China slips into deflation as post-Covid recovery falters

China slipped into deflation as consumer prices contracted last month for the first time in more than two years, official data showed on Wednesday, as slowing domestic spending weighs on the country’s post-Covid economic recovery.

The Consumer Price Index, the main gauge of inflation, fell 0.3 in July, the National Bureau of Statistics said, having flatlined in June.

Analysts polled by Bloomberg had anticipated a 0.4 percent decline in the index for July.

It is the second round of disappointing data for the Chinese economy this week, after figures Tuesday showed the country suffered its biggest fall in exports for more than three years.

Deflation refers to falling prices of goods and services and is caused by a number of factors, including waning consumption.

And while cheaper goods may appear beneficial for purchasing power, deflation poses a threat to the broader economy.

As prices fall, consumers tend to postpone purchases in the hopes of further price cuts.

A lack of demand then forces companies to reduce production, freeze hiring or lay off workers, and agree to new discounts to sell off their stocks -- weighing on profitability even as costs remain the same.

China experienced a short period of deflation at end of 2020 and early 2021, due largely to a collapse in the price of pork, the most widely consumed meat in the country.

Prior to that, the last deflationary period was in 2009.

And many analysts fear a longer stretch of deflation this time around, as China’s main growth engines stall and youth unemployment is at a record high of over 20 per cent.

Ongoing turmoil in real estate, a sector that has long accounted for a quarter of China’s GDP, is the “main source” for this “deflationary shock”, said economist Andrew Batson of Gavekal Dragonomics.

Deflation is also being driven by flagging exports -- historically a key source of growth for the Chinese economy, Batson said.

Wednesday’s data comes after July saw the strongest decline in exports in more than a year -- down 14.2 per cent -- precipitated by weak demand abroad.

This has had a direct impact on tens of thousands of export-oriented companies in China, which are now operating at a much slower pace.

Meanwhile, the producer price index fell again in July by 4.4 percent, marking the 10th consecutive month of contraction.

The index measures the cost of goods leaving factories and gives an overview of the health of the economy and was down 5.4 percent in June this year.

Declining producer prices mean reduced margins for companies.

 Asian markets fluctuated on Wednesday after data showing China slipped into deflation compounded worries about the world number two economy’s faltering post-Covid recovery.

The mood on trading floors was already glum after another sell-off on Wall Street fuelled by fresh concerns over the banking sector and talk of another possible Federal Reserve rate hike.

The 0.3 percent drop in China’s July consumer prices was the first since the start of 2021 and comes as slowing domestic spending weighs on the country’s economic recovery.

Investors were already in a dour mood a day after China announced its biggest drop in exports since the beginning of the pandemic more than three years ago, while imports also tanked owing to slimming demand at home.

An extended period of disappointing indicators out of Beijing this year has ramped up pressure on authorities to provide much-needed support to the economy.

However, while leaders have made a number of pledges in recent weeks to introduce stimulus -- particularly for the property sector -- there have been very few concrete moves save for some small interest rate cuts by the People’s Bank of China.

China’s anaemic prices contrast sharply with the crippling inflation most other major economies have seen, which forced central banks elsewhere to rapidly raise interest rates.

However, there are signs global inflation may be peaking and in some cases reversing. Brazil last week cut interest rates for the first time in three years amid more benign inflationary conditions. Beijing has set a consumer inflation target of around 3% this year, which would be up from 2% recorded in 2022, and for now, authorities are downplaying concerns about deflation.

Liu Guoqiang, deputy governor of the central bank, last month said there would be no deflationary risks in China in the second half of the year, but noted the economy needs time to return to normal after the pandemic.

China’s CPI fall in July was mainly caused by an acceleration in pork price declines to 26% from 7.2% due to a combination of weak consumption at a time of ample supplies. On a month-on-month basis, the CPI actually rose 0.2%, defying expectations for a fall, driven by a surge in holiday travel.