By Michael Lelyveld
China’s government is promoting increased consumption to keep pace with production as deflationary pressures threaten to stall economic recovery.
Last month, the National Bureau of Statistics (NBS) cited the risk of returning to rapid production, voicing concern over a key manufacturing indicator following the government’s drive to get enterprises back to work.
“The reading showed that demand is recovering slower than production,” said NBS senior statistician Zhao Qinghe on April 30, according to state media.
Zhao cited lower readings for new orders than for production in the official purchasing managers’ index (PMI) for April, signaling weaker demand.
The NBS warning reflected a growing decline in the producer price index (PPI) with progressive drops of 0.4 percent in February, 1.5 percent in March and 3.1 percent in April, extending a string of softening wholesale prices.
In the first quarter, the PPI readings were down by a monthly average of 0.6 percent from year-earlier levels, the official Xinhua news agency reported.
During the same period, the consumer price index (CPI) averaged 4.9 percent higher, but the rise at the retail level was driven by food prices which have also started to cool down.
This week, the NBS announced that the CPI in April rose 3.3 percent, dropping back from a 4.3-percent increase in March.
State media quoted analysts as saying that the easing of inflation would give regulators more room to loosen lending and stimulate the economy.
The government has been struggling to reverse a doubling of pork prices over the past year, brought on by an outbreak of African swine fever, leading to months of CPI readings above the 3-percent annual target rate for 2019.
But the spikes in pork prices and CPI numbers have tended to mask weaker demand as a result of the epidemic, dragged down by a huge 20.5-percent drop in retail sales in the first two months of the year.
Deflation and weak demand
Despite CPI growth, China’s greater risk remains low demand and deflation as the government seeks to speed up production before foreign markets recover and supply chains are restored.
Figures released Friday suggest that production is picking up speed while consumption continues to lag behind.
Industrial output in April climbed 3.9 percent from a year earlier after falling 1.1 percent in March, the NBS said. Production slid 13.5 percent in the first two months of the year.
Retail sales were down 7.5 percent from a year before in April following a 15.8-percent decline in March,
Last week, the official English-language China Daily cited experts as saying that “the bulk of (China’s) efforts should be aimed at curbing deflation amid weak external demand.”
The People’s Bank of China (PBOC) responded on May 10 with a reassuring statement in its first-quarter monetary policy report. Despite “short-term price disruptions … there was no foundation for persistent inflation or deflation in the country,” the central bank said.
China’s repeated bouts of deflation at the factory-gate level have become a familiar feature of the country’s economy and a challenge for monetary and fiscal policies.
Some analysts are concerned that China may be on the verge of repeating the slide in producer prices that stretched from 2012 to 2016 through 49 consecutive months.
“The situation China had a few years ago when deflation lasted dozens of months may happen again,” said Nie Wen, an economist at Huabao Trust Company, quoted by Bloomberg News.
The danger of deflation is that it can lead to stagnation.
“Domestically, a faster fall in Chinese prices would hurt company profits and revenue, discouraging them from investment and hiring just when the government needs all sectors to quickly return to normal,” Bloomberg said on April 22.
In China’s case, PPI deflation has spurred overproduction by state-owned enterprises (SOEs) and powerful industries like steel with access to perpetual credit that allows them to continue their costly battles for market share.
Despite a shift to “supply-side” policies and efforts to curb overcapacity in recent years, the government has left the way open for overproduction to serve larger interests.
“China runs stimulus attempts through firms for the sake of jobs. The invariable result is that supply outstrips demand and deflationary pressure rises,” said Derek Scissors, an Asia economist and resident scholar at the American Enterprise Institute in Washington.
In the current case, deflationary pressure was relatively low before the COVID-19 crisis and stimulus policies have been comparatively restrained, Scissors said.
But one major difference between previous episodes and the current price risks of the coronavirus pandemic is that China is now surrounded by deflationary forces and demand weakness both at home and abroad.
China’s economy has been only partially protected from the effects of slumping oil prices and demand downturns overseas.
The April plunge in world oil prices may have had only a limited impact on China’s CPI because of government controls that freeze retail fuel prices when international crude costs fall below U.S. $40 (283 yuan) per barrel.
But even with partial recovery, internationally traded Brent crude has stayed in the range of U.S. $20-30 per barrel, far below the production costs of China’s national oil companies (NOCs). Low prices have decimating NOC profits and raised the risk of deflation.
In a statement for the first quarter, state-owned China National Petroleum Corp. (CNPC) said it would cut spending, citing “unprecedented pressure.” The company lost 16.23 billion yuan (U.S. $2.3 billion) in the period as Brent prices plummeted 73 percent.
As the government tries to break the string of declining producer prices, much may depend on the sequencing of strategies for stimulating production and demand.
China’s steelmakers, a perennial source of overproduction, have been responding quickly and perhaps prematurely to the government’s plans for restarting construction, extending tax cuts and boosting loans to businesses.
This week, the PBOC reported that yuan-denominated lending in April jumped 67 percent from a year earlier to 1.7 trillion yuan (U.S. $239.4 billion).
In late April, Reuters reported that steel stockpiles had eased for six straight weeks but remained near five-year highs with renewed activity in both construction and production.
Output of crude steel rose 1.2 percent in the first quarter but fell 1.7 percent from a year earlier in March, according to the NBS.
Official figures and indicators have painted a mixed picture of China’s progress in staging an economic recovery.
At the end of last month, the NBS reported that 98.5 percent of large and medium-sized enterprises had resumed production as of April 25.
But with contagion controls in place, tourism revenues of 47.5 billion yuan (U.S. $6.7 billion) resulting from five days of the recent May Day holiday were only about 50 percent of a year before, the Ministry of Culture and Tourism said.
Whether the government succeeds in avoiding deflation by matching the recovery of consumption with the pace of production will also depend on preventing a second wave of infections and another series of lockdowns.
“The way deflation could become serious is if demand is hit by autumn or winter lockdowns, but Beijing unwisely keeps trying to support output despite weaker demand,” Scissors said.
“That’s an obvious mistake and one they’d only make due to panic,” he said.