China Grapples with Deflation in Further Signs of a Faltering Recovery

Slide into Deflation

Consumers in the world's second largest economy have been keeping their purses tight for a while now and the situation worsened in July. Today's data revealed that the Consumer Price Index (CPI) shrank 0.3% y/y, in the first negative print in over two years.

Things are more grim on the producer side, since the Producer Price Index (PPI) stayed on contraction levels for tenth straight month, even though the -4.4% y/y print marked an improvement over June.

Weak Data

Today's inflation report is only the last, in a stream of discouraging data. Just yesterday, we saw further deterioration in trade. Exports fell 14.5% y/y in USD terms in July and imports dropped 12.4%, both marking the worst figures since early 2020 and the height of the pandemic.

Factory activity meanwhile has also been a source of disappointment recently, since Manufacturing PMI came in at 49.3, in the fourth consecutive month of construction.

Frail Recovery

Late last year, Chinese authorities shifted away from the strict zero-Covid policy that would shut down whole factories and neighborhoods for a handful of cases. After this pivot, economic activity picked up and the government targeted 2023 growth of 5%, after the weak 3% of the prior year. ^[1]

After the initial boost however, we have been getting a continuous stream of disappointing economic releases, from the second quarter onwards. Weak demand form home and abroad, consumer and producer deflation, contraction in factory activity and a feeble 0.8% q/q Q2 GDP, point to a frail recovery.

Stimulus Hopes

Chinese authorities are not standing still, trying to prop the waning recover. The Politburo recently pledged to support the economy, with a series of measures aiming to expand domestic demand, spur private investment and optimize property policies ^[2]. Earlier in the summer, the central bank (PBoC) had slashed a series of rates, in order to provide liquidity.

The latest round of data create hopes for more robust stimulus by policymakers, but also raises questions around the effectiveness of their actions so far, which appear to lack force and detail.