Deflation in China: Consumer Price Index Decline in July 2023

Context:

China’s National Bureau of Statistics has reported a 0.3% year-on-year decline in the Consumer Price Index (CPI) for July 2023, leading to a state of deflation in the country.

Relevance:

GS III: Indian Economy

Dimensions of the Article:

1. Deflation
2. Impact of Deflation:
3. Deflation Causes in China
4. Impacts of China’s Deflation on India and the Global Economy

Deflation

Deflation is the opposite of Inflation. It refers to a sustained and general decrease in the overall price levels of goods and services in the economy.

• Consumer Advantage: In a deflationary scenario, consumers can acquire more goods and services for the same monetary amount over time.
• Factors Behind Deflation: It can stem from reduced consumer demand, excess supply of goods, technological advancements lowering production costs, or stringent monetary policies by central banks.
• China’s Case: China experiences deflation due to diminished consumer demand and an economic slowdown.

Impact of Deflation:

Positive Aspects:

• Central Bank Actions: In response to deflation, central banks may decrease interest rates, fostering borrowing and spending. Lower rates can reduce borrowing expenses for individuals and businesses, potentially invigorating economic activity.
• Encouraging Savings: Deflation can promote saving as money’s value appreciates. This incentivizes saving for the future, contributing to long-term financial stability.
• Efficiency Drive: Businesses may enhance efficiency to counter deflation, leading to cost reduction, innovation, and increased competitiveness. This can drive productivity growth and long-term economic development.
• Fixed-Income Benefit: Individuals with fixed-income investments like pensions or annuities can benefit from deflation. The increased value of money provides reliable income sources for retirees.

Negative Aspects:

• Consumer Behavior Impact: In anticipation of lower prices, consumers postpone purchases, leading to reduced demand, production cuts, and potential layoffs. This initiates an economic downturn cycle.
• Economic Contraction: This cycle intensifies with decreased business revenue, lower profits, reduced investments, and potential unemployment.
• Debt Challenge: Deflation amplifies the real burden of debt. Debt value remains steady or increases as prices fall, creating challenges for individuals, businesses, and governments managing debt obligations.
• Higher Debt Repayment Impact: During deflation, the purchasing power of every dollar spent on debt repayment increases, exacerbating repayment pressures.
• Varied Effects: The impacts of deflation depend on specific economic circumstances, with effects varying according to each economy’s unique context.

Deflation Causes in China

Zero-Covid Policy Impact:

• Stringent Measures: China’s economy faced significant challenges due to an assertive Zero-Covid policy, resulting in entire cities being shut down periodically, lasting weeks at a time.
• Objective: These measures aimed to curb the spread of the coronavirus but had notable economic repercussions.

Slowdown in Property and Banking:

• Property Sector Impact: The property sector, historically contributing 20-30% of GDP, underwent a marked slowdown. Major developers struggled to manage debts, leaving several projects unfinished.
• Banking Sector Challenges: China’s banking sector faced issues due to a plethora of non-performing loans. Many loans extended to local government entities faced declines in revenue, exacerbating financial pressure.

Unemployment Pressure:

• Youth Unemployment: Increasing youth unemployment is a pressing concern. The official jobless rate among individuals aged 16 to 24 stood at 21%, with apprehensions that the actual figure could be significantly higher.
• Broader Impact: Rising unemployment rates among young workers pose broader socio-economic challenges for China’s economy.

Impacts of China’s Deflation on India and the Global Economy

India:

• Manufacturing Hub Opportunity: China’s economic slowdown and deflation could potentially lead to reduced investments in their economy. India, by accelerating economic reforms, might emerge as an alternative manufacturing hub for developed economies.
• Iron Ore Export Impact: China is a major importer of Indian iron ore. Reduced imports due to China’s economic slowdown could negatively affect India’s economy.

Global Impact:

• Supply Chain Disruptions: Global supply chains intricately tied to China could face disruptions if their export engine falters due to deflation and diminished demand. Industries worldwide, including those in India reliant on Chinese intermediate goods, might be affected.
• Global Growth: China, as the second-largest economy, significantly influences global growth. A sharp economic decline due to deflation could lead to decreased worldwide demand for goods and services, contributing to a global economic slowdown.
• Monetary Policy Challenges: Central banks globally may grapple with managing monetary policies in response to China’s deflation. Lower demand and potential disinflation could affect interest rate policies’ effectiveness.
• Inflation and Interest Rates: Reduced global demand could mitigate inflationary pressures, impacting interest rate policies’ effectiveness and potentially leading to prolonged low interest rates.

-Source: The Hindu