China’s battle against deflation has entered a perilous new phase. Producer prices have now fallen for 33 consecutive months, marking one of the longest bouts of factory‑gate deflation in modern memory. Despite Beijing’s renewed vows to curb “destructive” price wars and prune excess industrial capacity, economists warn that this effort alone is unlikely to lift China out of deflation as swiftly or smoothly as the supply‑side reforms of a decade ago.
Persistent Price Pressures Undermine Recovery
In June, China’s Producer Price Index (PPI) plunged 3.6% year‑on‑year—the sharpest decline since July 2023 and worse than market forecasts of a 3.2% drop. Factory‑gate deflation has now persisted for nearly three years, undercutting profit margins across the industrial landscape. At the same time, consumer prices barely budged: the Consumer Price Index (CPI) in June ticked up just 0.1% from a year earlier, after four months of outright deflation.
Weak domestic demand remains at the heart of this downturn. Food prices continue to drag on overall CPI, with staples like pork down 8.5% year‑on‑year and eggs off by 7.7%. Shelter costs and services have provided little offset, reflecting persistent caution among both households and service providers. Low consumer confidence—stoked by a protracted property slump and rising unemployment—means that even modest price cuts fail to stimulate spending at scale.
Meanwhile, sluggish global demand and intensifying trade tensions have compounded the deflationary spiral. Export‑oriented manufacturers, squeezed by U.S. and EU tariffs and grappling with a stronger yuan, have resorted to aggressive price‑cutting to defend market share abroad. Beijing’s recent public admonishments—labeling these intra‑industry “price wars” as harmful to the broader economy—aim to curtail such tactics. But reversing deeply entrenched deflationary expectations will require more than exhortations and patchwork measures.
Structural Obstacles to Swift Capacity Reduction
Beijing’s playbook in 2015–16 focused on shuttering inefficient plants in steel, cement, glass and coal through blunt administrative directives and incentivized buyouts. That campaign coincided with a dramatic rebound in PPI by mid‑2016, ending 54 straight months of falling producer prices. This time, however, the industrial landscape is vastly more complex.
Unlike the dominance of state‑owned enterprises in heavy industries a decade ago, today’s overcapacity is largely rooted in the private sector. Cheap credit, generous land deals and tax incentives have fuelled rapid expansion in higher‑tech fields—electric vehicles, batteries, solar panels and semiconductors—often without regard for market fundamentals. Local governments, eager to showcase “new‑energy champions,” have routinely dangled subsidies and preferential financing packages, even as factories struggle to run at “healthy” utilization rates above 80%.
Curtailing capacity in these sectors will mean rolling back subsidies, rescinding land grants and tightening loan standards. But doing so risks bankruptcies, mass layoffs and a hit to social stability—an outcome Beijing is desperate to avoid. Youth unemployment is already at a 16‑year high of 14.5%, and dozens of export‑driven factories have begun to shed workers and cut wages. With the property sector no longer a reliable sponge for absorbing displaced workers—as it was during the last pruning campaign—authorities face a starker trade‑off between growth and reform.
Limited Demand and Policy Constraints Hamstring Progress
Even if Beijing manages a phased reduction in industrial overcapacity, the deflationary drag may outlast the cuts themselves. Manufacturing now accounts for one‑third of global output, so trimming capacity in isolated sectors will have only a marginal effect on the national PPI. Moreover, the coordinated urban reconstruction initiatives that provided redeployment opportunities in the mid‑2010s are no longer feasible at a comparable scale.
Monetary and fiscal policy options are also constrained. Unlike in 2015, China cannot afford large‑scale stimulus via real estate or bond‑financed infrastructure without risking further debt accumulation and asset bubbles. Nor can it engage in aggressive currency devaluation, having pledged stability to retain foreign investor confidence. That leaves policymakers with a narrower toolkit: targeted tax cuts, modest public‑works spending and selective credit easing for small‑and‑medium enterprises. Such measures may shore up fragile demand, but they are unlikely to generate the surge in prices needed to reverse deflationary expectations quickly.
Analysts note that ending deflation ultimately requires restoring robust consumption growth. Yet household incomes remain under pressure from weak wage gains in the private sector and rising living costs. Without a credible lift in consumer spending, any gains from capacity cuts may be fleeting. As Yan Se of Peking University’s Institute of Economic Policy observes, “Important and necessary” pruning will have to be a drawn‑out, gradual process—meaning deflationary pressures could persist well into next year and beyond.
A Risk of Prolonged Stagnation
The deflation predicament poses a critical test for China’s economic model. If price declines continue to stifle investment and consumption, GDP growth could slip below the government’s 5% target for 2025. That, in turn, would complicate efforts to reorient the economy from investment‑led expansion to a more balanced, consumption‑driven trajectory.
Beijing’s decision to publicly call out price wars and signal an industrial pruning campaign underscores the urgency of the situation. Yet the narrowly targeted cuts and cautious policy stance suggest authorities are bracing for a long, uphill battle. With limited fiscal headroom, entrenched local‑government incentives and weak domestic demand, China’s path out of deflation looks steeper and far more uncertain than it did a decade ago. Unless demand‑side measures are scaled up in tandem, industrial pruning alone is unlikely to deliver the rapid, decisive turnaround that Beijing needs.
In the end, China may find that the hardest lesson of all is that supply‑side remedies, however necessary, cannot substitute for genuine demand revival—and that lifting deflation will require unlocking the spending power of its vast consumer base.
(Source:www.reuters.com)
Persistent Price Pressures Undermine Recovery
In June, China’s Producer Price Index (PPI) plunged 3.6% year‑on‑year—the sharpest decline since July 2023 and worse than market forecasts of a 3.2% drop. Factory‑gate deflation has now persisted for nearly three years, undercutting profit margins across the industrial landscape. At the same time, consumer prices barely budged: the Consumer Price Index (CPI) in June ticked up just 0.1% from a year earlier, after four months of outright deflation.
Weak domestic demand remains at the heart of this downturn. Food prices continue to drag on overall CPI, with staples like pork down 8.5% year‑on‑year and eggs off by 7.7%. Shelter costs and services have provided little offset, reflecting persistent caution among both households and service providers. Low consumer confidence—stoked by a protracted property slump and rising unemployment—means that even modest price cuts fail to stimulate spending at scale.
Meanwhile, sluggish global demand and intensifying trade tensions have compounded the deflationary spiral. Export‑oriented manufacturers, squeezed by U.S. and EU tariffs and grappling with a stronger yuan, have resorted to aggressive price‑cutting to defend market share abroad. Beijing’s recent public admonishments—labeling these intra‑industry “price wars” as harmful to the broader economy—aim to curtail such tactics. But reversing deeply entrenched deflationary expectations will require more than exhortations and patchwork measures.
Structural Obstacles to Swift Capacity Reduction
Beijing’s playbook in 2015–16 focused on shuttering inefficient plants in steel, cement, glass and coal through blunt administrative directives and incentivized buyouts. That campaign coincided with a dramatic rebound in PPI by mid‑2016, ending 54 straight months of falling producer prices. This time, however, the industrial landscape is vastly more complex.
Unlike the dominance of state‑owned enterprises in heavy industries a decade ago, today’s overcapacity is largely rooted in the private sector. Cheap credit, generous land deals and tax incentives have fuelled rapid expansion in higher‑tech fields—electric vehicles, batteries, solar panels and semiconductors—often without regard for market fundamentals. Local governments, eager to showcase “new‑energy champions,” have routinely dangled subsidies and preferential financing packages, even as factories struggle to run at “healthy” utilization rates above 80%.
Curtailing capacity in these sectors will mean rolling back subsidies, rescinding land grants and tightening loan standards. But doing so risks bankruptcies, mass layoffs and a hit to social stability—an outcome Beijing is desperate to avoid. Youth unemployment is already at a 16‑year high of 14.5%, and dozens of export‑driven factories have begun to shed workers and cut wages. With the property sector no longer a reliable sponge for absorbing displaced workers—as it was during the last pruning campaign—authorities face a starker trade‑off between growth and reform.
Limited Demand and Policy Constraints Hamstring Progress
Even if Beijing manages a phased reduction in industrial overcapacity, the deflationary drag may outlast the cuts themselves. Manufacturing now accounts for one‑third of global output, so trimming capacity in isolated sectors will have only a marginal effect on the national PPI. Moreover, the coordinated urban reconstruction initiatives that provided redeployment opportunities in the mid‑2010s are no longer feasible at a comparable scale.
Monetary and fiscal policy options are also constrained. Unlike in 2015, China cannot afford large‑scale stimulus via real estate or bond‑financed infrastructure without risking further debt accumulation and asset bubbles. Nor can it engage in aggressive currency devaluation, having pledged stability to retain foreign investor confidence. That leaves policymakers with a narrower toolkit: targeted tax cuts, modest public‑works spending and selective credit easing for small‑and‑medium enterprises. Such measures may shore up fragile demand, but they are unlikely to generate the surge in prices needed to reverse deflationary expectations quickly.
Analysts note that ending deflation ultimately requires restoring robust consumption growth. Yet household incomes remain under pressure from weak wage gains in the private sector and rising living costs. Without a credible lift in consumer spending, any gains from capacity cuts may be fleeting. As Yan Se of Peking University’s Institute of Economic Policy observes, “Important and necessary” pruning will have to be a drawn‑out, gradual process—meaning deflationary pressures could persist well into next year and beyond.
A Risk of Prolonged Stagnation
The deflation predicament poses a critical test for China’s economic model. If price declines continue to stifle investment and consumption, GDP growth could slip below the government’s 5% target for 2025. That, in turn, would complicate efforts to reorient the economy from investment‑led expansion to a more balanced, consumption‑driven trajectory.
Beijing’s decision to publicly call out price wars and signal an industrial pruning campaign underscores the urgency of the situation. Yet the narrowly targeted cuts and cautious policy stance suggest authorities are bracing for a long, uphill battle. With limited fiscal headroom, entrenched local‑government incentives and weak domestic demand, China’s path out of deflation looks steeper and far more uncertain than it did a decade ago. Unless demand‑side measures are scaled up in tandem, industrial pruning alone is unlikely to deliver the rapid, decisive turnaround that Beijing needs.
In the end, China may find that the hardest lesson of all is that supply‑side remedies, however necessary, cannot substitute for genuine demand revival—and that lifting deflation will require unlocking the spending power of its vast consumer base.
(Source:www.reuters.com)