China’s January CPI was down -0.8% y/y, while producer prices fell -2.5%. Meanwhile money supply growth slowed further as did loan growth. None of this points to an early acceleration in China’s lacklustre economic growth although the cyclical outlook may be better than often thought. In particular, if world-wide manufacturing picks up this year as we expect, China will benefit. Still, deflation makes monetary policy less stimulatory and means that China’s huge debts become more burdensome.
The fall in the consumer price level for the year to January was driven by falling food prices and especially pork prices, down 17% year-on-year. Pork is a staple in China and prices tend to fluctuate according to the prevalence of disease. With African swine fever spreading, farmers are sending more pigs to slaughter, depressing prices. Excluding food, the CPI was up 0.4% y/y and it is the same figure excluding both food and energy. So, not deflation but almost a flat price level.
Domestic demand in China is on a low trajectory as house-building continues to decline and consumers worry about weak house prices and the slumping stock market as well as a slow labour market. However, world manufacturing tends to move in a 3-4 year cycle and is due for an upturn this year after weakness in 2022-3. That could help China, as the country most dependent on manufacturing.
Most observers are still looking for new stimulus from the government but we expect only small moves. The problem is that the overall government deficit including local government is already large at 9.4% of GDP according to the IMF while total government debt is 80% of GDP and even higher on some definitions.
And this is one reason why deflation matters. If prices are flat the debt burden gets no relief from inflation. Contrast with the West where the sudden jump in the price level in 2021-23 added an extra 12% to the US price level beyond the expected 2% pa inflation. Effectively that amounts to a 12% cut in debt burdens, very welcome for governments after the run-up in debt during Covid and handy for companies and households too. Investors in bonds and long-term debt were the losers.
The other problem with deflation is that the scope to stimulate with monetary policy is reduced. China’s interest rates were lowered in 2022 and further in 2023 but inflation fell by more, holding real rates up. If the Fed cuts rates this year as expected, China will likely make further cuts, since the risk of excessive currency depreciation will be reduced. An uptick in inflation from here would help real rates to fall but that looks unlikely as long as the economy is stuck with low growth and excess capacity.
Ultimately what China needs is a boost to confidence. A pick-up in manufacturing could help as could a bottoming out in housebuilding – it wont decline for ever. But don’t expect the government to wave a magic wand. Too much debt combined with deflation limits its options.