China’s Easing Deflation Is Just a Minor Reprieve, Experts Say

People walk at a shopping mall in Beijing on Jan. 16, 2024. Pedro Pardo/AFP via Getty Images

News Analysis

China’s consumer price rebound in February—the first in six months—offers only temporary relief from deflationary pressures on the economy, experts say. They caution that the economy still faces challenges and urge policymakers to adopt a more proactive approach.

Experts suggest the boost came from an uptick in service activities and is overshadowed by manufacturing imbalances, weak consumer demand, and the persisting property sector drag.

China’s consumer price index (CPI), a key indicator of inflation, rose 0.7 percent year-on-year in February, reversing a 0.8 percent drop in January, according to data released on March 9 by Beijing’s National Bureau of Statistics (NBS).

Dong Lijuan, an NBS statistician, attributed the rise in CPI to increased demand during the Lunar New Year, which was observed between Feb. 10 and Feb. 24.

According to a Reuters report, consumer prices increased year-on-year for the first time in 11 months, boosted by increases in several major commodities, including pork and fresh vegetables, as well as travel during a seasonal rush around the Lunar New Year in February.

The bounce to positive territory also contrasted with the biggest dip in over 14 years, owing to a larger statistical base in January 2023 as the Lunar New Year arrived earlier that month and increased expenditure.

Analysts argue, however, that rather than relying just on headline statistics, the true state of the economy is reflected in sectoral numbers.

“China’s eased deflationary pressure cannot mask the unbalanced growth model favoring manufacturing sectors,” according to a Natixis Research note released on March 11.

Natixis adds that the numbers reveal a significant increase in the service component while the products component continued to drop. Hence, the current manufacturing imbalance—defined as weaker demand than supply—remains, and the rebound in China’s service activity is mainly responsible for the country’s easing core deflation.

According to the NBS data, China’s producer pricing index (PPI), which measures product prices at the factory gate, fell 2.7 percent year-on-year in February. On a monthly basis, the PPI fell 0.2 percent in February.

“Our seasonally and holiday-adjusted month-over-month PPI, which comprises more goods component than CPI, remained in negative territory, even though it increased in February,” Natixis said.

“The gap between supply and domestic manufacturing demand is bound to continue, which does not bode well for overcapacity issue and deflationary pressures down the road.”

Deflation Is a Concern

China’s deflation has been a global concern since July 2023, when consumer prices in the world’s second-largest economy fell 0.3 percent from the previous year. This marked the first time in almost two years that the country suffered deflation.

The last time prices dropped for consumers was in February 2021.

This raised concerns about how quickly China would recover from the pandemic. Despite lifting COVID-19 restrictions, which led to a surge in consumer spending in most developed nations, China’s economy did not experience a corresponding price surge after lifting some of the world’s strictest coronavirus regulations.

Falling prices can pose challenges for China, including a heavier debt burden and slower growth. The country also struggles with ballooning local government debt, housing market issues, and high youth (aged 16–24) unemployment.

China’s manufacturers (factory gate prices) have also experienced falling prices, which reflects poor domestic demand compared to the rest of the world.

However, China’s deflation is an added concern for the international community because the nation is a major global producer, and deflation there can have ripple effects. While it may help curb rising prices in other countries, it could flood global markets with cut-price Chinese goods, impacting manufacturers elsewhere.

China’s deflation is already adding to disinflationary pressure and trade tensions in advanced countries as competitors allege unfair pricing, with its exporters shipping more products and services overseas at cutthroat costs to offset the slowdown within.

According to the Institute of International Finance, China’s deflation and overcapacity in its industrial sector have led to a sharp decline in product prices (by 1.1 percent in 2023) and service prices (by 1.0 percent).

That also leads to reduced investment by businesses, employment squeezes, and lower consumer spending.

Additionally, decreased demand for energy, raw materials, and food from China—the world’s largest marketplace—is impacting global exports.

‘Not Yet Out of the Woods’

Consequently, Beijing is having difficulty regaining consumer confidence and domestic demand, which have taken a battering from the protracted housing downturn, as seen by China’s dismal inflation data, say experts.

At last week’s “Two Sessions” meeting, Chinese Premier Li Qiang vowed to transform the country’s development model and defuse risks fueled by bankrupt property developers. However, analysts say the most effective way for China to raise consumption would be to improve demand.

“The recovery in consumer prices is a welcome sign of improved domestic demand. However, we are not yet out of the woods with trade still facing uncertainty and the property drag ongoing, which means policymakers will need to keep a proactive stance,” HSBC said in a note published on Saturday.

Overall, according to ING Bank, while the February rebound in the CPI may temporarily alleviate concerns about deflation, inflation could remain weak for most of the first half of 2024.