China Faces Deflationary Challenge

China, the world's second-largest economy, is facing a new challenge as it enters a period of deflation. This comes after a sharp drop in exports in the month of July, raising concerns about the country's ability to rebound. While the United States and Europe have been grappling with soaring inflation, China is now experiencing the opposite phenomenon.

Factors Contributing to China's Deflation

One of the factors contributing to China's current deflationary situation is the crisis in the real estate sector. This sector, which once accounted for a quarter of the country's GDP, is now struggling. The international political landscape and the search for lower costs have prompted foreign investors to turn to other countries in the region. The cautiousness of Chinese consumers further exacerbates the situation. Despite incentives to borrow, the fear of rising unemployment, particularly among young people, hinders their confidence. China's economic miracle has relied heavily on exports, but now it must be bolstered by the growth of its domestic market. The real estate market, in particular, has played a significant role in the country's economy. However, heavily indebted developers who are unable to sell their inventory are now forced to lower prices. This trend is also followed by manufacturers of manufactured goods. These conditions create the perfect environment for the specter of deflation to take hold, further slowing down economic activity. Such a failure is not something that the massive Chinese economic machine can afford. The country's leaders understand that guaranteeing prosperity and justifying China's aspiration to become the world's leading power are crucial for maintaining the acceptance of the regime's authoritarian nature. They have the capacity to implement targeted stimulus plans and may even be tempted to resort to nationalist sentiments, blaming external enemies for the current conjunctural difficulties, albeit at the risk of exacerbating international tensions.

China's Deflationary Trend and its Implications

While the rest of the world is grappling with rising inflation, China finds itself moving towards deflation, characterized by declining prices and services. In July, the consumer price index dropped by 0.3% compared to the previous year, according to the National Bureau of Statistics. This marks the first decline since early 2021.

Although deflation may initially seem beneficial for purchasing power, it poses a threat to the overall economy. Deflation creates a vicious cycle where falling prices lead consumers to delay their purchases, expecting even lower prices in the future. As a result, companies are forced to reduce production and halt hiring, making it difficult to break free from this downward spiral.

China is the first G20 country to announce a year-on-year decline in consumer prices since Japan reported a decrease in August 2021. Previously, China experienced a brief period of deflation at the end of 2020 and the beginning of 2021 due to a collapse in pork prices, the most consumed meat in the country. This recent deflation is also attributed to a decline in food prices, particularly pork, which has seen a 26% drop in price over the past year.

With key growth drivers in China faltering and youth unemployment reaching record levels of over 20%, many analysts fear that this period of deflation may be more prolonged. Chinese exports continue to decline, with a 14% decrease, largely due to weak global demand. The real estate sector, a crucial driver of the country's economy, remains fragile, further weighing on the prospects of a robust recovery. Many experts doubt whether China will achieve its growth target of 5% this year.

Words of the day

exports : exportations

deflation : déflation