China’s Stalled Stimulus: Deflation Threats Loom Large
Despite China’s bold and prompt response to the economic downturn caused by the COVID-19 pandemic, with a
stimulus package
worth over 6% of its GDP, recent data suggests that the economic recovery may be stalling.
Deflation risks
, once a distant memory for China, are rapidly reemerging. The producer price index (PPI) fell by 2.4% year-on-year in November, marking the
fifth consecutive month
of decline. Moreover, the consumer price index (CPI), which measures inflation at the consumer level, rose by only 0.5% year-on-year in November, the lowest increase since February 2016.
Slowing industrial production and
weak demand
are contributing to the deflationary pressures. Industrial output grew by 6.4% year-on-year in November, a significant slowdown from the previous month’s 6.9% growth.
Exports
China’s exports have been another major concern. In November, exports grew by 4.5% year-on-year, a sharp
decline
from the previous month’s 12.3% growth. The US-China trade tensions, which have been simmering for over a year now, are negatively impacting China’s export sector.
Imports
The situation with imports is even worse. In November, imports fell by 7.3% year-on-year, marking the sixth consecutive month of decline. The
weak domestic demand
, coupled with the ongoing trade tensions, are causing a significant drop in imports.
The government’s response
In an effort to boost the economy, the Chinese government has announced a
new round of stimulus measures
. These include increasing infrastructure spending, tax cuts for businesses, and reducing the reserve requirement ratio for banks. However, it remains to be seen whether these measures will be enough to counteract the deflationary pressures.
I. Introduction
The global economic downturn caused by the COVID-19 pandemic has brought unprecedented challenges to international trade and investment. With lockdowns and travel restrictions imposed worldwide, the flow of goods and services has been disrupted, leading to a sharp decline in economic activities. The impact on international trade has been particularly severe, with the World Trade Organization estimating a 13% to 32% contraction in global merchandise trade volume in 2020. The central banks‘ response to the crisis has been swift and coordinated, with monetary easing and fiscal stimulus packages being implemented to mitigate the economic fallout.
Focus on China as the world’s second-largest economy
Amidst this turbulent economic landscape, China, as the world’s second-largest economy, has emerged as a critical player. Given its significant role in global supply chains and its large domestic market, China’s economic recovery is crucial for the overall health of the global economy. In the early stages of the pandemic, China was able to quickly contain the virus and gradually resume economic activities, making it a beacon of hope in an otherwise bleak landscape.
Importance of China’s economic recovery for global economy
The importance of China’s economic recovery cannot be overstated. As a major exporter, China plays a critical role in global supply chains, and its recovery is expected to help restart the wheels of international trade. Moreover, as a large consumer market, China’s economic health is closely tied to that of other countries, particularly those in Europe and the Americas. A strong recovery in China could help boost demand for goods and services from these regions, leading to a ripple effect on their economies.
Central banks’ role in supporting China’s economic recovery
The central banks of China and other major economies have taken various measures to support China’s economic recovery. For instance, the People’s Bank of China (PBOC) has used monetary tools such as interest rate cuts and increased liquidity injections to stimulate lending and investment. Meanwhile, the Federal Reserve, European Central Bank, and other central banks have engaged in large-scale asset purchases and forward guidance to stabilize financial markets and provide liquidity to the global economy.
Challenges facing China’s economic recovery
Despite the positive signs, China’s economic recovery is not without challenges. The ongoing tensions with the United States and other major economies could pose a threat to its export-oriented economy. Moreover, the continued spread of the virus and the need for stringent containment measures could impact consumer confidence and disrupt supply chains. The Chinese government will need to navigate these challenges carefully to ensure a sustainable economic recovery and maintain its role as a key driver of the global economy.
Background: China’s Previous Successes in Stimulating Economic Growth
Response to the 2008 Global Financial Crisis
China’s economy, which had been growing at an average annual rate of around 10%, was not immune to the impacts of the 2008 Global Financial Crisis. However, the Chinese government took swift and decisive action to mitigate the effects of the crisis on its economy. One of the most notable responses was massive investment in infrastructure projects, totaling over $600 billion, aimed at boosting domestic demand and creating jobs. Another key measure was targeted lending to support Small and Medium-sized Enterprises (SMEs), which account for the majority of China’s businesses and employment.
Response to the 2015 Economic Slowdown
In late 2014 and early 2015, China’s economy began to slow down due to factors such as declining exports, overcapacity in certain industries, and a significant decrease in investment. The Chinese government responded with several measures aimed at boosting growth. One of the most notable responses was a RMB devaluation by around 3% against the US dollar in August 2015, which made Chinese exports more competitive and boosted exports. Another measure was monetary easing, including cuts in interest rates and reserve requirements for banks, which made it easier for businesses to borrow. Additionally, the government announced
tax cuts
for SMEs, which helped to reduce their production costs and improve their competitiveness.
I Current Challenges:
Stalled Stimulus in China’s Economic Recovery
Reasons for the stalling stimulus
- Fiscal constraints: Due to rising debt levels and financial risks, China’s fiscal system is facing significant pressures.
- Debt-to-GDP ratio reaching historic highs:
- China’s debt-to-GDP ratio has surpassed 30% for the first time, making it a cause of concern.
- Local government debts and SOEs: Local governments and State-Owned Enterprises (SOEs) are posing a substantial burden on the fiscal system.
Consequences of the stalled stimulus
The stalling stimulus in China is having far-reaching consequences on the economy:
- Slowing economic growth:
- Q1 2023 GDP growth rate was recorded at 4.8%, which is below the target of 5%.
- Downward pressure on inflation and wages:
- Falling producer prices: due to excess capacity in industries like steel and coal.
- Decreasing consumer demand: leading to deflation threats.
- Rising unemployment:
- Particularly among migrant workers and youth, this is a major concern.
IV. Policy Responses:: Chinese Authorities’ Current Efforts to Revive the Stimulus
Monetary policy
- Lowering interest rates to encourage borrowing and investment:
- a) Reducing the reserve requirement ratio for banks:
- b) Implementing targeted lending programs:
Fiscal policy
- Increasing infrastructure spending to stimulate economic activity:
- Investment in new energy, transportation, and technology sectors:
- Providing targeted support for SMEs and vulnerable populations:
Structural reforms
- Addressing excess capacity in industries by promoting consolidation and closing loss-making companies:
- Promoting consolidation:
- Closing loss-making companies:
- Implementing supply-side structural reforms to improve efficiency and competitiveness:
Reforms to boost private sector participation and innovation
- Encouraging entrepreneurship, particularly in the technology sector:
- Streamlining regulations and reducing bureaucracy to foster a business-friendly environment:
- Improving intellectual property protection to attract foreign investment and innovation:
This paragraph discusses the Chinese authorities’ current policy responses to revive their economy. Under monetary policy, efforts include lowering interest rates by reducing the reserve requirement ratio for banks and implementing targeted lending programs (1.) to encourage borrowing and investment. In terms of fiscal policy, there’s a focus on increasing infrastructure spending, particularly in new energy, transportation, and technology sectors (1.) as well as providing targeted support for SMEs and vulnerable populations (2). Structural reforms are also being implemented, such as addressing excess capacity through consolidation and closing loss-making companies (1) and implementing supply-side reforms to improve efficiency and competitiveness (2). Additionally, measures are being taken to boost private sector participation and innovation, including encouraging entrepreneurship in the technology sector (1) and streamlining regulations for a business-friendly environment (2). Intellectual property protection is also being improved to attract foreign investment and innovation (3).
Conclusion:: Navigating the Challenges of Deflation Threats in China’s Economic Recovery
Significance of Addressing Deflation Threats for China and the Global Economy
- Preventing a debt crisis due to rising debt levels: As deflation can lead to falling prices, income, and wages, it can also result in an increase in real borrowing costs. This could lead to a debt crisis, especially for countries with high levels of debt like China. Therefore, it is crucial to address deflation threats to prevent a potential financial stability risk.
- Maintaining Stability in the Global Economic Order: Deflation can also have ripple effects on the global economy, potentially disrupting trade flows and economic growth. Therefore, it is essential for China to address deflation threats not only for its own economic recovery but also for maintaining stability in the global economic order.
Need for Coordinated Efforts between Monetary, Fiscal, and Structural Policy Measures
- Ensuring a Sustainable Economic Recovery: Addressing deflation threats requires a combination of monetary, fiscal, and structural policy measures. Monetary policy can be used to stimulate demand through lower interest rates, while fiscal policy can provide short-term relief through government spending. Structural reforms can improve efficiency and competitiveness, contributing to long-term growth.
- Balancing Short-Term Stimulus with Long-Term Reforms: However, it is essential to balance short-term stimulus measures with long-term reforms. Overreliance on monetary and fiscal measures could lead to unsustainable debt levels, while failing to implement structural reforms could hinder long-term growth prospects.
Implications for International Cooperation and Multilateral Institutions in Supporting China’s Economic Recovery and Maintaining Global Economic Stability
Addressing deflation threats in China has implications for international cooperation and multilateral institutions. The global economy is interconnected, and the economic recovery of one country can affect others. Therefore, it is essential that international organizations, such as the International Monetary Fund (IMF) and the World Bank, provide support to China in implementing policy measures to address deflation threats. This could include technical assistance, financing, and policy advice to ensure that China’s recovery is sustainable and contributes to global economic stability.
