Deflation has become a sticky problem for the Chinese economy, forcing the authorities to turn up their countervailing policies a notch to keep it from spreading and becoming entrenched. Stalking China since last year, falling prices have shown signs of spiraling, threatening to undermine the outlook for the world’s second-largest economy.
Since September 2022, China’s producer price index has been pointing to deflation in the industrial sector. As for consumer prices, apart from food costs, there has been barely any growth in large areas of the economy – and this at a time when incomes are sagging.
A continuation of the trend could set off a spiral: households hit by falling wages could cut back on spending, or delay purchases, because they expect prices to fall further. This would cause company sales to suffer, smothering investment and leading to further pay cuts and layoffs.
The authorities have recently responded with a sizeable stimulus package. It includes cuts in interest rates and bank reserve requirements, money for small and medium-sized firms, property market support, capital for state-owned banks, cash for financial institutions to buy stocks (and support the equity market), and one-off cash handouts for the poor.
Is this the turning point? The package has not directly addressed weak consumer confidence and the clogged-up property market. Crucially, clear fiscal easing measures are missing. Even the cash handouts to consumers are too small to have a significant macroeconomic impact. To turn around both investor sentiment and the economy, more stimulus (including support to boost consumption) is needed. So, be on the watch for stimulus programmes in the coming months, signs that the property market is stabilising and consumption is recovering, more private sector investment, and a recovery in lending.
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