China faces persistent deflation challenges as economic fragility persists

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China’s struggle against deflationary pressures continues, casting a shadow on the stability of its economic recovery as 2023 approaches its end.

Economists surveyed by Bloomberg anticipate that the data to be released on Thursday will likely reveal a return to deflation in China’s consumer prices for the month of October. Furthermore, it is expected that producer prices will have declined for the 13th consecutive month, reinforcing the presence of deflationary forces in the economy.

Consumer costs have remained stubbornly weak throughout the year, with the consumer price index having dipped into deflation in July and fluctuated on the edge of negative year-on-year growth since then. Despite the People’s Bank of China’s August statement predicting a rebound in prices after a rough patch in the summer, the current data suggests that the outlook might have been overly optimistic.

Morgan Stanley has expressed concerns that China may be facing an ongoing battle against falling prices in the coming years. According to the institution, Beijing is still in the “initial stage of the deflation battle” as it endeavours to transition away from an “overextended, credit-fuelled growth model.”

The presence of weak inflation figures could add further uncertainty to China’s economic growth prospects, particularly following an unexpected contraction in factory activity and slowing growth in the services sector observed in October. According to Larry Hu, Head of China Economics at Macquarie Group Ltd., the broadest gauge of pricing, the GDP deflator, is expected to turn negative in the last three months of the year due to the country’s continued weak consumption demand. Bloomberg estimates, based on official data, show that this indicator has already declined for two consecutive quarters, marking the first time since 2015.

Additional reports scheduled for the coming days may provide further insights into the trajectory of China’s economic recovery. On Tuesday, export figures are anticipated to show a narrowing drop in October, mainly due to a lower base for comparison with the same month in 2022 when China was contending with pandemic-related lockdowns.

Furthermore, credit data for the previous month is expected to indicate an increase in overall financing compared to the same period in the previous year, as a substantial number of government bonds enter the market.

There is a growing expectation for the central bank to introduce further liquidity support by reducing the reserve requirement ratio, which determines the amount of cash that banks must keep in reserve. Some analysts even suggest that the central bank may take this step ahead of its monthly policy loan operations in mid-November, responding to the pressure created by the surge in government bond issuance on interbank liquidity.

(With inputs from Bloomberg)

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