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China on brink of deflation again reveals still-fragile recovery

Bloomberg • 6 min read
China on brink of deflation again reveals still-fragile recovery
China’s economy still has a ways to go before it’s out of the woods. Photo: Bloomberg
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China’s economy still has a ways to go before it’s out of the woods.

Data on Friday was mixed: Consumer prices unexpectedly retreated to the brink of deflation as concerns linger about weak demand. And while a slump in the nation’s exports moderated, consistent growth remains elusive for what was once a key driver for the world’s second-largest economy. 

More figures to come will paint a clearer picture of how much the government’s recent stimulus is helping to stabilize activity. The People’s Bank of China will report credit data later Friday, and authorities next week will unveil statistics on everything from industrial output to employment as the third quarter finished.

That data will illustrate how much pressure President Xi Jinping remains under as his government tries to ensure the economy hits a growth goal of about 5% this year. While economists still see Beijing hitting that target, consumer sentiment remains stubbornly weak, and Xi has yet to find a sustainable solution to the property crisis.

Before next Wednesday’s data release, the central bank will set a key policy rate, which economists mostly see as staying unchanged Monday. Chinese policymakers are likely taking a wait-and-see approach before deciding whether to ramp up support again, according to Larry Hu, head of China economics at Macquarie Group Ltd.

See also: Navigating China's markets

“There are two scenarios. One, these piecemeal efforts would add up eventually,” he said, referring to existing stimulus. “Two, at the certain point, the policy stance would turn more decisive as patience is exhausted.”

Markets struggled for traction on Friday, though investors were also likely weighing hot US inflation data that may push the Federal Reserve to consider another rate hike next month. The CSI 300 Index of stocks extended its declines in the afternoon session to 1.4%, the biggest intraday loss in over one month. The Hang Seng China Enterprises Index dropped 2.6%. The onshore and offshore yuan were little changed.

After an alarming slowdown in activity over the summer, some parts of the economy began showing signs of improvement. That sparked some cautious optimism about whether China had moved past the worst this year. The manufacturing sector improved and credit recorded bumper growth in August. Friday’s trade data for September — while still in contraction — suggested that global demand for Chinese-made goods is improving.

See also: Feel the pulse of real China at the street level

The surprise flatlining of the nation’s consumer inflation rate last month, though, reflected how precarious this recovery really is. 

“Deflationary pressure in China is still a real risk to the economy,” said Zhiwei Zhang, president and chief economist at Pinpoint Asset Management. “The recovery of domestic demand is not strong, without a significant boost from fiscal support.”

While China’s National Bureau of Statistics stressed that the slip could be partly explained by slower growth in food prices — there was ample supply ahead of Golden Week celebrations — it added to a few other warning signs on activity in recent weeks. Home sales have failed to mount a turnaround, while spending data over the lengthy holiday period was weaker than anticipated. 

Key Figures From Friday’s Data Releases:
  • The consumer price index was 0% y/y, lower than a forecasted 0.2% rise
  • Core CPI — which strips out volatile food and energy costs — rose 0.8%
  • The producer price index fell 2.5%, moderating from a prior 3% decline
  • Exports dropped 6.2%, not as severe as a forecasted 8% decrease
  • Imports decreased 6.2%, down for seven months in a row

“The government has announced hundreds of counter-cyclical measures to boost domestic demand,” said Zhaopeng Xing, senior China strategist at Australia & New Zealand Banking Group Ltd. Even so, “consumer confidence remains weak.”

Even if the central bank doesn’t adjust policy rates next week and the government doesn’t roll out massive stimulus, authorities do seem to be mulling some measures to juice the economy. 

China is weighing the formation of a state-backed stabilization fund to shore up confidence in its $9.5 trillion stock market, Bloomberg News reported on Friday. Those discussions coincide with a move by China’s sovereign wealth fund to buy the equivalent of about $65 million of shares in the nation’s biggest banks this week. While a token amount, it nonetheless underscores concerns among top leaders over the sinking market.

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That’s on top of considerations among authorities to make a rare mid-year revision to the national budget. That would see policymakers issuing at least 1 trillion yuan ($137 billion) in sovereign debt for infrastructure spending — an amount that would push the deficit to well above the 3% cap set in March. That move would amount to about 0.7% of gross domestic product. 

“There is a lot of optimism around a bazooka stimulus,” said Xiaojia Zhi, head of research at Credit Agricole CIB. “We think the probability is relatively small for anything too exciting, but policy easing will continue with more measures on multiple fronts.”

Room to move on monetary policy, meanwhile, may be constrained, with another interest rate hike by the Fed still potentially in play after September’s hotter than expected inflation figures.

What Bloomberg Economics Says ... 

“The slip in China’s CPI back to zero inflation in September indicates demand remains too weak to stoke prices. Green shoots in manufacturing suggest the economy is starting to turn around. But it will probably take time for demand to pick up broadly on the back of the increase in policy stimulus in recent months.”

— Eric Zhu, economist 

China’s economic challenges have led to some concerns about growth over the next couple of years. The International Monetary Fund recently cut its growth forecast for the country this year to 5% from 5.2%, and for next year to 4.2% from 4.5%. The Fund cited lost momentum because of the property market, along with weak consumer sentiment. 

As for the surprising inflation figures, “one month does not constitute a trend,” wrote Robert Carnell, regional head of research for Asia-Pacific at ING Groep NV., in a research note. Base effects may still “slowly lift Chinese inflation over the coming months.”

“However, if the underlying run rate is softer even than the conservative figures we are pencilling in,” he said, “then this may be a much more nuanced improvement.”

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