While inflation concerns are on the minds of Americans, policymakers in Beijing are worried about declining prices and their direct impact on China’s economy. The consumer price index (CPI) in China has been on a downward trend for the past three months, and November’s inflation figures revealed a faster-than-expected drop in consumer prices. The CPI fell by 0.5 percent year-on-year, surpassing economists’ predicted decline of 0.1 percent. This represents the most significant decline since November 2020.
At the same time, China’s Producer Price Index (PPI) experienced a 3 percent year-on-year decline, exceeding October’s 2.6 percent drop and the projected 2.8 percent decrease. This marks the fourteenth consecutive month of decline for the PPI and the fastest rate of decline since August. It also signifies the longest period of deflation since 2009.
Concerns about an economic contraction
Concerns about an economic contraction in China started to emerge in the summer of 2023. In July of that year, consumer prices contracted by 0.3 percent compared to the corresponding month in 2022, a situation not seen since the peak of the pandemic. While other advanced economies were experiencing rapid growth, China showed signs of potential stagnation. Prices seemed to stabilize in August until pork prices plummeted dramatically, leading to an overall decline in the price index in October, November, and December. However, there was some hope for policymakers as a significant portion of the contraction was driven by China’s highly volatile pork prices. Nevertheless, recent data from the Central Bank of China reveals that underlying inflation, which excludes the most volatile groups like food and energy, remains weak, with a meager 0.6 percent year-on-year increase in December.
China’s economic growth falls short of expectations
China ended 2023 with growth below expectations, as the economy expanded by 5.2 percent in the fourth quarter compared to the same period in the previous year. Although this growth rate was slightly below analysts’ expectations, it was sufficient to meet the government’s annual growth target.
Series of obstacles hindering economic recovery
As the world’s second-largest economy, China has faced significant challenges due to the COVID-19 pandemic. The country’s economy suffered a severe blow from halted flights, disrupted trade, and restricted mobility. Since then, China has been working to rebuild its economy, but it faces several obstacles in the recovery process, including:
- Real Estate Crisis: The decline in China’s real estate sector, which is a major driver of the economy, presents a significant challenge. Reduced property sales value and increased debt burden among real estate companies have created uncertainty and hindered investment and spending. To address this crisis, the Chinese government has taken an unprecedented step of allowing banks to provide short-term loans without collateral to eligible real estate developers.
- Weak Consumer Confidence: Consumer confidence plays a crucial role in driving economic growth. The decline in consumer confidence, driven by fears of a recession and precarious employment conditions, has had a negative impact on consumer spending. In response, China has implemented measures to stimulate domestic consumption. However, the government has refrained from announcing significant new spending or tax cuts. Li Chunlin, vice chairman of the National Development and Reform Commission (NDRC), emphasized the importance of boosting consumption to stimulate recovery and expand demand during a press conference in Beijing.
- Growing Local Government Debt: The accumulation of debt among local governments limits their ability to invest in infrastructure and other sectors, putting pressure on public spending. China’s debt ratio reached a new record in the first quarter of 2023, with banks increasing corporate lending following the lifting of coronavirus restrictions under a zero-infections strategy. According to data from the Central Bank of China and the National Statistics Office, China’s debt ratio reached 279 percent of GDP, as reported by Bloomberg news agency.
- Weak Global Growth: The slowdown in the global economy further strains China’s exports and overall economic activity. The projected growth rate for the global economy in 2024 is a mere 2.4 percent, lower than the figures of 2023 (2.6 percent), 2022 (3 percent), and 2021 (6.2 percent).
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Fragile outlook
Recently released data indicates that China’s economy has entered 2024 with a fragile outlook. Ongoing decreases in inflation and the presence of deflationary pressures pose risks to consumer and investment spending, which could potentially hinder the economic recovery. Although there have been slight improvements in exports, they are insufficient to compensate for weak domestic demand. Additionally, the decline in bank loans suggests a reduced interest in investment and borrowing among companies and individuals, further dampening overall economic activity.
China’s economic landscape currently reflects a combination of challenges and government efforts to demonstrate market stability, economic strength, and openness to investment. However, there are also indications of significant outflows of financial resources.
Based on balance of payments data, China has recorded its first-ever quarterly deficit in foreign direct investment (FDI). This highlights the challenge Beijing faces in attracting foreign companies, particularly due to the “de-risking” measures implemented by Western governments in response to escalating geopolitical tensions with China.
Preliminary balance of payments data reveals a deficit of $11.8 billion in direct investment commitments (a measure of FDI) from July to September. This quarterly deficit is the first since China’s foreign exchange regulator began compiling data in 1998 and can be attributed to the impact of risk reduction measures adopted by Western countries concerning China.
Debt troubles in the real estate sector
However, China’s primary concern lies in its debt situation, particularly within the real estate sector, which accounts for approximately 25 to 35 percent of the country’s GDP. Years of excessive construction, estimated at nearly twice the population, combined with slower population growth, have led to significant price declines. The challenges in the real estate market have negatively affected the financial well-being of Chinese households, as they heavily relied on real estate savings. Consequently, this issue has overshadowed other sectors of the economy.
While deflationary events are infrequent, they present challenges in debt repayment due to limited available funds. This scenario, known as “debt contraction,” highlights the importance of preventing deflation rather than addressing its consequences. China is likely striving to apply this principle to avoid a complete contraction of its economy.
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