China is entering a precarious economic phase as inflationary pressures loom, prompting its former central bank governor to sound the alarm on deflation. Yi Gang, who served as the head of the People’s Bank of China (PBoC) until July 2023, recently taken the stage at the Bund Summit held in Shanghai to discuss current economic challenges facing China, particularly the urgent need to combat deflationary pressures.
Yi’s statement marked one of the clearest signals from top officials acknowledging the serious threat posed by falling prices. He stated, “I think right now they should focus on fighting deflationary pressure.” This recognition is particularly significant as deflation can undermine economic growth—leading consumers to delay purchases, prompting businesses to cut wages, and creating a self-reinforcing downward spiral.
At the summit, Yi emphasized the necessity of turning China’s gross domestic product (GDP) deflator positive within the next several quarters. Unfortunately, this deflator has been negative for several periods—a worrying trend reflecting weak economic conditions. Yi pointed out, “Overall we have the problem of weak domestic demand, especially on the consumption and investment side, so there needs to be proactive fiscal policy and accommodative monetary policy.”
This call for action contrasts sharply with Yi's previous stance when he downplayed deflation risks, focusing instead on the time lag expected between supply recovery and enhanced consumer demand post-pandemic.
Currently, China's economic recovery remains sluggish. According to officials, the country's consumer price index (CPI) is forecasted to show only modest growth. Economists predict the CPI will rise from 0.5% year-on-year growth recorded in July to about 0.7% in August. Yet, this still indicates minimal inflationary pressures, leaving Yi's concern over the economy underscored.
Yi’s insights align with the views expressed by other former central bank officials, such as Haruhiko Kuroda, the ex-Governor of the Bank of Japan. Kuroda highlighted Japan’s long battle with deflation, emphasizing the need for central banks to prevent prolonged deflation, even if mild. He warned, “That could affect wage determination,” underscoring the latent, insidious effects of sinking consumer expectations.
The challenges placed before China are considerable. Yi noted the importance of stimulating domestic demand, especially amid persistent issues within the housing market and local government debt. Building consumer confidence and invigorative fiscal strategies were deemed necessary to alleviate these pressures.
Analyzing the situation, Jeffrey J. Schott, senior fellow at the Peterson Institute for International Economics, remarked on the central role domestic demand plays. Schott remarked, “The challenge for Chinese policymakers is to manage the housing crisis and to guarantee there is enough domestic demand to sustain high economic growth.” Without invigorated domestic demand, the potential for economic stability remains jeopardized.
Reflecting on the broader economic milieu, consumption has stagnated significantly since the pandemic, particularly within China's metropolitan centers. Recent data revealed retail sales have dropped by 3.8% and 6.1% respectively for major cities like Beijing and Shanghai when comparing to last year.
These statistical indicators have stirred considerable concern among citizens. The declining sentiments surrounding consumer spending are contributed to by uncertainty related to future income and the substantial impact of the real estate sector downturn on wealth. Such sentiments delay consumer purchases, influencing overall domestic demand.
Adding to this grim picture, Yi stated optimism for the upcoming months, stating he expects the CPI to trend above zero by year’s end. Meanwhile, the producer price index (PPI), which had been wallowing for 22 consecutive months of declines, may also recover, moving toward zero, though it remains firmly entrenched within negative territory.
Despite the rather bleak outlook, suggestions from Yi and Kuroda propose constructive paths forward. Yi indicated the need for enhanced monetary and fiscal strategies, such as lowering the reserve requirement ratios for banks—essentially dictuating how much capital they must retain for daily operations. These adjustments are strategic as they can improve liquidity within the financial system, allowing banks to lend more freely, which might stimulate growth.
This call for fiscal intervention holds weight, especially as China saw recent government policies aimed at bolstering consumption through trade-in incentives. Nevertheless, localized measures to lift the sluggish real estate markets have yet to yield significantly improved sales or investment.
To summarize, Yi Gang’s remarks at the Bund Summit highlighted the urgent need for China to combat deflation and stimulate economic growth through strategic fiscal and monetary measures. With the current trends indicating persistent deflationary pressure, both Yi and other economic leaders like Kuroda have laid out the frameworks necessary to navigate these troubled waters, advocating for proactive rather than reactive measures.
Indeed, as Japan’s experiences showed, prolonging deflation could create significant hurdles for wage growth and economic recovery. A shift toward addressing these challenges effectively could mark the difference between enduring stagnation and fostering renewed economic vigor.
