Why China’s Struggle with Deflation May Have Global Implications Investing.com

Investing.com — While much of the world is getting signs of cooling inflation following a historic bout of skyrocketing price gains, China is facing growing fears that it could be entering a period of entrenched deflation.

China’s consumer price inflation hit its fastest pace in half a year in August, but the data did little to ease concerns about the state of demand in the world’s second-largest economy. Much of this was because food prices — the main driver of the 0.6 percent rise in China’s consumer price index from a year earlier — were mainly supported by unfavorable summer weather, rather than a more sustainable return of domestic demand. .

Core consumer inflation, excluding items such as food and fuel, came in at 0.3% in August, slowing from 0.4% in July. It was the lowest reading in nearly three and a half years.

At the same time, producer prices fell 1.8 percent year-on-year, accelerating from a 0.8 percent decline in the previous month.

Prolonged deflation poses a potential danger to the economic outlook, analysts at Morgan Stanley warned, adding that wage growth in particular could see declines. Such a trend threatens to initiate a domino effect of lower spending, lower corporate income and subsequent layoffs.

In the 1990s, Japan entered a similar period of deflation that triggered what has since become known as the “lost decades” — or a period of economic stagnation following the peak of the country’s meteoric rise after the World War II in the 1980s.

“Decades in Japan have shown that deflation can lead to a cycle that becomes increasingly difficult to break,” Morgan Stanley analysts said in a note to clients.

To avoid a similar fate, economists have argued that China’s government may need to implement sweeping — and potentially costly — measures to stop the deflationary cycle.

Beijing has already tried to revive the economy by lending to the industrial sector, although aid to these firms has increased the supply of consumer goods without boosting overall demand, further fueling deflation.

“Consequently, near-term growth in employment, income and thus domestic spending has been very limited,” Morgan Stanley analysts said.

China has currently set a plan to achieve 5 percent real gross domestic product growth in 2024. But deflationary pressures could threaten that goal, economists said.

Lawmakers may begin to consider fiscal support for housing and welfare programs, Morgan Stanley analysts predicted, saying the moves could shore up China’s “critical” real estate sector and boost economies.

However, they warned: “Despite early signs of some change in tone from Beijing, it is hard to imagine a significant change in the direction of politics and subsequently the economy anytime soon.”

The ongoing struggle with contracting prices is not limited to China, the analysts added, pointing out that from its position as one of the world’s leading trading destinations, the country “continues to export disinflationary pressure globally”.

They noted that China’s deflationary cycle has so far affected core inflation in both the US and the euro area by about 0.1 percentage point, adding that this is “significant” as central banks in both regions begin to embark on a new interest rate cycle. discounts.