Is China Exporting Deflation to the World?

Chinese yuan banknotes are seen on a table at a bank counter in Hangzhou, China, on Aug. 30, 2019. STR/AFP via Getty Images

News Analysis

As the economy slows and official data point to continued declines in consumer prices, flat import growth, and sluggish domestic demand—all indicating strong deflationary pressure in the world’s second-largest economy—China is not only an outlier as the only major economy facing increased deflation risk rather than inflation pressure.

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

“Deflation in China has added to disinflationary forces in the advanced economies as its export prices have fallen sharply,” said a report by Capital Economics viewed by The Epoch Times last week. “The direct impact has not been huge, accounting for only a small fraction—about 0.4 percent—headline consumer price index inflation last year, and the drag will probably ease in the year ahead. However, even gradual further falls in China’s export prices will add to geopolitical tensions.”

In July 2023, China’s headline inflation rate fell due to lower food and energy prices and a large drop in core goods inflation.

The industrial sector’s excess supply may also have contributed to the drop.

Manufacturers in China invested heavily in ramping up production as the pandemic boosted demand for Chinese products across the world, but when product demand normalized, Chinese manufacturers were left with excess capacity to export at heavily discounted prices, Capital Economics noted.

Falling property and real estate values, rising outflows of foreign investment, excessive debt, declines in population, and poor consumer demand are some of the other problems plaguing China’s economy today.

Consumer prices, for instance, plummeted at their fastest rate in over 14 years in January, while producer prices fell as well, putting additional pressure on officials to boost a confidence-shattered economy vulnerable to deflation.

“Despite the decent real GDP growth of 5.2 percent (which many say is not a true reflection) in 2023, Chinese investors and consumers are still gloomy,” said a client note by The Institute of International Finance (IIF), and viewed by The Epoch Times, released on Wednesday. “This is because deflation is hurting household incomes, corporate earnings, investor returns, and government taxes, which are all in nominal terms.”

IIF also agrees that China’s deflation is mainly a result of industrial overcapacity and a real estate slump. The overcapacity in the industrial sector led to a sharp decline in product prices (by 1.1 percent in 2023) and service prices (by 1.0 percent), the research firm said.

Apart from that, food disinflation, mostly owing to excess supply and the base effect rather than insufficient demand, at 2 percent in 2023, also contributed to lowering the consumer price index (CPI) by 0.6 percentage points.

Similarly, last year’s decline in house sales (by 6.5 percent) negatively impacted retail sales of home appliances, furniture, and home improvement products.

“China is the only major economy that experienced deflation in 2023,” the IIF note said. The country’s CPI (-0.3 percent) in December was well below that of Japan (2.6 percent), the U.S. (3.3 percent), the EU (3.5 percent), and the aggregate emerging market’s high of 10.6 percent, it added.

Pushing Cheap Exports

One strategy China employs to combat its flagging economy is selling off its vast surplus of manufactured products at reduced rates.

“Certainly, companies like TEMU and Shein are gaining market share and undercutting the dollar stores and other retailers in the U.S.,” Michael Ashley Schulman, chief investment officer at California-based Running Point Capital, told The Epoch Times.

According to Mr. Schulman, while the impact of China’s exported deflation has somewhat reduced “with the [post-pandemic] economic decoupling” in the U.S., “that could drastically change if BYD, or other Chinese electric vehicle makers start selling their vehicles in the U.S.”

Capital Economics notes that vehicle prices have slumped as electric vehicle producers in China have fought to secure market share and stay afloat. This has all contributed to a sharp decline in the overall price of exports from China, which falling import prices in the developed markets have understandably mirrored.

The research firm also added that China’s exports are underreported in official statistics since many imports, especially to the U.S., are re-routed via other nations.

“What’s more, falling export prices from China might have put downward pressure on the prices of other local suppliers, although there is only limited support for this in the data,” the note said.

Experts believe that given China’s global leadership in manufacturing sectors such as batteries, solar, drug intermediaries, and many more products, whenever the country’s manufacturers compete head-on, middle-market companies globally face margin pressure and sharp price drops for some inputs.

“We watch the currency exchange rate between China and the U.S. carefully to understand and measure this effect,” Mr. Schulman added.

With its yuan-denominated export price falling by nine percent year-on-year (Y/Y) and the currency depreciating by two percent Y/Y in the fourth quarter of (September to December) 2023, China’s exports were about 11 percent cheaper than a year ago when paid in dollars, IIF reckons.

“China is exporting deflation through trade,” IIF said.

Backfire Risks

According to Capital Economics, industrial policies aimed at boosting manufacturing investment mean that overcapacity is likely to persist, keeping durable product prices on a downward trend for the foreseeable future. The research firm said that China’s dollar export prices also seem likely to keep falling, albeit at a much slower pace than last year.

Nevertheless, experts fear that through high discounting, China’s exporters could reduce the strain on major global central banks to maintain price stability; this strategy may ultimately backfire.

Chinese manufacturers’ profit margins and equity returns will be chronically squeezed as a consequence of excessive discounting to utilize the surplus capacity.

Additionally, anti-China sentiment might be stoked during the U.S. election campaign in November if more and more Chinese companies are compelled to dump cheap products on global export markets.

“One of the main things on our radar is if Donald Trump wins the presidential election in November, he may raise tariffs further on Chinese imports, thus lessening their deflationary effect,” said Mr. Schulman.

Internally, to fight domestic deflation or disinflation, Beijing needs to boost consumer confidence in order to increase consumer spending across all income levels, he added.

“China has ample industrial capacity to support its growth,” the IIF note concluded. “However, to realize the growth potential, policy stimuli are needed to boost domestic consumption and investment demands.”