth in financial indicators and, accordingly, a decrease in stock valuations. Moreover, according to the expert, in conditions of deflation, the effectiveness of China's monetary policy is also decreasing, since it makes no sense for Chinese companies to take out loans even at reduced rates if they cannot pay them off due to falling demand.
Stock market problems
China's slow economic growth, problems in the country's real estate sector, as well as increased global geopolitical tensions have a negative impact on Chinese company stocks. Since the beginning of this year, the CSI300 index has decreased by 12%, while the indicator remains at its lowest level since February 2019.
At the beginning of this year, shocks increased in price on the Chinese stock market in the hope of economic recovery after the devastating "zero tolerance policy" for COVID-19. However, the observed slowdown in the country's GDP growth, as well as the defaults of large Chinese developers on dollar debt, prompted investors to dump Chinese securities. Additional pessimism was given to the bidders by the deterioration of China's relations with the United States, as well as pressure from Washington on asset managers due to their investments in a number of Chinese companies. The measures of the authorities, which were aimed at reviving capital markets and increasing investor interest, did not help to suspend the sales.
The next working conference of the Communist Party of China on economic issues is to be held in China this week. According to Andrey Kochetkov, a leading analyst for global research at Otkritie Investments, such statements have become commonplace for the market, which for a very long time does not turn into specific figures and programs. In addition, according to the expert, for foreign investors who withdrew more than 9 billion RMB from the Chinese market in the first half of Monday, China's opportunities may decrease against the background of a reduction in the forecast for the sovereign rating by Moody's to "negative".
The uncertainty and problems of the Chinese stock market call into question the effectiveness of investments in stocks of Chinese companies. At the same time, the growth prospects of the S&P 500, which have recently been announced by a number of experts, open up wide opportunities for additional income.
It's too early to panic
According to Roman Lukyanchikov, the Chinese economy is not going down yet, although deflationary pressure in the country will increase next year. "Global demand may slow down, which will mean a decrease in demand for Chinese exports and an oversupply of the domestic market, and further reduction in energy prices is also possible, which will continue to put pressure on broad inflation. Do not forget about the problems in the development sector, where the possible acceleration of the fall in housing costs will put pressure on citizens' savings and also force them to curb consumption. At the same time, the authorities can solve the problem by expanding fiscal support, but they are very reluctant to do this for fear of a high debt burden. The overall economic situation in the country remains uncertain and primarily depends on the actions of the Government. If the state resorts to new loans, the economy has a high chance of strong growth, but if the authorities continue to take half measures and take a wait-and-see attitude, the situation will continue to deteriorate and in the future will require even more borrowing than is necessary now," the expert noted, answering questions Finam.ru .
Dimitri Rezepov from General Invest agrees with his colleague, noting that the Chinese economy is not going to the bottom, but on the path of economic transformation, and the final will depend on the success of this transformation. "The measures taken after the implementation of the policy of reform and openness, such as, for example, an active program for the development of the real estate market, can no longer provide the necessary growth rate for China. The main problem of the country at present is the risk of falling into the so-called "middle income trap". The way out of it is to reorient the economy and put it on the rails of a high–value-added industry. Moreover, according to IMF forecasts, China will finish this year with an economic growth of 5.4%. The growth rate is slower than the historical average, which is explained by an increase in the absolute values of the economy, however, the figures are far from indicating a collapse," the expert emphasizes.
At the same time, according to Rezepov, the Chinese economy does not exist in a vacuum and is influenced by global trends. China, as the world's top exporter, is also feeling the weakness of economic activity in the trading partner countries, which is exacerbated by problems in the local real estate market and the savings behavior of the population. "According to our estimates, China needs more active monetary and fiscal incentives, but it is difficult to switch to them while the entire Western world is in a countercycle of tightening monetary policy. At the same time, it should be remembered that many media outlets predicting the collapse of the Chinese economy may have certain interests and an agenda, especially for Western publications. According to our estimates, we can expect a gradual revival of economic indicators in China in 2024," the expert concluded.
