China’s Deflationary Trap and Its Sectoral Impacts on India

China’s Deflationary Trap and Its Sectoral Impacts on India

Ira Singh
21 Oct’23

In recent years, China has found itself ensnared in a deflationary trap, with far-reaching implications for the global economy. This economic conundrum in the world’s second- largest economy is not only affecting China but is also having significant sectoral impacts on countries like India.

Direct impact of China’s slowdown on India should be relatively limited. Although China is India’s fourth-largest export partner and leading source of imports, the share of India’s exports to China is only 3.5% of its total exports in the past year, significantly less than India’s exports to the US, EU or UAE.

This article delves into China’s deflationary woes and how they are reverberating across various sectors in India.

Writing about China’s ills will certainly invite yawns from most of the quarters as the social and mainstream media have been swarmed by countless articles in the recent past on its economic troubles. Some of these have termed China’s challenges as Japanification of China while others like Noahopinion column had taken a deep dive into the dragon’s ills to provide insights on how China’s economy has run off the rails. The magazine Economist had stopped short of saying that it will never regain its glory days. Given these innumerable views flooding the media, it will be extremely challenging for anyone to add anything new to the perspectives that have already been provided by those posts. So, what we intend to write here is not about the China’s economic woes, but about the implications for certain Indian sectors that may be useful from an investment perspective for readers.

Understanding China is not easy,say experts. It hardly reveals anything. Notwithstanding its general opaqueness, one thing it doesn’t want to hide is its secret wish for inflation. While the rest of the world is busy in battling to tame inflation, China is busy worrying about falling prices. While falling prices are good, it is only up to a point. If people start expecting prices to fall precipitously, then they start holding back buying which in turn leads to further fall in prices and so on. Eventually what we get is a vicious fall in demand.

When an economy gets caught into such a downward spiral, it is not easy to get out of this muddle of deflationary trap. Japan will know it better. It is three decades since Japanese economy got into this deflationary entanglement.They are yet to find a way out. If right policy tools are not used, China may be staring at a similar fate. Policy response from the central regime so far is not very encouraging. To know what triggered this spiral in China, as mentioned in the beginning, there are innumerable columns which readers can tap from social to mainstream media. We will skip that and straight dive into the devious impacts that the deflationary China can have on certain sectors.

As the domestic demand collapses in China from the impact of deflation, where will the Chinese companies find refuge? Of course, it will be in export markets. But export markets are not what they used to be before the pandemic. Supply chain de-risking and China+1 are no longer a back-room discussion as it used to be pre-covid. It is now a mainstream mandate for global management. In such a scenario, if global corporates have to sidestep China+1 policy, the offer has to be very compelling. This is precisely where Chinese aggression on exports pricing will come into play, according to economic experts.

If there is any one trend that Indian companies are worried on Chinese slowdown, it is this ultra-aggressive pricing from China in export markets. Sectors that are more capacity-driven with little to differentiate in terms of value proposition will be the ones that are most vulnerable in this Chinese price aggression. Of course, what comes to the top of the mind are commodities and metals. The fear is it may not stop there. As witnessed in some of the specialty chemicals and agrochemicals over last few months, the deflationary pressure from China might seep into even the extended value-added commodities like aroma and crop protection chemicals. India being import intensive economy, falling commodity prices in one sense are good as it will aid consumption.However, it will hurt the commodity producers and exporters.

Further, as per the research firm Continuum Economics, China has as much as a 30% chance of experiencing a “hard landing” this year despite the nation’s efforts at stimulating the economy using fiscal and monetary policy. It goes on to add that, the pessimism comes as recent data showed the economic outlook worsening with bank loans plunging to a 14-year low last month, while deflation is setting in amid contracting exports. In another sign of global investors losing confidence on China’s ability to shore up its economy, the yuan traded internationally is seen further falling by 4% to 7.6 to a dollar by year end from its already weak level of 7.29 now – currency has already tumbled by over 5%+ from beginning of the year.

For now, it is a wait and watch for investors. To quote WSJ, “Ideology is driving China’s economic policy now to a degree not seen since the country’s opening to the West nearly half a century ago, deterring its leaders from taking the right steps to spur the sputtering economy”.