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Inside China 22 January 2024

Trying to shake off deflation

Jeremy Stevens

Consumer price deflation for first time in 30 years

  • Inflation data has been demonstrating deflationary threats. Indeed, for only a second time in 30 years, there was consumer price deflation in 2023. Given that the post-Covid stimulus playbook had focused on boosting supply, producer price deflation unsurprisingly deepened in 2023. Even more surprising, consumer goods deflation confirming the consumption “rebound” has been driven by base effects, and catering and restaurant sales. On aggregate, households have seemingly seen their purchasing power altered, or changed their preferences and spending patterns.
  • The story of soft demand and widespread is made plain in the GDP deflator – the broadest measure of prices in an economy. Unlike other major economies, China’s GDP deflator has fallen over the past two years, eventually in 2023 turning negative for the first time in eight years.
  • Deflation causes the real debt burden of an economy to rise dramatically as asset prices fall while the costs of debt liabilities remain fixed. Also, corporate earnings are generally more sensitive to changes in prices than to sales volumes, which means that deflation hits corporate earnings and so disincentivizes capacity expansion. 
  • Strange, then, that the outstanding stock of bank loans still increased at twice the speed of the economy. So much for concerns over the efficiency of credit allocation. All in, the stock of credit increased by a staggering CNY33tn in 2023 (versus CNY30tn and CNY29tn in 2022 and 2021 respectively). The acceleration in the growth of the overall credit stock since July is a result of the new central government special treasury bond (STB) and local government special purpose bonds (SPB), and additions to the Pledged Supplemental Lending (PSL) program.
  • Corporate credit demand is still weak. In December, new bank loans growth continued a year-long trend of slowing. The rare exception was banking loans to manufacturing, which ballooned even though price deflation has hits profit growth, which, alongside soft export orders, should have weighed on manufacturing production.
  • Expect further easing of monetary policy in 2024. That said, at this juncture, the PBOC doesn’t seem to be anchoring its policy decisions to inflation and inflation expectations. This for a variety of reasons, such as the constraints on opening the credit taps being more fundamental in nature; the PBoC has does not want to send a broad easing signal to the market; and the PBOC is waiting for clarity over the direction of the US Fed and others.
  • The disproportionate deceleration of nominal GDP growth versus real GDP growth is worrisome. So are the pro-cyclical dynamics between credit and nominal growth. The spectre of more widespread deflation at this juncture may still a low-probability threat, but we a watching items carefully, such as: food and pork prices; the Chinese Commodity Index (CCI); and industrial inventory levels.

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