A much-weaker 2019 appears to be in the offing for China, but it’s not solely due to trade tensions with the United States. The domestic economy was already on weak footing and the CBB argues that government support is unlikely.
The CBB is a research service that speaks to thousands of companies and bankers on the ground in China every quarter. It contends that deflation is the bigger threat compared to inflation.
“Because of China’s structural problems, deflation has very clearly emerged as the bigger threat in a slowing economy than inflation. Consumer demand has weakened, and you see that reflected in retail and services prices,” said Shehzad Qazi, CBB managing director, in an interview.
While lower prices look good for consumers, policy-makers don’t like deflation for a number of reasons. With prices falling, companies produce less, often lay off workers, and reduce investment, leading to a vicious circle of sorts. While the trade war hurts export-sensitive regions, local orders have now weakened for two straight quarters.
Hiring fell for the first time since early 2016. Worse still, the fall was concentrated in services and retail, two sectors being counted upon to pick up the slack left by manufacturing’s woes.
Also, debt—of which China has plenty—becomes more problematic under deflation, as its value adjusted for inflation rises.
And it’s an issue for central bankers, who typically target 2 percent inflation for price stability. Rate cuts to spur the economy and inflation are less effective, since the real interest rates are higher when accounting for deflation.
“China is an aging, leveraged country, with excess industrial capacity. Appearances by inflation should be cheered,” according to the CBB Q4 preview. “They are also rare.”
Qazi says that the only inflation is in agriculture commodities, which is not what Beijing wants.
Two metals symbolic of global growth—copper and aluminum—are languishing. The CBB reports that the net share of copper firms raising production capacity fell to 30 percent from 60 percent two quarters prior, while aluminum firms raising capacity fell to 18 percent, which is half the Q3 figure.
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“A major misconception presently is that China will announce another massive stimulus plan in the coming weeks,” Qazi said.He added that further measures to stimulate the economy are unlikely. This is because true fiscal stimulus has never been attempted, and government spending distributed via state banks ends up being akin to monetary accommodation, which is what the Chinese authorities insisted would not happen again under their watch.
“The bottom line is that we see pervasive weakness in the economy as we look to 2019,” Qazi said.
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