Suddenly, China is being inundated with talk about deflation.
Slowing consumer price increases are fueling a conversation that no government wants. Price rises eased to a negligible 0.3% in April year on year, down from a 0.7% pace in March. Producer prices, meantime, are seen contracting another 3.0% in April after falling 2.5% in March.
These are figures that Jerome Powell in Washington might kill for. The Federal Reserve chairman is bedeviled by the worst US inflation in 40 years. And gridlock on Capitol Hill is keeping the US from addressing inflation coming from the supply side, over which the Fed has little influence.
For many, though, China’s weak prices despite the economy’s reopening from Covid-19 are ringing alarm bells. Loud ones, too.
“Deflationary risks could tilt the balance in favor of more People’s Bank of China easing,” says Carlos Casanova, economist at Union Bancaire Privée.
Yet another argument is worth considering: that China is experiencing disinflation, not outright deflation, and that there are more positives than negatives to the phenomenon.
Rather than trouble to come, “this indicates China’s economic transformation is accelerating and we’re ushering in a digital economy and high-tech transformation,” argues economist Chen Fengying, the former director at the China Institutes of Contemporary International Relations.
Chen points to the 5.1% jump in fixed-asset investment in the first quarter year on year. Investment in high-tech industries, meantime, rose by 16%. For the e-commerce services industry, investment surged nearly 52%.
Does this “indicate notable optimization of China’s economic structure” and “industrial transformation and upgrading,” as economists like Wan Zhe at Beijing Normal University argue?
Increased productivity
Only time will tell. It’s entirely possible that the strong downward pressure from technological change means increased productivity, not economic gloom.
Recent news from Alibaba Group may buttress the argument. In late April, the e-commerce behemoth’s cloud computing unit slashed prices 50% amid rising competition.
It seems no coincidence that the move – one that could lure users from rivals like Tencent Holdings – comes as Alibaba works to break up the US$214 billion empire that founder Jack Ma built. Is this proof positive that increased tech efficiency is gaining traction in Asia’s biggest economy?
Economist Helen Qiao at BofA Global Research notes that “central bankers in China seemed to have little concerns about deflation, judged by the PBOC’s quarterly monetary-policy reports and meeting minutes.”
Generally, she adds, they “expect inflationary pressure to rise as the output gap narrows in the second half of 2023, especially on the back of a new credit cycle kicking off.”
Private-sector reforms needed
Again, only time will tell. In the interim, though, Chinese President Xi Jinping and Premier Li Qiang must accelerate reforms to create a bigger and more vibrant private sector. This means prioritizing regulatory retooling over aggressive stimulus that might encourage bad behavior on the parts of local government officials and property developers.
In late March, Li visited the southern export metropolis Guangdong to call for Chinese self-reliance in technology and plans to support the private sector. Li also met with founders of tech “unicorn” startups.
As Bill Bishop, author of the Sinocism newsletter, sums up: “Among the key themes from his trip: deepening reform and expanding ‘high-standard’ opening up; food security; green development; regional connectivity between Guangdong, Hainan and the Guangdong-Hong Kong-Macau Greater Bay Area; water resource management; rural revitalization; common prosperity; opportunities for foreign investors; manufacturing and accelerating the construction of a modern industrial system supported by the real economy; real economy and self-reliance; indigenous development of core technologies in ‘key fields’; Chinese modernization; and the importance of the ‘Xi Thought’ education campaign.”
The worry, Bishop says, is that this could be remembered merely as a “propaganda list.” The latter reference is to Xi’s vaguely defined political ideology, one that is being introduced into school curricula in the most populous nation. It now falls to Li to flesh out exactly what that means.
Li is thought to be pro-innovation and pro-startup from his days as governor of Zhejiang province. That’s where Alibaba is headquartered, and Li reportedly was close to founder Ma. During his days as Shanghai party boss, Li successfully lobbied Elon Musk to build a giant electric-car factory in the city, the Tesla founder’s first overseas facility.
The hope is that Li’s rise to the top of Beijing power signals that the regulatory assaults on the high-tech sector are now in the past, and that Xi’s efforts in recent years to prioritize the growth of the state sector are pivoting back toward nurturing private enterprise. The question, of course, is how much latitude Xi gives his new No 2 to make space for entrepreneurs to innovate and create good-paying jobs from the ground up.
It’s one thing for Communist Party officials to claim “unwaveringly” support for the private sector and commitments “to open up further China’s economy to the outside world,” says economist Louis Kuijs at S&P Global Ratings. It’s more important that the words are matched with action.
That’s one reason, perhaps, that business confidence among private and foreign firms has lagged in recent months. Deteriorating US-China relations hardly help, particularly when considered in the context of Xi’s crackdowns on the Internet sector.
As Kuijs notes, there’s “only so much that China can do” to reduce decoupling pressures. The answer, he says, is clear and deliberate steps to equalize the playing field for state and both private and foreign firms.
Getting the mix right would buttress China’s soft power, helping Xi’s argument that Beijing deserves a bigger say in global affairs. As International Monetary Fund head Kristalina Georgieva puts it, “the robust rebound means China is set to account for around one-third of global growth in 2023, giving a welcome lift to the world economy.”
Yet China’s work is decidedly undone. China’s post-Covid rebound in household consumption has often disappointed. To be sure, many are optimistic that the tide is turning. In March, for example, total retail sales of consumer goods jumped 10.6% year on year.
“The combination of a steady uptick in consumer confidence as well as the still-incomplete release of pent-up demand suggest to us that the consumer-led recovery still has room to run,” says economist Louise Loo at Oxford Economics.
At the same time, though, others argue that “the current market concerns about deflation largely reflect concerns about the strength and sustainability of the economic recovery,” says economist Wen Bin at China Minsheng Bank. “After the optimization of epidemic prevention and control, the production side has basically returned to the pre-epidemic level, but the demand-side momentum is still weak.”
Global headwinds
Here, weak global trends are hardly helping. The cumulative fallout from the Powell Fed’s aggressive interest-rate increases continue to imperil the global banking system – from Silicon Valley Bank to Credit Suisse to First Republic Bank. On top of that, US President Joe Biden’s intensifying effort to contain China’s role in global trade, finance and security is creating fresh headwinds.
As Christine Lagarde, head of the European Central Bank, said last week: “We are witnessing a fragmentation of the global economy into competing blocs, with each bloc trying to pull as much of the rest of the world closer to its respective strategic interests and shared values. All this could have far-reaching implications across many domains of policymaking.”
As all these crosscurrents challenge Xi’s economy, it’s incumbent on Beijing’s reformers to stay the course on recalibrating growth engines. As Premier Li’s office works to put some supply-side upgrades on the books, it will fall to the central bank to smooth out cracks in Chinese recovery.
China’s 4.5% annualized growth rate in the first quarter was in line with “full-year bullish view for China growth,” notes economist Hui Shan at Goldman Sachs.
Exports, meantime, rose 8.5% in April, the second-straight monthly increase.
Yet the relative weakness of consumer prices may have PBOC governor Yi Gang feeling pressure to add bursts of monetary stimulus now and again.
Economist Lu Ting at Nomura Holdings argues that “after adjusting for base effects, we see an increasing number of signs pointing to weakening post-Covid recovery momentum, especially in the property sector. We expect Beijing to step up policy support in coming months.”
Even so, rumors that China is sliding toward a Japan-like deflationary funk are looking greatly exaggerated.