What should China do to tackle declining prices? That is a question that has generated heated exchanges among economists and analysts as the world’s second-largest economy struggles with slowing growth and dangerously low inflation.
While many parts of the world are facing high costs, China is an outlier. Its consumer prices fell by 0.5 per cent in November, year on year, marking the sharpest decline in three years.
Producer prices, which are measured at the factory gates and heavily driven by the cost of commodities and raw materials, also dropped by 3 per cent in November and have remained in negative territory for the past year.
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Larry Hu, chief China economist at Macquarie Group, estimated that the consumer price index (CPI) may only rise by 0.3 per cent in 2023, much lower than Beijing’s target of “around 3 per cent.”
Beijing has resisted so-called flood-like stimulus – large scale monetary and fiscal expansion – often a textbook response to slow growth and low inflation.
However, there are rising concerns that policymakers might not be doing enough to prevent China from slipping into a Japanese-style deflation.
Comparisons have been consistently drawn with Japan, which experienced two so-called lost decades of stagnant growth and deflation after its real estate and asset bubble burst in the early 1990s.
Hong Kong-born American economist Steven Ng-Sheong Cheung, known for his pro-market stance, argued earlier this month that China’s central bank needs to raise its inflation target to 6 per cent “as soon as possible”, and then adjust it to 4 per cent to rescue its sluggish economy.
Economist calls for China to stimulate activity with controlled inflation rate
Cheung pointed out that falling property prices had already affected wealth among Chinese homeowners, and that deflation would be “disastrous” for the economy.
His blog post, published on December 8 on Chinese social media platform Weibo, triggered a backlash among the general public and analysts.
By raising its inflation target, critics said, China’s central bank would need to increase the size of its balance sheet and inject new cash into the economy, adding to the risk of asset bubbles.
“If we really push inflation to 6 per cent as proposed [by Cheung], without supplementing it with other means to stabilise inflation expectations, it may be difficult for people to believe that inflation will only stop at 6 per cent,” Bank of China International chief economist Xu Gao said in a blog post on Sunday.
He added that the US Federal Reserve has struggled to curb inflation even after raising interest rates.
Xu said that low inflation in China is a “symptom” largely driven by the inability of property developers and local governments to raise funds.
Financing conditions remain difficult for Chinese property developers, some of which have already defaulted on their debts, while some local governments have been directed by Beijing to curb borrowing as a result of their already high leverage.
Lu Gan, associate professor at Central University of Finance and Economics, argued that setting a higher inflation target does not necessarily mean that there will be “excess” money in the markets.
“Once the central bank’s policy efforts lead to the realisation of inflation expectations and speed up money circulation, there is no need to issue too much money, it will flow from some channels to the overall economy,” Lu said in a blog post on Monday.
And property developers and local governments are not the only channels for credit growth, Lu argued.
Banks no longer rely on the two groups as key customers, Lu said, citing his own research on lenders.
Li Xunlei, chief economist with Zhongtai Securities, suggested that the government can try to set a lower limit for price targets.
“In the past, 3 per cent CPI has been set as the upper limit. In the future, a lower limit of no less than 1 per cent can be set, which will help raise expectations,” Li said on Monday.
During the annual central economic work conference, which concluded last week, policymakers acknowledged the deflationary pressure facing China’s economy.
It was the first time that the top leaders had discussed a “price target” in the tone-setting meeting, according to Macquarie Group’s Hu.
“In other words, monetary policy could turn more accommodative in the face of deflationary risks, implying more policy rate and reserve requirement ratio cuts to come in the months ahead,” Hu said last week.
More from South China Morning Post:
- China should keep inflation around 4% to boost activity, household wealth, economist says
- China inflation: 4 takeaways from November’s data as deflationary pressure heightened
- China’s consumer prices mark steepest fall in 3 years as post-Covid rebound falters
- Outspoken Chinese economist Yu Yongding issues stagflation warning on Beijing’s fiscal policies
- China inflation: October’s consumer, factory-gate price drops do not portend ‘deflationary spiral’, analysts say
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