China slips into deflation as post-Covid recovery falters

China slipped into deflation for the first time in more than two years in July, official data showed Wednesday, as slowing domestic spending weighs on the post-Covid economic recovery.

The reading comes a day after news that the country suffered its biggest fall in exports since the early days of the pandemic, while imports tanked again as domestic and global demand fall away.

The Consumer Price Index, the main gauge of inflation, fell 0.3 in July, the National Bureau of Statistics said, having flatlined in June.

While it was marginally better than the 0.4 percent decline forecast in a survey by Bloomberg, it marked the first drop since the beginning of 2021 and will add to pressure on authorities to provide much-needed support to the economy.

Deflation refers to falling prices of goods and services and is caused by a number of factors, including waning consumption.

And while cheaper goods may appear beneficial for purchasing power, falling prices pose a threat to the broader economy as consumers tend to postpone purchases in the hopes of further reductions.

A lack of demand then forces companies to reduce production, freeze hiring or lay off workers, and agree to new discounts to sell off their stocks -- dampening profitability even as costs remain the same.

China experienced a short period of deflation at the end of 2020 and early 2021, due largely to a collapse in the price of pork, the most widely consumed meat in the country.

Prior to that, the last deflationary period was in 2009.

Many analysts fear a longer stretch of deflation this time around, as China's main growth engines stall and youth unemployment is at a record high of more than 20 percent.

Ongoing turmoil in real estate, a sector that has long accounted for a quarter of China's economy, is the "main source" for this "deflationary shock", said economist Andrew Batson of Gavekal Dragonomics.

Deflation is also being driven by flagging exports -- historically a key source of growth for China, he added.

Tuesday's worst-than-expected drop in exports had a direct impact on tens of thousands of export-oriented companies in China, which are now operating at a much slower pace.

"The latest Chinese inflationary data did little to inspire confidence that an economic turnaround is forthcoming," Tim Waterer, chief market analyst at KCM Trade, said in a note.

"The inflation data... was further evidence that China remains a cause for concern from a global growth perspective," he added.

Meanwhile, the producer price index fell 4.4 percent in July -- slightly better than June's 5.4 percent fall but marking the 10th consecutive month of contraction.

The index measures the cost of goods leaving factories and gives an overview of the health of the economy.

Declining producer prices mean reduced margins for companies.

The grim data suggests that China may struggle to achieve a five percent growth target set for the year.

The world's second largest economy only grew 0.8 percent between the first and second quarters of 2023, according to official figures.

And many economists are now calling for a vast recovery plan to boost activity.

But for the time being, the authorities are sticking to targeted measures and declarations of support for the private sector -- with little in the way of tangible steps.

Still, Wednesday's poor numbers may "put pressure" on the government to reconsider, economist Zhiwei Zhang of Pinpoint Asset Management suggests. (AFP)