Will deflationary pressures stretch beyond China?

Capital Economics’ Neil Shearing and PIMCO’s Carol Liao argue whether or not China’s slowdown will have a negative global impact

China economic downturn with stock exchange market showing stock chart down and in red negative territory


There are “several reasons” why deflationary pressures in China could spill over into developed markets, according to PIMCO’s Carol Liao, who warned that China continues to dominate global trade and industrial cycles.

However, Capital Economics’ group chief economist Neil Shearing believes it would take a “full-on Chinese hard landing” to sufficiently degrade the global outlook, which he believes is unlikely.

According to China’s latest inflation figures, headline CPI fell 0.3% during July – in part caused by lower energy prices. Core inflation has also been falling within ‘shelter’-related categories, according to Liao, with household furnishing, equipment and property maintenance all sliding in price growth.

See also: Antipodes Partners: How troubled China is changing tact to take trade market share

This has been sparked by yet more complications for the country’s real estate sector, with property developer giant Country Garden on the brink of default and Evergrande having filed for bankruptcy protection in the US.

China is therefore facing a property-induced debt crisis – given these companies are likely insolvent – with the country’s Hang Seng Index having recently fallen into bear market territory.

Real estate represents a large proportion of China’s economy and there are therefore concerns that a Lehman-style collapse could be on the cards and create further deflationary pressure on China, in addition to increasing deglobalisation and a subsequent fall in exports, a weakening yen and a lack of large-scale fiscal stimulus from the People’s Bank of China.

But despite more and more economies moving away from importing goods from China, Liao does not think deflationary pressures are “only for China”.

“While disruptions and changes to post-pandemic economies have raised questions about the extent to which the Chinese economy still dominates global trade and industrial cycles, we see several reasons to expect spillovers to intensify in developed markets,” she said.

Made in China

Firstly, the China economist argued that Chinese-manufactured products still dominate the consumer goods sector – in particular in the US.

“US core goods consumer price inflation appears to be following the typical lag between the recent declines in the exchange-rate adjusted purchasing price index (PPI) of China’s consumer goods,” Liao pointed out. “According to US Census Bureau data as of June, prices of goods imported from China are down 3% on average versus last year, while producer prices of consumer goods in China are down 5% in dollar terms.

See also: Is China a ‘dead weight’ in emerging market equity funds?

“Importantly, these declines are being passed on to US consumers; July marked the first time since the early days of the pandemic that US consumer retail goods prices declined on a three-month annualised basis.”

She added that, given other developed countries’ inflationary trends have been correlated to the US since the Covid pandemic, slowing growth in US prices is “likely to eventually show up in the inflation metrics of other developed markets”.

Sale of goods overseas

While exports from China are falling and are expected to continue to do so over the short term, Laio said Chinese policymakers could try to boost the country’s growth by encouraging more sales overseas, in a bid to resolve domestic oversupply issues.

“This already appears to be happening in Germany, as Chinese exports of lower-cost electric vehicles have recently surged, while domestic price cuts may spill over into other countries,” she said.

However, Capital Economics’ Shearing said that while China is “clearly a hugely important part” of the world economy, its influence on the global cycle is “often overstated”.

“The relationship between growth in China and growth in the rest of the world is not particularly strong,” he argued in a note published on the Capital Economics website on Monday (21 August). “Also, despite China’s size, it has not been a source of significant net demand for other economies.

“Admittedly, when measured as a share of global GDP, China’s current account surplus has fallen back from the highs seen in 2021. But the fact that it remains positive means that China is still a net drain on demand at a global level.”

Market versus economy

Shearing added that, over the years, economic uncertainty in China has led to market dips on a global basis. However, he argued this is sentiment-driven, given investors perceive the country to be a significant source of global demand, in addition to the fact it accounts for a large proportion of revenues from the likes of Apple and Tesla – which make up a disproportionately large part of the US stock market.

See also: India poised to replace China as core emerging market allocation

“It is possible that weakness in China could have little bearing on other major economies, but still cause significant dislocation in financial markets,” Shearing said.

Headwind to commodity producers

The level of risk that a structural slowdown in China presents to developed markets is also “misunderstood”, according to Shearing, who explained: “While this will arithmetically pull down global GDP growth over the next couple of decades, and will be a headwind to emerging market commodity producers such as Brazil, Chile and Zambia, we do not think it will have a significant bearing on the long-term growth outlook for the US or Europe.”

He added that a move towards deglobalisation and rivalry between the US and China will likely have a greater negative effect on multinational corporations headquartered in developed markets, than it will on the GDP growth in the actual economies.

“While vulnerabilities in China’s economy are mounting, [a negative global impact] isn’t our base case,” Shearing said. “Instead, the effects of a slowing China are a greater problem for those global firms and commodities producers that do business with it.

“Worries about China’s impact on the global economy are continuing to dog markets, showing how little has been learned over the years.”

However, Liao said global deflationary factors still remain in place such as a decline in commodity prices – a factor which China is “an important determinate of”.

“Deteriorating Chinese economic fundamentals have produced deflationary pressures that are already moderating inflation both in China and in the global markets served by Chinese goods,” she argued. “Given the usual lags, deflationary spillovers have likely only just begun to impact global consumer markets, with discounting likely to accelerate over the coming quarters.”

Latest Stories