The global economy is grappling with inflationary pressures, with many countries struggling to control rising prices. However, China finds itself facing the opposite challenge: deflation.
While lower prices may seem like a boon for consumers, deflation is often a sign of weak demand, economic stagnation, and financial distress. China’s ongoing deflationary spell is affecting households, businesses, and policymakers, presenting a formidable challenge for the ruling Communist Party.
The Impact of Deflation on Chinese Households
Deflation manifests in the everyday struggles of Chinese citizens like Zhou Fujin, who invested in a Beijing apartment near a good high school in 2020. Zhou expected rental income to cover most of his mortgage, but declining property values and falling rental rates have severely strained his finances.
His apartment, once valued at 2 million yuan, is now worth only 1.4 million yuan, while rental income has dropped from 2,300 yuan to 1,700 yuan per month. Meanwhile, his mortgage payments remain fixed at over 3,000 yuan, leaving him with a significant financial gap.
Zhou’s experience is not unique. Many Chinese homeowners have seen their property values shrink, leaving them reluctant to spend money on anything beyond essentials. This reluctance is compounded by the broader economic slowdown, which has led to job losses and declining business revenues.
In the past, property booms gave homeowners a sense of wealth and security, encouraging consumer spending. But with an estimated $18 trillion in household wealth wiped out due to the property crisis, families are cutting back on discretionary spending and prioritizing savings over consumption.
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For business owners, the deflationary environment has been devastating. Lu Wanyong, who runs a picture framing workshop in Beijing, has seen a dramatic drop in foot traffic.
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Before the pandemic, he had over a dozen customers daily, but now he gets only one or two. Many of his customers opt to repair old frames rather than buy new ones. With dwindling sales and mounting rent expenses, Lu fears he may soon be unable to keep his shop open.
The Economic Forces Driving Deflation
China’s deflation is rooted in structural economic challenges, including excess industrial production and a faltering real estate market. The country’s factories continue to churn out goods in massive quantities, but domestic demand has failed to keep up. As a result, businesses struggle to sell products at profitable prices, further reducing wages and discouraging investment.
The housing market crisis is another major factor. The government’s crackdown on excessive borrowing by real estate developers has led to financial turmoil in the property sector, causing defaults and a sharp drop in property values.
Homeownership has traditionally been a major source of wealth for Chinese citizens, and the steep decline in real estate prices has undermined consumer confidence.
Another significant issue is falling consumer demand. Many households, uncertain about their financial future, are choosing to save rather than spend.
This creates a vicious cycle: lower consumption reduces corporate revenues, leading to job cuts and wage stagnation, which in turn further dampens consumer spending. Economists warn that this cycle could spiral into a long-term economic slump if left unaddressed.
While other major economies grapple with rising inflation, China’s deflationary trend has persisted. Prices fell throughout 2023 and 2024, marking the country’s longest period of deflation since the 1960s. The GDP deflator—a broad measure of price changes—dropped to -0.8% in late 2024, signaling that deflationary pressures are intensifying.
The Communist Party’s Response and Policy Dilemma
China’s leadership is acutely aware of the deflation problem but has been cautious in its response. Policymakers have taken steps to counteract deflation, such as cutting interest rates and reducing mortgage down-payment requirements.
The government has also launched initiatives to encourage local governments to buy unsold apartments for conversion into affordable housing. However, these measures have had limited impact, as consumer confidence remains weak.
One of the key challenges for the Communist Party is the public perception of deflation. Unlike inflation, which visibly erodes purchasing power, deflation can be less immediately noticeable but equally damaging.
The government has avoided using the term ‘deflation’ in official statements, fearing that openly acknowledging the issue could further weaken consumer confidence.
Some economists argue that China needs to implement deeper structural reforms to address the root causes of deflation. Michael Pettis, a finance professor at Peking University, contends that economic rebalancing is necessary, with a shift away from excessive investment in real estate and infrastructure toward strengthening consumer purchasing power.
This would require redirecting wealth from state-controlled sectors to households, a politically sensitive move that China’s leadership has been reluctant to make.
Other experts, such as Louis Kuijs from S&P Global Ratings, suggest that long-term solutions must include reforms in healthcare, pensions, and education. Improving social security systems could make people feel more financially secure, encouraging them to spend rather than save excessively.
In the short term, policies aimed at increasing household incomes—such as tax cuts, wage subsidies, or direct stimulus payments—could help boost demand and mitigate deflationary pressures.
Meanwhile, global economic factors add another layer of complexity to China’s deflation woes. The recent imposition of new tariffs on Chinese exports by U.S. President Donald Trump is expected to further weigh on economic growth.
A severe scenario, in which Chinese exports to the U.S. are cut by half, could reduce China’s GDP growth by up to 1.1 percentage points, according to Maybank Investment Banking Group. With external demand weakening, China’s ability to stimulate domestic consumption becomes even more crucial.
China’s battle with deflation presents a unique economic challenge at a time when much of the world is struggling with inflation. While lower prices might seem beneficial on the surface, prolonged deflation can lead to declining business revenues, job losses, and weakened consumer confidence.
The housing market downturn and excess industrial production have exacerbated the situation, leading to a cycle of reduced spending and economic stagnation.
The Chinese government has taken some steps to address deflation, including interest rate cuts and housing market interventions. However, long-term solutions will likely require significant structural reforms, including strengthening social security systems and increasing household incomes.
With deflationary pressures continuing to mount, Beijing must navigate a complex economic landscape to restore confidence and reinvigorate growth. The outcome of this battle will not only shape China’s future but also have far-reaching implications for the global economy.
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