China slides into deflation as efforts to boost recovery fail

China’s consumer sector slipped into deflation and ex-factory prices fell further in July as the world’s second largest economy struggled to rekindle demand and pressure mounted on Beijing to provide more direct policy stimulus.

There are growing concerns that China is entering an era of much slower economic growth, akin to Japan’s “lost decades” when consumer prices and wages stagnated for a generation, in stark contrast to rapid inflation elsewhere.

China’s post-pandemic recovery has slowed after a buoyant start in the first quarter as domestic and overseas demand weakened and a spate of economic support measures failed to boost activity.

The consumer price index (CPI) fell 0.3% year-on-year in July, the National Bureau of Statistics (NBS) said on Wednesday, compared with a Reuters poll’s median estimate of a 0.4% decline. It was the first drop since February 2021.

The producer price index (PPI) fell 4.4% for the tenth straight month, faster than the forecast 4.1% decline.

China has become the first G20 economy to report a year-on-year decline in consumer prices since Japan’s last negative CPI read in August 2021, and the weakness is raising concerns about the impact on business at key trading partners.

“For China, the divergence between manufacturing and services is becoming increasingly clear, which means the economy will grow at two speeds throughout 2023, especially as the real estate problem resurfaces,” said Gary Ng, senior economist for Asia -Pacific Rim at Natixis. “It also shows that China’s slower-than-expected economic recovery is not strong enough to offset weaker global demand and boost commodity prices.”

The data comes a day after trade figures showed both exports and imports slumped in July, and follow a spate of reports of further debt problems in China’s huge real estate sector. Concerned consumers and businesses are hoarding cash rather than spending or investing, despite lower interest rates.

Asian stocks were on the defensive on Wednesday as Chinese price data confirmed that the economic recovery is losing momentum.

Sluggish prices in China stand in stark contrast to the crippling inflation experienced by most other major economies, which has forced central banks elsewhere to rapidly raise interest rates.

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

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

China’s CPI decline in July was mainly due to an accelerated decline in pork prices from 7.2% to 26%, driven by a combination of weak consumption coupled with plentiful supply. On a month-to-month basis, the CPI actually rose 0.2%, beating expectations of a decline attributed to a surge in holiday travel.

Core inflation, which excludes food and fuel prices, rose to 0.8% from the year-ago period of 0.4% in June.

Some analysts say comparisons to Japan may be premature.

Xia Chun, chief economist at Yintech Investment Holdings in Hong Kong, expects deflation in China to last six to 12 months, but not to match Japan’s history, where prices have largely stagnated for the past two decades.

In recent weeks, policymakers have announced measures to boost sales of cars and home appliances, while some cities have eased restrictions on real estate. However, some market participants say more determined stimulus is needed.

“China’s plan to revive consumer spending remains uncertain,” Fitch Ratings said, noting that the plan will largely depend on a recovery in consumer confidence and the implementation of policies by local governments, while details of the measures remain vague.

After last month’s influential Politburo meeting, investors have been eagerly awaiting policymakers to start stimulating the economy, with the stock market largely disappointing on a lack of concrete action.

“Markets and businesses should get used to the ‘new normal,’ in which the Chinese government will avoid big stimulus measures,” said Tommy Wu, chief economist at Commerzbank.

“Instead, targeted stimulus will be implemented and most policies will focus on the supply side,” Wu said.