When will China’s deflation weigh more heavily in the policy calculus? Via Investing.com

Investing.com — China’s deflationary pressures have become a growing concern as recent data continue to reveal widespread price declines and weak demand. Despite some attempts at correlation, policymakers remain focused on real GDP growth rather than nominal inflation numbers.

According to analysts at Citi Research, the question of when deflation will start to weigh more heavily in policy calculations centers on whether authorities perceive real growth to be under significant threat.

The Citi Research report points to August’s inflation readings as the latest evidence of deflationary pressure.

While food prices rose due to supply constraints caused by weather disruptions, contributing to a 3.4% month-on-month increase, this was not enough to offset overall weakness in demand.

Core inflation, excluding volatile components such as food and energy, fell to its lowest level since 2016, with commodity prices particularly affected.

Home appliances, telecommunications equipment and automobiles posted sharp declines, signaling weakness across sectors. The prices of services also contracted, the demand for tourism decreased significantly compared to previous years.

The producer price index (PPI), which reflects changes in prices received by domestic producers, also saw a deeper-than-expected deflation.

In August, PPI deflation worsened to a 1.8% year-on-year decline, driven largely by lower prices of upstream commodities such as oil and ferrous metals. Downstream industries such as durable goods and motor vehicles showed little improvement with only minor sequential changes.

Despite rising food prices, the underlying narrative of widespread demand weakness remains.

“Looking ahead, online sales events in November may add further downside risks to inflation. Soft oil prices may not bode well for industrial prices either,” analysts said.

Structural problems in the Chinese economy have been vital in maintaining this deflationary environment.

Citi notes that while food price inflation has persisted, it has failed to lift broader inflation readings due to persistently weak demand across most sectors.

Consumer sentiment remains fragile, with cautious spending and limited appetite for large purchases such as automobiles and electronics.

Anticipation of lower prices, especially during upcoming online sales events such as November, heightens concerns.

Combined with global factors such as low commodity prices, China’s domestic economy is facing increasing challenges.

Current government policies appear insufficient to spur a broad-based recovery as demand remains sluggish and manufacturers continue to face an uphill battle.

The consequences of deflation in China are complex. Citi Research highlights two main dimensions of its impact.

First, deflation could entrench the economy in a vicious circle, where falling prices reduce corporate incomes, which in turn lead to weaker wages and lower population demand.

This feedback loop deepens deflationary pressures, making it more difficult to break out of the cycle.

Second, deflation accentuates the disconnect between macroeconomic indicators and policy responses. Despite nominal deflation, the government’s main focus remained on increasing real GDP.

“Some minor easing moves could have begun, however, given policymakers’ primary focus on real GDP, we may not see a policy pivot until real growth becomes more challenging,” analysts said.

Citi Research argues that deflation has not yet become a key issue in policymaking as the government’s focus is still on real GDP growth.

The current policy stance is based on the assumption that as long as real growth remains constant, inflationary and deflationary pressures are secondary concerns. So far, minor relational moves have been seen, such as the government’s emphasis on tackling “anti-involution” strategies. Certain sectors, such as cement production, have taken steps to shed excess capacity, which could pave the way for higher prices in the future.

However, these moves are seen as sector-specific adjustments rather than broad measures to counter deflation.

Without improving final demand, these strategies are unlikely to reverse the deflationary trend.

For now, the broader policy paradigm remains unchanged, as policymakers appear to believe that headline deflation does not pose an immediate threat to the wider economy.

The key question posed by Citi Research is: When will deflation begin to carry more weight in policy decisions? According to their analysis, the answer depends on whether real growth begins to decline.

At present, deflation has not caused a major change in government thinking, as the main focus remains on maintaining constant real growth.

However, if economic conditions worsen and downside risks to real growth become more pronounced, deflation will inevitably become more important in shaping policy responses.

While some initial efforts to address deflation are evident, such as government efforts to reduce overcapacity in certain industries, these moves are unlikely to make a difference without an improvement in underlying demand.

Citi analysts warn that if deflationary pressures continue to intensify, a broader policy pivot may be needed to support both consumer and business confidence.