China deflation threat grows as companies cut prices to survive

SHANGHAI - When China

abandoned pandemic restrictions after three years

of stringent controls, Mr Nie Xingquan was expecting booming sales for his handmade leather shoes. Instead, demand has been so poor that he has had to cut prices 3 per cent from a year ago and reduce his profits.

It is an ominous sign of the deflationary pressure that is hitting Chinese businesses as

the economy weakens

and threatening to undermine Beijing’s stimulus plans if consumers opt to defer spending.

Mr Nie said his Italy Elsina Group, which is based in eastern China’s Wenzhou city and caters to domestic retailers and consumers, has seen business tail off since February. Many of his clients are still scarred from the damage Covid-19 did to their cash flow and profits.

Some retailers, rather than putting in new orders, are trying to sell all the stock they accumulated while expecting sales to surge.

Instead of rapid price gains predicted by some economists at the beginning of 2023, China is experiencing a rare period of falling prices. That is a clear contrast to the rocketing inflation that followed the reopening of the United States and other major economies, and is visible both at the factory gate and retail side.

Producer prices have been contracting on a year-on-year basis since October 2022, largely due to falling prices for commodities like coal and crude oil. Data on Wednesday will likely show consumer prices declined in July, which would be the first time since late 2020 that both consumer and producer prices register contractions.

Using the gross domestic product (GDP) deflator – a measure of economy-wide prices – China is already in deflation.

The International Monetary Fund defines deflation as “a sustained decline in an aggregate measure of prices”, such as the consumer price index or the GDP deflator. Unlike the temporary decline in late 2020 and early 2021, the drop in consumer prices this time around is more cause for concern. Back then, falling pork prices were the main reason.

Now, exports have plunged as consumers in some of China’s biggest markets, including the US and Europe, pull back on spending.

A

prolonged downturn in China’s property sector

has cut prices for rent, furniture and home appliances. Also, a price war among carmakers triggered by Tesla’s reductions led other major brands to join in with steep discounts earlier in 2023.

If prices keep dropping across a broad range of goods for an extended period, consumers could delay their purchases, curbing economic activity further and forcing businesses to keep reducing prices. That, in turn, would cut into revenue and profits, prompting firms to curb investment and jobs – resulting in the kind of economic stagnation that Japan suffered for decades.

To be sure, China is not in the same boat. Not all prices are falling, with consumer spending on services remaining fairly strong. Tourism prices surged 7.1 per cent in the first six months from a year ago, as hotels rates surged. Costs for services such as recreation and education, and medical care, are also still rising.

The problem of low or falling prices is most acute in the consumer goods industries.

“It feels like people are no longer spending much on clothing like they used to,” said Mr Chen Yubing, manager of Jiayao Textile, a maker of polyester and nylon fabric based in the eastern province of Zhejiang.

“Competition has become fiercer and many factories are slashing their prices in order to sell, which leads to a vicious cycle,” said Mr Chen, whose factory lowered prices by 5 per cent in 2023 even though costs have risen by just as much.

The government has been downplaying concerns about deflation, with officials from the People’s Bank of China (PBOC), National Statistics Bureau and other agencies repeatedly saying there is no foundation for long-term price declines.

Talking about deflation publicly is also off-bounds for many Chinese analysts. One economist at a local brokerage said he was instructed by regulators not to discuss deflation.

He was told to promote the narrative that China’s economy is steadily improving, he said, declining to be identified in order to discuss private information.

Another China-based economist said they received guidance from regulators and their company’s public relations department not to discuss deflation publicly.

A big driver of low prices in 2023 is the build-up of inventories over the pandemic and in the first quarter during a burst of optimism following the end of Covid-19 restrictions.

That has since reversed, with businesses cutting prices to reduce their stock.

Ms Vivian Feng is a Shanghai resident who purchases discounted goods, from farm products to Nike T-shirts, and sells them to neighbours of her residential community.

She said her suppliers have cut prices significantly in 2023 due to high inventories and soft demand.

“Some well-established apparel brands used to offer products for the group buy channel at around 40 per cent of the original prices in 2021, and they’re now selling at just 10 per cent or even less,” said Ms Feng.

Some economists expect consumer inflation to trend lower for a few more months before picking up towards the end of the year as the higher base of comparison with 2022 fades and domestic demand picks up. Economists surveyed by Bloomberg expect full-year inflation to reach just 0.8 per cent in 2023, the slowest pace since 2009.

Low inflation is driving up real, or inflation-adjusted, interest rates in the economy, pushing up businesses’ debt-servicing costs and undermining the central bank’s pledge to spur lending.

While that increases the case for the PBOC to add stimulus to the economy, the central bank is facing several constraints that are making it cautious, including a weaker renminbi and elevated debt levels in the economy.

Central bank officials have hinted at some easing measures, such as reducing the amount of cash that banks must hold in reserves. Economists also predict a 10 basis point policy rate cut in the third quarter.

“The ongoing weakness in China data will continue to dampen consumption, as households will remain cautious about making purchases of big-ticket items given the potential risks of job losses and salary cut,” said Mizuho Bank chief forex strategist Ken Cheung. “The uncertainties surrounding deflation may prompt the PBOC to implement additional monetary easing measures.” BLOOMBERG