China Faces Deflation Risk as Consumer Prices Fall for First Time in Two Years

China’s consumer prices dropped in July for the first time since February 2021, while factory gate prices continued their declines, data showed on Wednesday, as lacklustre demand weighed on the economy.

Consumer Price Index Down 0.3% Year-on-Year

The consumer price index (CPI) for the month dropped 0.3% year-on-year, the National Bureau of Statistics (NBS) said, a slightly slower fall than the median estimate for a 0.4% decrease in a Reuters poll. CPI was unchanged in June.

This was the first year-on-year decline in CPI since early 2021, according to official data accessed via Wind Information.

A 26% year-on-year drop in pork prices, a staple food in China, contributed to the overall decline in the CPI in July. Tourism prices rose by 13.1% from a year ago.

Excluding food and energy prices, the so-called core CPI rose by 0.8% from a year ago — the highest since January, according to official data accessed via Wind Information.

Producer Price Index Down 4.4% Year-on-Year

The producer price index (PPI) fell for a 10th consecutive month, down 4.4% from a year earlier after a 5.4% drop the previous month. That compared with a forecast for a 4.1% fall.

China Faces Deflation Risk as Consumer Prices Fall for First Time in Two Years
China Faces Deflation Risk as Consumer Prices Fall for First Time in Two Years

The PPI measures the change in prices that producers receive for their goods and services. It reflects the cost pressures faced by businesses and can affect their profitability and investment decisions.

The PPI deflation was mainly driven by lower prices of raw materials, fuel and power, which fell by 8.7%, 9.6% and 6.2%, respectively, from a year ago.

Economic Recovery Slows Amid Weak Domestic Demand

China’s economic recovery slowed after a brisk start in the first quarter, as demand at home and abroad weakened.

The country’s gross domestic product (GDP) grew by 7.9% year-on-year in the second quarter, down from a record 18.3% in the first quarter.

The slowdown was partly due to a high base of comparison from last year’s pandemic-induced slump, but also reflected the challenges facing the world’s second-largest economy amid rising Covid-19 cases, supply chain disruptions and regulatory crackdowns on various sectors.

Domestic consumption remained sluggish, as retail sales growth moderated to 12.1% year-on-year in June from 12.4% in May.

Exports also lost momentum, as global demand softened and trade frictions with the U.S. persisted. China’s trade surplus narrowed to $56.6 billion in July from $51.5 billion in June.

Policy Support Needed to Prevent Deflation Spiral

The CPI deflation may put more pressure on the government to consider additional fiscal stimulus to mitigate the challenge.

“China is falling into a deflationary spiral,” said Raymond Yeung, chief economist for Greater China at Australia & New Zealand Banking Group Ltd. “Domestic demand is very weak,” he said, with producer costs and the core consumer price index that excludes food and energy both trending lower.

Deflation is a persistent decrease in prices over time that can erode profits, discourage spending and investment, and increase debt burdens.

Some analysts have called for more policy support to boost domestic demand and prevent deflation from taking hold.

The central bank has maintained a prudent monetary policy stance, but has injected more liquidity into the banking system through various tools.

The government has also announced some fiscal measures, such as tax cuts and increased spending on infrastructure and social welfare.

However, some economists have argued that these measures are not enough to offset the downward pressure on the economy and that more aggressive action is needed.

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