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In six short months, worries in financial markets about a reopening China adding fuel to global inflation have flipped to fears that the world’s second largest economy may tip into deflation. Producer prices in China are falling at their fastest rate since 2015, as consumer price growth veers close to sub-zero.
This week’s Chart Room zooms in on the risks stemming from cost deflation in China. Our monthly Analyst Survey, based on observations made by our analysts on the ground, has been projecting lowering labour costs for six consecutive months. Non-labour cost expectations have been trending down for three straight months. Both sets of expectations are now below 2020 levels, which reflects the scale of China’s challenge to restore business and consumer confidence. It also makes China an outlier in the world economy. Globally, labour costs are expected to rise mildly, while non-labour costs are forecast to stay flat, although expectations have moderated over the last few months.
At the heart of this discrepancy is China’s housing market. Up until late last year, China had been trying to keep a lid on the sector’s ballooning debt for some time, sending ripples across the real estate value chain. Alex Dong, a Shanghai-based analyst who covers construction companies, reported “meaningful cuts to salary and substantial layoffs” as housebuilding stalled.
The service sector is doing better. But with so much household wealth tied to housing, consumers are cautious in spending dry powder accumulated during the pandemic. Research associate Eric Zhu in Shanghai, who covers consumer discretionary companies, said “managements are trying to get their staff to be more efficient, but with similar salaries.”
Parts of the financial sector are also feeling the squeeze. “Uninspiring stock market performance is hurting trading and deal flow,” said Qijing Tan, a credit research associate covering the non-bank financial sector, who is also based in Shanghai. Declining asset quality due to a slowing economy would put pressure on leasing companies as well, Tan added. On top of that, regulators are driving down asset management fees. Though this last point has more to do with the sector’s structural reform, all three are headwinds that lead to cuts in headcounts, bonuses, and in some cases, even base salaries.
What happens in China won’t stay in China. “China, the largest exporter in the world, is exporting disinflation,” said Peiqian Liu, our Asia economist. “Much of this disinflation is in the goods sector, such as costs in raw material and intermediate goods, a lot of which China sells to the rest of the world.” Commodities could be one channel of such passthrough. “China is influential in setting the price for a number of commodities, both as a buyer and an exporter,” said James Richards, London-based senior industry analyst.
It’s not all doom and gloom. Policymakers, who displayed dovish signals last week in their policy priorities, still have time to turn things around, with further support measures to stabilise the property market still an option. And even if cost deflation continues, certain industries in China are likely to benefit by becoming more competitive. Among them, machinery makers. “We may even see Chinese companies win more market share from their global peers”, said Dong, who also covers this sector.