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China’s deflation threat: cause for concern or just a minor headache?

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As China grapples with a serious deflation threat, investors will be worrying what that could do to global markets. The relative health of China’s economy is an important driver of global growth, and since the country stepped away from its zero COVID policy, analysts have been hoping the country would return to form as an economic power house.

The Chinese government has been actively playing down fears about deflation, with officials from the People’s Bank of China and National Bureau of Statistics, among other agencies, repeatedly saying there is no basis for long-term price declines.

Talking about the threat publicly is also off the agenda for many China-based analysts and economists, according to media reports.

Nigel Green, CEO of deVere Group, said: “China’s economic trajectory has been a focal point of global attention for decades, with its staggering growth and transformation capturing the world’s imagination. But the recent emergence of serious deflationary pressures in the world’s second-largest economy is triggering concerns that extend well beyond its borders. This economic phenomenon has the potential to set off a chain reaction of global repercussions that could reshape financial markets, trade dynamics and even international relations.”

Deflation – a persistent decline in prices of goods and services – can be as detrimental as rampant inflation, “if not more so”, says the deVere CEO.

In China’s case, the underlying factors driving deflation are complex and interconnected; rooted in weak consumer demand, declining exports and a highly subdued – but critical – property sector.

Why investors need to worry about China

China is a critical trade partner for many nations. As its exports become cheaper due to deflation, other economies might face increased competition, forcing them to lower their own prices or risk losing market share.

Also, reduced demand for raw materials and commodities due to China’s economic slowdown is likely to lead to a decrease in global commodity prices. Those countries heavily reliant on commodity exports would then experience economic hardships as their revenues decline. We have seen this at play recently in the oil market.


The deflationary environment can put pressure on central banks to implement aggressive monetary policies, such as lowering interest rates or engaging in quantitative easing. This could distort global financial markets, affecting asset prices and investment strategies.

This scenario is “worsened by the lack of transparency” as some leading Chinese academics, analysts and economists are reportedly being censored by Beijing, which is fearful of creating a doom cycle with negative news.

Can China bounce back though?

Recent data signals that a gradual, consumer-led recovery is underway, and the two main, short-term obstacles to a return to pre-pandemic growth levels are likely to recede in the coming quarters.

First, most of the developed world moved on from COVID two years ago, while the last wave of COVID cases and deaths in China only ended in January, restraining household sentiment and spending. With each passing month, Chinese consumers should regain more confidence, supported by high savings and strong income growth.

Second, in July, the government took the pragmatic step of voicing enthusiastic support for the private sector, including platform companies, in an effort to restore entrepreneurs’ animal spirits, which have been weak for two years.

The resilience of Chinese consumers and entrepreneurs, as well as the pragmatism of the country’s policymakers, have often been underestimated, and that is likely the case again today.

The last several quarters have been rough, but Xi’s 10-year, economic track record as Party chief has been pretty good. Between 2012 and 2022, China recorded average annual real income growth of 6.2% (vs. 1.4% in the U.S. and 1% in the UK); average annual real retail sales growth of 6.7% (vs. 4.4% in the U.S. and 2.2% in the UK); and China accounted for 33% of global economic growth during that period (vs. an 11% contribution from the U.S. and 1% from the UK).

A return in confidence could be supported by continued accommodative monetary policy and high savings. Family bank balances have increased 63% from the start of 2020, as Chinese households were in savings mode during zero-COVID.

The net increase in household bank accounts is equal to US$7.1 trillion, which is greater than the GDP of Japan in 2022, and equal to 125% of China’s 2019 retail sales. This is significant fuel for a continuing consumer spending rebound, as well as a recovery in mainland equities, where domestic investors hold about 95% of the market.

“China’s debt problem is serious, but the risk of a hard landing or banking crisis is, in my view, low,” said Andy Rothman, an investment strategist at Matthews Asia. “In China, potential bad debts are corporate, not household, and were made at the direction of the state, by state-controlled banks to state-owned enterprises (SOEs). This provides the state with the ability to manage the timing and pace of recognition of nonperforming loans.”

Rothman thinks it is also important to note that the majority of potential hidden bad debts are held by state-owned firms, while the leverage of the privately owned companies that employ the majority of the workforce and account for the majority of economic growth isn’t high.

One of the government’s efforts to stimulate growth and mitigate the impact of those challenges has been the use of industrial policies to promote new sectors. Some of these policies have been successful, so it is likely that Beijing will continue down this path.

For example, industrial policies have resulted in China becoming the world’s largest producer, consumer and exporter of electric vehicles, and accounting for two-thirds of global EV battery production, as well as about 80% of global solar panel production. China is on track to surpass Japan as the world’s largest auto exporter in 2023, after edging out Germany last year.

Should non-China investors be concerned then?

The interconnected nature of the global economy means that China’s deflation doesn’t remain confined within its borders. As such, investors around the world should adopt strategies that “promote diversification, consider more defensive investments, and remain adaptable to changing economic conditions.

By staying informed and understanding the nuances of China’s deflation, investors can better position themselves to mitigate risks to their long-term wealth and capitalise on the significant opportunities that we expect to emerge amid the turmoil.

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This article does not constitute investment advice. Do your own research or consult a professional advisor.

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