China has long been a major economic force in the world. It draws companies from all over the globe who want to take advantage of its enormous consumer market and developing industries. Despite its apparent economic strength, China is currently dealing with a serious problem: deflation.
Deflation is a persistent decrease in the general price level of goods and services. And it can have far-reaching consequences for a nation’s and the global economy.
As locals know that prices will fall even more, they will hoard cash and reduce their spending to take advantage of the lower prices later on. This causes current demand to decrease and companies’ revenue as well. Over time, this forces some companies to drop prices to attract consumers. With declining revenue, job security is affected, contributing to lower consumption. This cycle repeats and may cause an economic recession or depression.
China only exited its strict zero-COVID measures in December 2022. At this time, the global economy had already recovered and found alternatives to China’s supply of goods. One factor that enabled China’s export-driven growth is cheap labour. The local population does not have the necessary purchasing power and spends less, reducing local demand.
Provincial and local governments have been leveraging debt for years to meet GDP growth targets set by the central government. The property bubble has burst with the likes of Evergrande and Country Garden. Youth unemployment rates have been skyrocketing, at 21.3% as of June 2023.
With these factors and more, China’s population doesn’t feel confident. What makes it even worse is that most of their wealth is locked up in property.
Domestic demand has since faltered and left China with idle capacity, while deleveraging in the property and local government financing sectors has deepened disinflationary pressures and hit domestic investment, leading to broad-based excess capacity in manufacturing. The government’s reaction to these weakening fundamentals has been far from sufficient.
Tiffany Wilding and Carol Liao, PIMCO economists
According to economists, China’s consumer spending is taking more time to recover after its strict zero-COVID measures. There is probably a structural issue with China’s economy due to its reliance on government-led investment to the detriment of private consumer spending.
China is entering balance-sheet recession like Japan did.
Richard Koo, chief economist at the Nomura Research Institute
This deflation crisis presents both challenges and opportunities for businesses seeking to expand into this dynamic market.
Businesses that are heavily reliant on consumer spending, such as restaurants and retailers, are affected by weaker demand. For those competing on price, such as retailers and manufacturers, are affected by increased competition. Businesses that have fixed costs, such as rent and wages, are more vulnerable to higher costs.
For businesses that have plans to expand in China, our advice is to mitigate your risk as much as possible. Some measures include following the economic situation and currency fluctuations, adapting to regulatory changes, building relationships with local businesses and governments, focusing on delivering quality goods and services, and being patient.
Conclusion
The implications of deflation for businesses expanding into China are complex. By understanding the risks and taking steps to mitigate them, your business can increase its chances of success.
While China’s August consumer price index has rebounded, China is still not out of the deflation threat. We will be closely following China’s economic outlook and the initiatives that its central government will put in place.
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