Prices in China enter negative territory for the first time in more than two years

Inflation in China has entered negative territory for the first time since February 2021. The Consumer Price Index (CPI) fell 0.3% year-on-year in July, after flat data the previous month, as revealed on Wednesday by the National Statistics Office (ONE). The news is not surprising after the business figures published a day earlier, which showed that domestic demand has not fully picked up despite the post-pandemic reopening and that private companies remain reluctant to invest. Given this situation, more and more experts are warning that China could fall into a deflationary trap —in which its neighbor Japan has been plunged for decades—, a situation that could weigh down consumption even more and hinder economic recovery.

Although the consensus of the analysts expected this result, the data “is still striking”, they point out from Danske Bank in a note. In fact, the CPI was somewhat higher than the most widespread forecast, which predicted a drop of 0.4% compared to prices a year ago. “It is rare for consumer prices to go down in China. It happened during the international crises of 2020 and 2009,” says Jens Nærvig Pedersen, an expert at the aforementioned Danish bank, who points out that, on this occasion, the situation coincides with “a time when many large economies continue to struggle against high inflation.” .

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The data from the ONE show that the year-on-year drop in July was largely caused by the 26% drop in the price of pork, due to the high comparative base after a rise in its cost last year. Inflation in China has been strongly affected in the last five years precisely by the amount of this basic food in the Asian giant’s diet.

For this reason, from the ONE they assure that the fall in the CPI is a temporary matter: “With the recovery of the Chinese economy, the sustained expansion of market demand, the continuous improvement of the relationship between supply and demand and the elimination Due to the effects of last year’s high comparative base, the CPI is expected to gradually rebound,” said statistician Dong Lijuan. In fact, in month-on-month terms, the CPI grew to 0.2% in July, after five consecutive months of decline.

For its part, core inflation, which excludes the items with the most volatile prices, fresh food and energy products, rose 0.8%, its peak since January, while the prices of services reached their maximum of the last 17 months, rising 1.2%.

The producer price index (PPI), which measures industrial prices and which has been in negative territory for 10 months, registered a year-on-year contraction of 4.4% in July, one point less than the previous month. The British consultancy Capital Economics relates the relative progress to the volatility of the prices of raw materials, on this occasion, to the increase in the cost of crude oil and gas.

“Both the CPI and the PPI are in deflationary territory,” says Zhang Zhiwei, president and chief economist at Pinpoint Asset Management, quoted by the South China Morning Post. “CPI deflation may put pressure on the government to consider additional fiscal stimulus,” Zhang says. According to the International Monetary Fund, deflation is considered a widespread and prolonged decline (at least two semesters) in the prices of goods and services due to an inconsistency between demand and excess supply.

3% target

The ONE reported that average consumer price inflation so far this year was only 0.5%, well below the 3% target set by the Government for 2023, which highlights the growing divergence between expectations and reality on the ground. However, from Capital Economics they are “skeptical about the possibility that China is entering a prolonged period of deflation.” In March, China announced a GDP growth target of 5% for this year, the lowest in decades.

Although it was considered a prudent target at the time, economic data released in recent months has raised doubts about whether it will be able to meet it. The economy only grew by 0.8% between the first and second quarters of the year, after a promising start to 2023. In addition, in July, the dollar-denominated value of exports plummeted 14.5% year-on-year, the biggest drop since the start of the pandemic, while that of imports experienced its biggest decline since January, contracting 12.4 %.

At the end of July, in a meeting chaired by the Chinese leader, Xi Jinping, the main decision-making body of the Communist Party recognized that the economic recovery was being “torturous”. According to what was published then by the state media, the powerful Politburo approved making political adjustments to “actively stimulate domestic consumption, help private companies and strengthen the real estate sector”, although not many more details have been offered in this regard.

Analysts say that to turn the economic situation around, reforms and more political support are needed, including increased public spending, cuts in interest rates and taxes, as well as a more comprehensive social safety net to encourage consumption. Last week, the China Finance 40 Forum, a leading national think tank, warned in a report that “managing deflation may be more difficult than addressing high inflation, so close attention should be paid to potential risks from a with low inflation.

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