Deflation of the Chinese Characteristics

China's February statistics are all out today. CPI rose to 1.4% from 0.8%, not adjusted for Lunar New Year's price effect. PPI negative growth deteriorated to (-)4.8%, indicating shrinking industrial activities for the 36th month. Growth in total volume of consumable retail, in added value of above-acale industries, in fixed assets and real estate investment all fell considerably and were around 1% lower than expected. 

Picture Source: Baidu
The official explanation for such malperformance as affected by the holiday do not hold. Traditionally, the pre-holiday season has been a period of shopping spree and housing market boom, as families exchange holiday gifts and brag with relatives about new apartment purchase. Thus even with the vacation factor, such significant decline has been rare historically. While the authority never admits that China has already dipped its forehead into the vicious deflation swamp, the PBoC has already lowered both the RR and the interest rate in February to offset the deflationary pressure. However, these monetary efforts didn't improve the situation until now, nor did they establish a clear supportive signal for the market. The 1980s reform and opening transformed China into a market economy of the Chinese characteristics as an adherence to the nation's founding theory. Since then economic policies have been a mixture of Keynesian theories and plans discussed on the annual State Congress. Many analysts compare today's China to Japan in the 1980s, yet there's one more to beware: China's deflation risk possesses unique traits that could hardly be observed in other economic entities. 

With the deeply-rooted tradition of seeking financial stability, deflation in China will cause much more severe consequences than on other economies. As a market economy built on five-year plans, which is hard to not ignore each and every aspect of the economy, industries struggle harder to recover from the business cycle mechanism and obsolete business funded by state capital may grow to big to fail. Household consumption would also fall sharply during deflation and over-thriftiness will dominate again, both due to shrinking returns on property investment (over 70% of Chinese household wealth) and precautionary worries on rising medical and welfare expenses. Asset prices would be tangled into a downward swirl driven by pessimistic expectations and, because China's social insurance funds were largely invested into the stock market, aging problems would intensify and arouse social upheaval. More importantly, no structural reforms could continue delivering positive support for growth under deflation, let alone business innovation and emerging entrepreneurship. 

Preempting deflation in China's situation requires not only monetary easing or targeting on inflation. Also a strong and clear policy attitude should be expressed. Although allowing a slower growth rate benefits the economy from a structural perspective, public policy should not beat off the bushes and only keep "calm" faced with downward pressure. As the former chief economist of the World Bank Justin Lin Yifu puts it, China still has the potential of annual growth rate at 8% for the next two decades based on his model. Given China's rather low GDP per capita and capital resources per person, this is a necessary rate to ensure the general welfare improvement of the Chinese as well as China's evolution to a developed economy. According to Mr.Lin, fiscal investment on infrastructure should remain the foremost engine for growth and help facilitate reforms in areas such as the financial market. It is noteworthy that many rural areas in China remain underdeveloped and many agricultural facilities are obsolete, both of which yearns for fiscal support. China's economic growth still abounds with more opportunities than challenges. However, lack of policy attention on these under-exploited potentials will hurt more than deflation.

This entry was posted on Thursday, 12 March 2015 and is filed under ,,,,. You can follow any responses to this entry through the RSS 2.0. You can leave a response.

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