China has slipped into deflation for the first time in six years. Given its conspicuous excess capacity in a world of falling consumer demand, that now puts the country at great risk of copying America’s position (as a surplus country) in the Great Depression of 1929.
As Reuters reports:
BEIJING, March 10 (Reuters) – China fell into deflation at the consumer level last month for the first time in more than six years, as ministers painted a gloomy picture of the economy’s near-term prospects.
The 1.6 percent drop in the consumer price index (CPI) in the year to February, which was bang in line with a Reuters survey of 26 analysts, gives the central bank ample scope to cut interest rates further if need be to boost the economy. Goldman Sachs said now seemed a “natural point” to lower borrowing costs to ease the financial burden on firms, which are battling a slump in overseas demand and in domestic construction.
Commerce Minister Chen Deming and Industry Minister Li Yizhong, speaking at a joint news conference, both used the word “grim” to describe the immediate outlook for Chinese exports and the manufacturing sector. Li said he was encouraged that power consumption had declined at a slower pace in the first two months of the year.
But he added, “The situation of industrial production remained grim.” The year-on-year drop in the CPI, reported by the National Bureau of Statistics, was the first since December 2002. Economists worry that, unless China’s 4 trillion yuan ($585 billion) stimulus plan kicks in soon, these deflationary pressures will intensify because the economy is saddled with excess capacity at a time of depressed demand.
Consumers who expect more price declines in future may delay their purchases, weakening the economy and undermining corporate profits. “I think this is the first sign of deflation,” Qing Wang, China economist for Morgan Stanley in Hong Kong, said of the CPI drop. “We expect an additional policy response, mainly to prevent deflationary expectations from getting entrenched.”
On top of that, RBC Capital highlights the fact that house prices across 70 cities fell 1.2 per cent year-on-year – the biggest decline since the series began in 2005.
Adding to concerns is the fact that China entered 2009 with a trade surplus of some $46bn in the first two months of the year, according to official statistics. That compares to $29bn in January-February 2008. Standard Chartered say this development is both odd and worrying. As they explain:
It is odd because the collapse of global demand was meant to push China’s massive trade surplus down. And it is worrying because we need just the opposite to happen in order to achieve global rebalancing allay concerns about protectionist outbursts in the West
Interestingly StanChart attributes the ballooning of the surplus not to Chinese exports still flooding the market, rather to a fall in non-processing imports (those which are not fed into stuff that is exported, such as energy, raw materials, and machinery), driven by a nasty combination of a price shock and a demand collapse in Q4-2008.
As they explain:
So, the bigger surplus did not result from China’s exports, boosted by artificial policy support, flooding global markets. Rather, it was caused by a demand shock in China’s commodity-intensive industrial economy, combined with sudden price adjustments in those same commodities.
But it is processing trade that remains the key issue for the bank, because back in 1998-99 and 2001-02 when China faced a recessionary global economy its processing trade did not collapse, it simply stopped growing. This time the bank predicts things will likely be different. “The severity of the contraction is much greater, meaning a significant decline in processing trade is likely in 2009. We expect a 15 per cent drop in processing trade this year.” But here the effect on the trade surplus is likely be minimal.
Non-processing trade will be harder to call.
On the imports they say:
Some commodities, like soybeans, should see relatively stable demand growth in real terms. Some, like iron ore, will be heavily dependent upon the ultimate scale of China’s fiscal package. Others, such as copper and aluminium, do not seem to be big components of the fiscal package.
We expect a 25% year-on-year decline in non-processing imports in 2009 in nominal terms, or around 7% in real terms
And on the exports:
…non-processing manufacturers face the same contracting global economy as their processing peers. … We look for a 10% decline in non-processing exports in 2009.
All of which leaves Standard Chartered predicting a trade surplus of around $366bn and a current account surplus of $406bn, about 8.2 per cent of forecast 2009 GDP.
The slightly smaller current account surplus means among other things that China will ‘only’ add $300bn to its FX reserves in 2009, compared to our estimate of $420bn in 2008 — which means its appetite for US debt will be smaller and that private buyers will have to take up more of the slack to prevent the expanded supply from pushing up auction rates.
Related links:
China: ‘Can I super-size my stimulus?‘ – FT Alphaville
Economists warn of China deflation – FT