"China's Deflationary Pressures Deepen in February"

China's deflationary pressures have deepened in February, with the consumer price index (CPI) edging up by just 0.7% year-on-year, reversing a 0.8% decline in January. This trend, coupled with a 1% monthly increase, has raised concerns about the sustainability of China's economic growth. The GDP deflator, a key indicator of inflation, fell to -1.1% in the first quarter of 2024, marking the longest deflation streak since the Mao era in the 1960s. This article explores the causes of China's deflationary pressures and the potential solutions to reverse this trend.



The contraction of the real estate sector, which began in 2021 with a stringent deleveraging policy, has directly reduced GDP growth by about 1.5 percentage points. This downturn has had extensive indirect effects, including impacts on upstream and downstream enterprises, local government revenue, and consumption, as a high proportion of the population's wealth is tied up in property. This rapid decline in the real estate industry may have lowered China's annual economic growth rate by 3 percentage points or more, contributing to deflationary pressures.

The sluggish growth in consumption and investment in China over the past two years has been a significant factor in the low inflation and deflation risks. In 2019, the growth rate of total retail sales of consumer goods and fixed asset investment was 8% and 5.4%, respectively. However, these rates dropped to 3% and 3.3% by January-November 2024. Consumption in the first-tier cities of Beijing, Shanghai, Guangzhou, and Shenzhen was even weaker than the national average, with total retail sales of consumer goods decreasing by 3.1% and 2.8% in Shanghai and Beijing, respectively.

The recovery of China's economy post-pandemic has been characterized by a stronger recovery on the supply side than on the demand side. This imbalance has led to intense competition in consumer products, further contributing to low inflation and deflation risks. The time gap between the recovery of supply and demand has also contributed to the declines in prices. Although the supply of products has been sufficient, demand has been constrained by unstable expectations.

To address these issues, China can implement unconventional macroeconomic policies such as fiscal stimulus, monetary policy easing, quantitative easing, exchange rate policy, structural reforms, and targeted income support. For example, increasing public spending and widening the budget deficit to support the economy can be targeted towards infrastructure projects, social welfare programs, and tax cuts for households and businesses. The People's Bank of China (PBOC) can lower interest rates and reduce the reserve requirement ratio (RRR) for banks to encourage lending and increase money supply. The PBOC can also engage in large-scale asset purchases, such as government bonds, to inject liquidity into the financial system and lower long-term interest rates. A weaker renminbi (RMB) can make Chinese exports more competitive internationally, boosting export growth and overall economic growth. Implementing structural reforms, such as reducing barriers to entry for private businesses, promoting competition, and improving the business environment, can enhance productivity and potential output. Providing direct income support to households, such as cash transfers or subsidies, can also help to boost consumption and investment.

In conclusion, the current deflationary pressures in China highlight the need for comprehensive policy responses that address structural issues, boost consumption and investment, and balance supply and demand. By learning from historical deflationary periods and implementing effective policies, China can mitigate deflationary risks and sustain economic growth.