China’s spiral into deflation is proving hard to fix. Overall prices in the world’s second-largest economy have fallen for two straight years, and if they drop again in 2025 -- as many analysts are predicting -- it would mark the longest deflationary streak for the country since the 1960s, reports Bloomberg.
Consumer prices across January and February of this year turned negative for the first time in four years. Core inflation -- which excludes volatile items such as food and energy -- decreased by 0.1 per cent in February, only the second contraction in more than 15 years.
Chinese policymakers have pledged to do more to shore up economic growth and ease the price declines. They’ve used some of their most direct language on monetary and fiscal stimulus in years as China fights a renewed trade war with the US on the back of President Donald Trump’s return to the White House. The 20 per cent tariffs he’s imposed on Chinese goods have already slowed export growth and weighed on businesses.
What is deflation?
The term describes a situation in which there is a sustained fall in the price of goods and services across an economy. It’s not to be confused with disinflation, which signifies prices are still rising, just not as quickly. The latter is what’s happening in the US, where annual price growth has slowed significantly since mid-2022.
Why is China experiencing deflation?
Prices rocketed in the US and other big economies when they reopened after the Covid-19 pandemic, as pent-up demand coincided with shortages in the supply of many goods. Predictions that the same would happen in China proved to be wrong. Consumer spending power is weak and a real estate slump has dented confidence, causing people to hold back from buying big-ticket items.
A tightening of regulations in high-paying industries like technology and finance has led to layoffs and salary cuts, further dampening the appetite for spending. A policy push to develop manufacturing and high-tech goods spurred increased production, but demand for these goods has been weak, forcing businesses to mark down their prices.
What’s so bad about falling prices?
Cheaper prices look good for consumers at first, but that doesn’t necessarily mean people will start spending again. In fact, they might hold off from buying expensive items in the hope that prices will fall further.
Deferring consumption would depress economic activity even more, eroding profits for businesses, reducing hiring and investment, and putting pressure on incomes. This could result in another dip in spending and further price cuts in a downward spiral.
Deflation could also raise the level of “real”, or inflation-adjusted, interest rates in the economy. Higher costs to service debt make it harder for businesses to invest, which in turn crimps demand, inducing more deflation. Some economists believe such “debt deflation” can trigger recessions as people default on their loans and banks are undermined.
Why is China’s deflation hard to fix?
Beijing responded to past bouts of deflation with forceful monetary easing and big fiscal stimulus measures. But since the pandemic, the government has approached stimulus with more caution, wary of piling too much debt onto the economy.
Policymakers are reluctant to go back to the old playbook of building infrastructure and engineering a property boom. President Xi Jinping is determined to shift the economy toward new growth drivers, such as advanced technologies.
As a result, stimulus measures have been relatively restrained, and investors remain somewhat pessimistic about the economic outlook. In a sign of the gloom, 10-year government bond yields fell to a record low earlier this year before rebounding.
What has China done about its deflation, and what was the impact?
The People’s Bank of China has cut interest rates several times over the past two years to reduce borrowing costs and boost demand. Officials have been trying to turn around the property market by relaxing purchase restrictions and lowering the threshold for down payments, as well as mortgage rates.
Banks were told to extend more credit to developers so that they could finish stalled projects, and local governments were urged to buy unsold apartments and convert them into public housing. While policymakers have refrained from handing out cash to consumers, they have subsidised purchases of cars and home appliances, and extended aid to low-income families and students.
A broad stimulus plan rolled out from late September 2024 included a $1.4 trillion programme to help local governments deal with their debt. The measures helped the economy improve in recent months but aren’t seen by economists as enough to reverse the downward trend in prices. The housing market remains weak and confidence is still low.
The government unveiled its highest level of borrowing on record in 2025, with the broad deficit set to rise to 9.9 per cent of gross domestic product, in a push to add a fiscal stimulus to the economy. But that’s still dwarfed by measures China took in past downturns or those adopted by other major economies in times of crisis. The US, for example, expanded its budget deficit by more than 13 per cent of its GDP in the span of a year in its initial response to the Covid pandemic.
China’s government also reduced its official target for consumer inflation to around 2.0 per cent for 2025, the lowest level since 2003. While this goal is largely regarded as a ceiling rather than a binding objective, the downward adjustment is a tacit recognition from officials that faster price growth will be a challenge.
How does China measure deflation?
There are three main gauges. Most cited is the consumer price index, which reflects changes across a range of goods and services bought by households. It weakened to a five-month low in November.
The producer price index measures changes in industrial products sold by manufacturers and has been in contraction for more than two years.
A gross domestic product deflator is calculated using the difference between the economy’s nominal and inflation-adjusted GDP growth. It provides the broadest measure of price changes across the economy, and is in its longest deflationary streak this century.
What products in China are seeing the biggest price falls?
Transport has been the biggest drag on consumer prices lately, driven mostly by falling car and gasoline prices. Vehicle makers including BYD Co have asked suppliers to cut prices, signalling an intensified price war in China’s auto market.
For the broader economy, the industrial sector -- including manufacturing -- recorded the deepest contraction in prices in 2024, based on a sector-level GDP deflator calculated by Bloomberg. The government’s support for manufacturing -- from cheap loans to favourable tax policies -- has increased the supply of goods that consumers are hesitant to purchase.
Following close behind was the drop in prices across the real estate sector, where a persistent property bubble has led to a glut in housing inventory.
How will Trump’s tariffs affect China’s deflation problem?
Even before two months had passed since his return to the Oval Office, Trump slapped additional tariffs on all Chinese goods imported to the US. China retaliated with targeted levies on US products. It’s unclear whether Trump will follow through on his campaign proposal to hike tariffs on China to 60 per cent, but a further increase in trade tensions between the world’s top economies is likely. There are signs that other countries could follow America’s protectionist lead. South Korea and Vietnam said in February that they would impose tariffs on Chinese steel imports, while Mexico has discussed similar measures with Washington. Put together, this has dimmed the prospects for China’s export growth in 2025. Exports contributed to a third of the country’s economic expansion last year. If manufacturers have to rely on domestic buyers in the face of weaker international demand, it will be even harder to raise prices at home. This could add to the deflationary pressure.
What does persistent deflation in China mean for foreign investors?
Investors in Chinese equities are exposed to deflation-related declines in the earnings of some of China’s companies. Meanwhile, overseas makers of premium cars and luxury brands have seen sales crater in China as consumers tightened their purse strings.