China’s consumer sector has entered a period of deflation, coupled with ongoing declines in factory-gate prices throughout July. 

The world’s second-largest economy is struggling to rejuvenate demand, intensifying pressure on Beijing to introduce more direct policy stimuli. 

This trend raises concerns that China might be moving toward slower economic growth, reminiscent of Japan’s ‘lost decades,’ during which consumer prices and wages remained stagnant for a generation.

China’s post-pandemic recovery, initially promising in the first quarter, has since waned due to domestically and internationally weakening demand. 

Despite policies aimed at bolstering the economy, these efforts have failed to uplift economic activity.

The National Bureau of Statistics (NBS) reported a 0.3% year-on-year drop in the consumer price index (CPI) for July. This decline contradicted the median prediction of a 0.4% decrease, according to a Reuters poll. This marked the first reduction since February 2021. 

Meanwhile, the producer price index (PPI) continued its downward trajectory for the tenth consecutive month, falling by 4.4%, surpassing the forecasted 4.1% decline.

China is the inaugural G20 economy to witness a year-on-year contraction in consumer prices since Japan’s last negative headline CPI reading in August 2021. 

The repercussions of this weakness extend to concerns over business impacts on major trading partners.

Gary Ng, the Asia Pacific senior economist at Natixis, highlighted the growing divergence between manufacturing and services in China’s economy. 

This divergence implies that the economy will experience dual growth rates in the latter half of 2023, especially with the resurgence of real estate issues. 

Ng indicated that China’s slower-than-anticipated economic rebound could not effectively counteract weakened global demand and the resultant dip in commodity prices.

China’s economic decline is evidenced by trade figures indicating a drop in both exports and imports in July. Additionally, reports of increased debt troubles in China’s property sector have further escalated worries among consumers and businesses. Consequently, these entities have opted to hoard cash instead of spending or investing, despite the lower interest rates.

Contrary to the inflationary trends observed in most major economies, China’s economy is grappling with anemic prices, prompting concerns over deflation. However, signs indicate that global inflation could be reaching its peak and, in some cases, even reversing.

In response to these challenges, Chinese authorities set a consumer inflation target of approximately 3 percent for the year, a modest increase from the 2 percent recorded in 2022. Authorities have downplayed deflation concerns for now.

While some analysts anticipate a period of deflation lasting 6 to 12 months, comparisons to Japan’s prolonged history of price stagnation are deemed premature.

Measures to boost car and appliance sales and the relaxation of property restrictions in some cities have been introduced recently. Nevertheless, market participants argue that more decisive stimulus measures are imperative.

Amid these circumstances, investors anxiously await concrete actions following a significant Politburo meeting. 

The stock market’s underwhelming response to the lack of substantial action suggests that the Chinese government might favor targeted and supply-side-focused stimulus measures over widespread interventions.