Why China’s economy has the world worried
While central banks in the US, Europe, Canada and the UK raised rates this summer in their continued fight against inflation, policymakers in Beijing face a different challenge: deflation. The analysis by Tiffany Wilding, PIMCO 's North American Economist
Last week, China posted a 0.3% year-on-year decline in its headline CPI in July, entering deflation for the first time in two years. The weakness in the headline was exacerbated by temporary factors, such as falling energy and pork prices. However, core inflation was also held back by declining prices of housing and related categories (home furnishings, equipment and routine maintenance), due to the continued woes in China's real estate sector.
Despite China's changing ties to the global economy, with Beijing attempting to shift to a consumption-led growth model and trade tensions with the West remaining high, China is still the world's producer. As a result, China's economic weakness and falling prices (especially in Chinese producer prices) are likely to spill over into global markets – good news in the near term for Western central banks' fight against high inflation.
An efficient manufacturing sector eases inflation…
Unlike Western economies, which experienced high inflation as they emerged from the pandemic with excess demand and limited capacity, China's economy has not faced high inflation since the end of its strict zero-COVID policy. last January. China's position as a global manufacturing hub, coupled with highly competitive production of final consumer goods, has helped ease inflationary pressures, as production bottlenecks due to zero-COVID policies have been resolved as the economy reopens and recovery of domestic consumption. The efficient matching of supply and demand through online platforms has further minimized frictions, while the moderation of global commodity prices, thanks to Europe's replenishment of winter energy stocks after the invasion of Ukraine from part of Russia, further eased inflationary pressures.
But deflation risks remain
However, with Chinese domestic demand faltering and global demand for Chinese products dwindling, China is left with spare capacity as manufacturers scramble to clear their high inventories.
Disinflationary pressures stemmed mainly from deleveraging in the real estate and local government loans sectors, which significantly affected domestic investment and led to large excess capacity. However, declining export sales also contributed, as global demand normalized towards services and moved away from the boom in Chinese-made goods amid the pandemic.
Furthermore, the government's reaction to this weakening of fundamentals has been far from sufficient. In fact, the government's push to stimulate and stabilize growth through subsidized credit, especially to state-owned enterprises and for infrastructure investments, has not been sufficient to compensate for the slowdown in the housing market, given that the flow of new credit to the economy has is contracted in the last year.
Spill over effect
It's important to note that we don't think deflationary pressures are unique to China. While the disruption and changes in post-pandemic economies have raised questions about the extent to which the Chinese economy still dominates global trade and industrial cycles, we see several reasons to expect an intensification of the spillover to developed markets.
First, Chinese products still dominate consumer goods markets, particularly in the US (although the share of Chinese consumer goods imports has declined since the Trump administration began imposing tariffs). US consumer price inflation of basic goods appears to follow the typical lag between recent declines in China's producer price index (PPI) of consumer goods adjusted for the exchange rate. According to data from the US Census Bureau in June, prices of goods imported from China fell an average of 3% from last year, while producer prices of consumer goods in China fell 5% in terms of of dollars. It is important to note that these declines are affecting US consumers; July marked the first time since the early days of the pandemic that US consumer goods retail prices fell on an annualized quarterly basis. US inflationary trends have led other developed markets since the pandemic, which suggests that US price moderation will eventually show up in other developed market inflation metrics as well.
Second, if China's downside risks materialise, Beijing could stabilize domestic growth with policies that boost exports, pushing cheap consumer goods into the global market. Exports have weakened in recent months and a further decline is expected in the coming months. After the pandemic, the government supported supply but provided few subsidies to consumers. As a result, China appears to have a domestic oversupply problem – the inventory to sales ratio appears high. Given weak domestic demand, amid a struggling real estate sector and declining consumer confidence, Chinese policymakers may choose to boost growth by encouraging overseas sales of these assets. This already appears to be happening in Germany, where Chinese exports of low-cost EVs have recently seen a surge, while domestic price cuts could spill over to other countries.
Third, a common global deflationary factor remains, namely falling commodity prices, which helped bring global headline inflation down from a year-ago peak of 8.2% to 4.4% in July . Commodity demand (or lack thereof) in China remains a major factor in global commodity prices. Weak Chinese domestic investment and large excess manufacturing capacity, as well as weak new home and land sales are likely to continue to depress global demand for commodities.
Conclusions
Deteriorating Chinese economic fundamentals have produced deflationary pressures that are already moderating inflation both in China and in the global markets served by Chinese goods. Given the usual lags, it is likely that the deflationary fallout has just started to impact global consumer markets.
For China, the risk of more pronounced deflationary pressure essentially depends on government policies in the coming months. Adequate fiscal stimulus to boost domestic demand could re-accelerate inflation, while delayed or inadequate measures could lead to a downward spiral. Persistent deflation in China would likely spill over into developed markets, as a weaker yuan and high inventory-to-sales ratios would lower the cost of Chinese goods abroad – a development developed-market central bankers would likely welcome.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/economia-cina-conseguenze-mondo/ on Sat, 19 Aug 2023 05:29:08 +0000.