China Cuts Key Rate Amid Worst Deflation Since '99

The lesson from Japan, of course, is that beating deflation requires bold and timely rate actions. But the PBOC is also worried about the second half of its 2024 balancing act: letting the yuan weaken significantly.

There are several reasons why Xi's party wants to avoid a weaker yuan. One is that it might make it harder for distressed property developers to make payments on offshore debt. Another China Evergrande Group -level default is the last thing Beijing wants or needs.

Two, Xi worries a weaker exchange rate would squander years of progress in internationalizing the yuan. Since 2016, when the yuan was added to the International Monetary Fund's“special
drawing
rights” basket joining the dollar, yen, euro and pound, its use in trade and finance has soared.

In 2023, the yuan topped the yen as the currency with the fourth-largest share in international payments, according to financial messaging service
SWIFT.
It also overtook the dollar as China's most used cross-border monetary unit, marking a first. Any sense Xi is devaluing the yuan could slam rising trust in the currency.

Third, Xi hardly wants to make China an even bigger election issue in the US. Just about the only thing both Democrats and Republicans agree on is the need to be tougher on China. So why provoke Washington with a falling exchange rate?

Trump's choice of Senator JD Vance as running mate ensures the strong dollar is going to be a major focus in the months ahead of November 5. The same goes for Trump's promised tariffs north of 60% on all mainland goods, levies that could grow in size if Republicans think Beijing is gaming exchange rates.

All these considerations explain why the PBOC's action Monday“was very modest and suggests further policy stimulus will remain incremental,” says Shane Oliver, an economist at financial services firm AMP.

Yet the deflationary pressures bearing down on Xi's $17 trillion economy are real and potentially intensifying.

“China's whole economy is in a state of excess supply as it continues to deal with the moribund housing market and associated debt overhang,” says Andrew Hencic, a senior economist at TD Economics

Domestically,“economy-wide prices continue to sink,” Hencic noted.“For global goods markets, China's sinking make industrial - and manufacturing -capacity utilization is a convenient illustrator of the accumulating slack in the sector.”

History, Hencic says,“has taught us that restoring price growth by rebalancing supply and demand after a financial shock – with large balance sheet effects for businesses and households – takes a notoriously long time. This could mean that China's factories and builders face a prolonged period of low pricing power, with meaningful implications for consumers worldwide.”

Economist
Alicia
Garcia-Herrero at Natixis notes that“increasingly serious problems have been piling up for China during the last few years, including the demise of the real estate market, the difficult financial situation of local governments, rapidly declining returns on assets because of over-investment and the deflationary pressures in the economy.”

Garcia-Herrero adds that“the response to all these woes, as aired by China's leadership during the past few months, will be the further strengthening of China's manufacturing capacity under the mantra of 'new productive forces.'”

“Chinese manufacturing capacity is already nearly a third of global capacity, while its consumption is less than half that amount. Given such a huge imbalance, one might expect that measures to foster private consumption would be the main takeaways from the third plenum, but this does not seem to be the direction China's leadership is taking,” Garcia-Herrero said.

Sign up for one of our free newsletters

• The Daily Report Start your day right with Asia Times' top stories
• AT Weekly Report A weekly roundup of Asia Times' most-read stories

For now, many economists worry that Xi's efforts to boost consumption aren't gaining traction. These include policy inducements to prod households to save less and spend more.

“The year-on-year decrease in excess savings growth has not yet translated into increased consumption,” says Tommy Xie, head of Greater China research at OCBC Bank.“This may be related to households deleveraging by repaying loans early and shifting deposits to wealth management products.”

Analysts at Maybank add that“instead of quick-fix stimulus, policymakers would need to address the root causes of consumers' risk-averse behavior and encourage them to spend their incomes. This calls for structural solutions to resolve fundamental issues such as the protracted property downturn, fragile employment market, patchy social safety nets and elevated debt burdens.”

All this has economists trying to gauge global spillover effects.“While the overall impact remains relatively modest,” write economists at Morgan Stanley,“it provides central banks like the Federal Reserve and the European Central Bank with additional leeway to consider monetary easing measures throughout the year.”

Yet the PBOC is more focused on events inside China than global currents. Looking forward, many economists expect a series of coordinated monetary and fiscal maneuvers in Beijing to hasten economic demand and prices.

“To counteract weak domestic demand, we believe more policy easing is necessary through the remainder of this year, especially on the fiscal and housing fronts,” says Goldman Sachs economist Lisheng Wang.

Follow William Pesek on X at @WilliamPesek

Already have an account? Sign i Sign up here to comment on Asia Times stories OR

Thank you for registering!

An account was already registered with this email. Please check your inbox for an authentication link.