China’s Post-Pandemic Rebound: Still Heading towards Deflation?

8 min readMay 12, 2023
Source. Dokpri

After 3 years of pursuing extreme zero-covid policies, China has finally relaxed its onerous restrictions including strict lockdowns and stressful quarantine protocols. China’s economy, which has been on a rollercoaster ride since the start of the pandemic, is expected to experience a significant rebound due to the diminishing leisure and travel restrictions. According to China’s first quarter financial report, the world’s second largest economy grew at a rate of 4.5% compared with the same quarter a year earlier, surpassing the forecasted rise of 4%. Despite the growth, indicators show that deflationary pressure in China is worsening as consumer prices increased at the slowest pace in two years. Has China’s economy really fallen into deflation? Which monetary policies have been and should be deployed to battle these deflation risks? It turns out that the underlying issue behind it all has been going on for years.

A monetary ‘desperation’

As the world battles desperately to lower soaring prices that reduces living standards, China is faced with a contradicting predicament. China’s consumer price index (CPI), a main gauge of inflation, rose by just 0.7% year-on-year in March. Compared to January’s 1%, it reflects persistently weakening domestic demand. According to a report from China Beige Book International (CBBI), companies registered the smallest growth in wages and input costs in the final three months of 2022 since mid-2020. In addition, growth in sale prices also dropped to the weakest level since late 2020, as shown in graph 1. This situation shows a short term disinflation, which could turn into a deflation if the economy receives another critical blow.

Graph 1, Source: China Beige Book International, 2022

Monetary policy is an action that a country’s central bank or government can take to influence how much money is in the economy and how much it costs to borrow (Bank of England, 2023). The People’s Bank of China (PBOC) has been fighting this situation using monetary weapons in its arsenal by cutting interest rates and pumping cash into the financial system to support the economy. These efforts can be seen as the broad money supply as measured by M2 grew by a record-breaking $5.6 trillion, in the past 16 months. Additionally, the PBOC has been attempting to stimulate consumer spending by increasing banks’ liquidity through a variety of policy instruments, including open market operations and lowering reserve requirement ratios to 7.6%. Despite these policies, prices are still stagnating or falling as consumers hardly reacted to these adjustments due to economic uncertainties and echoes of China’s notorious housing crisis since 2021.

Although the GDP increased by 4.5% in the first quarter, ANZ Research chief economist Raymond Yeung stated that the growth was primarily due to consumers’ pent-up demand as a result of three years of pandemic restrictions. If that were taken out, GDP growth would have just been 2.6%, far below expectations. Even though China’s economy looks like it’s bouncing back towards former glory, consumers are hoarding cash at a record rate. Former central bank adviser Li Daokui has even urged Beijing to give consumers 500 billion yuan cash handouts to stoke demand. Although the government could possibly receive at least 300 billion yuan through taxes generated by the increase in spending, this extreme discourse highlights the monetary disparity currently faced by China.

Consumer behavior similar to US great depression post-crisis effects

According to government data, individuals in China took out the equivalent of $564 billion in new loans in 2022, a decrease of more than half from a year earlier and the lowest number since 2014. The big drop was largely due to a decline in home sales, which translated into lower demand for new mortgages. People accumulated cash, causing China’s new household deposits to reach a record high of more than $2.6 trillion in 2022, as shown in graph 2. Some homeowners utilized their extra money to prepay their mortgages instead of making large purchases due to the lack of appealing investment options — the nation’s stock market had another dismal year.

Any major shift in Chinese consumer behavior could have significant implications for the country’s banks and businesses. Although increased deposits give them a more affordable source of finance, decreased borrowing might harm banks’ net interest margins. Additionally, following a difficult few years, online merchants, automakers, and travel agencies are expecting a rise in consumption to help with recovery.

Graph 2, Source: People’s Bank Of China Note: 1 trillion yuan = $147.6 billion

As long as there are still economic uncertainties, major purchases like real estate will take longer to recover. According to Li-Gang Liu, head of economic analysis at Citi Global Wealth Investments, the pandemic’s aftermath may cause Chinese residents to change their saving behaviors in a manner similar to that of Americans who experienced the Great Depression. If consumption growth is less brisk than anticipated in the first and second quarters, this could lead to poorer GDP growth than planned, forcing economists to reevaluate their forecasts.

Chinese consumers have little confidence moving forward, in contrast to the American economy, which boomed throughout the pandemic. This is partially due to the fact that the Chinese government did not offer subsidies to its population, leaving many individuals without a support system. People might have understood the value of conserving more money as a result to protect their security.

A familiar foe: overcapacity

China’s long-standing overcapacity issues may be another factor contributing to the country’s deflationary pressure. The development of various factories and the growth of sectors like steel, coal, and cement are results of the nation’s recent rapid economic growth. However, as demand for these products has slowed down, businesses are left with surplus capacity and are compelled to lower prices in order to remain competitive. Deflationary pressure is produced as a result, which might hinder economic growth.

Borrowing the impossible trinity concept

The Impossible Trinity actually refers to one of the most well-known theories in the study of economics — specifically international economics and macroeconomics, according to which it is impossible for a nation to pursue all three options simultaneously: a fixed exchange rate, unrestricted capital flow, and independent monetary policy. During the peak implementation of the zero Covid policy in 2022, Chinese authorities faced an impossible trinity of their own. They cannot achieve “zero Covid”, a synchronized monetary policy with the US Feds to maintain financial stability and 5.5% growth target at the same time (BBVA, 2022).

BBVA’s research in 2022 shows that there are only two possible policy combinations given that the authorities were still committed to maintaining “zero COVID” policy: (i) if they want “Zero COVID” and a 5.5% growth target, they must implement aggressive monetary easing measures, which will cause capital flight and currency depreciation; or (ii) if they want “Zero COVID” and a synchronized monetary policy, they must accept a lower growth rate. In an easing policy environment, the central bank lowers rates to stimulate growth in the economy. Lower rates lead consumers to borrow more, also effectively increasing the money supply. Fast forward to today’s situation, China has implemented monetary easing throughout 2022 to boost economic activities, especially with the deflationary risks lurking behind them. They have also suppressed their 5.5% growth target into a more feasible growth, currently being 4.5%.

Now, with the pandemic measures lifted, China could remove one variable from the three-way trilemma previously deducted — which is the zero covid priority. However now, deflation and growth will be added to the mix. The renewed trilemma would be choosing between “giving up” monetary policy, “giving up” a fixed exchange rate, or restricting capital movement. Learning from Hong Kong’s property crisis and its deflationary economy during the 1998 Asian financial crisis, China should make durable and necessary structural adjustments within the real economy.

China’s answers: going forward?

While reports indicate that deflation might be coming to China, all of the speculations are based on the first-quarter economic reports, which does not necessarily translate into long-term deflation. Chinese senior economist, Jinyue Dong claimed that China is currently in the phase of an ‘atypical’ deflation cycle, which means deflation amid economic recovery. Some economic indicators reflected a solid economic recovery, such as the increasing manufacturing purchasing managers’ index (PMI).

All in all, like Chinese senior economist Yu Yongding stated, the statement ‘deflation has begun’ is not necessarily accurate, but it is not a big mistake. Calling attention to deflation is entirely correct. Thus, the efficient Chinese government is already on the move — they have held international meetings and vowed that they will increase their efforts to promote continuous improvement of the national economy, while prioritizing the recovery and expansion of consumption.

To combat this long-established issue, priority has to be given to boosting confidence and stabilizing expectations, while expanding investment, boosting consumption and ultimately stabilizing foreign trade. The Chinese government should also attempt to conduct supply-side reform initiatives, to reduce excess capacity and improve the efficiency of industries — which will reduce overcapacity. The Chinese government should still pay attention to the possibility of falling into deflation, even if it is slight. Like Keynesian said, “It is better to be roughly right than precisely wrong.”

Michael Abimanyu Kaeng | Undergraduate Economics Student at the University of Indonesia | Staff of Economic Studies Division at Kanopi FEB UI


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