Recent economic data suggests that the contraction that has dogged China’s economy since last year has begun to deepen, raising concerns about the outlook for the world’s second-largest economy and bolstering calls for immediate policy action.
Data released on Monday showed that consumer price growth, excluding food, was almost non-existent in large parts of the economy, at a time when incomes are declining, according to Bloomberg.
The GDP deflator, a broader measure of price changes in the economy as a whole, is expected to continue falling through 2025, according to Bloomberg and analysts at banks such as BNP Paribas. If the trend continues, it would be China’s longest period of contraction since data collection began in 1993.
“We are definitely in the contraction phase and we may be in the second phase of this contraction,” said Robin Sheng, chief China economist at Morgan Stanley, pointing to evidence from falling wages.
He added that Japan’s experience in the 1990s shows that prolonged deflation will require greater stimulus to break the challenges of debt and deflation.
Effects of shrinkage
Private surveys show the negative impact is already starting to bite. In government-backed sectors like electric vehicles and renewable energy, starting salaries fell 10% in August from their peak in 2022, according to reports from Caixin Insight Group and Business Big Data.
A survey of 300 business executives showed that labor cost growth in August was the weakest since April 2020, when China began easing its Covid-19 lockdown.
Other data showed that average wages in 38 major cities barely changed in the second quarter of the year, compared with 5% growth in the two years before the pandemic.
This wage slowdown adds to a series of economic challenges similar to what Japan experienced in the 1990s during its “lost decades,” Bloomberg says.
Political response
While the Chinese government has tried to play down talk of deflation, former central bank governor Yi Gang acknowledged last week that tackling deflation should be a priority for policymakers.
He stressed at a summit in Shanghai that officials must adopt an “active fiscal policy and an accommodative monetary policy” to limit deflationary pressures.
Yi Jang urged officials to focus on turning the GDP price index positive in the coming quarters.
Lower inflation and increased market concerns
Core inflation, which strips out volatile items such as food and energy, slowed in August to its lowest level in more than three years, official data showed. The slowdown in inflation has boosted bond markets, where yields have fallen to record lows, adding to officials’ concerns about banks’ exposure to interest rate risks.
China’s nominal gross domestic product grew just 4% in the second quarter, well below the government’s target for real economic growth of about 5% this year, according to Bloomberg.
During periods of weak price growth, nominal expansion is a more useful indicator because it better reflects changes in wages, profits, and government revenues.
