Chinese economists debate potential for domestic stagflation, with most dismissing the risk

Cissy Zhou
·5-min read

A worrisome prediction by a renowned Chinese economist has sparked heated debate among experts in his field.

“Stagflation is coming,” Ren Zeping, chief economist at the Evergrande Group, warned earlier this month. He had earlier cautioned that China was at risk of “light stagflation” as a result of escalations in trade tensions with the United States since late 2018.

But not everyone is in agreement. Some economists argue that stagflation is indeed looming, while others are dismissing the suggestion out of hand, saying the odds of it occurring in China this year are very low.

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Stagflation is a situation in which low economic growth and high inflation occur at the same time, potentially leading to higher unemployment and lower wage growth.

China’s economic recovery continued in February, but the pace of the recovery was hard to gauge, given that the annual growth rates for statistics such as industrial production and retail sales were skewed sharply upward by the low virus-damaged comparison base from a year earlier.

Other indicators have suggested that the economy’s recovery slowed in recent months.

China’s economy advanced in January and February, but mixed data underscores uneven nature of recovery

The official manufacturing purchasing managers’ index (PMI) – a survey of sentiment among factory owners in the world’s second-largest economy – fell to the lowest point since February 2020, while the official non-manufacturing PMI that measures sentiment in the services and construction sectors fell to the lowest point since May.

“China’s economic cycle is shifting from recovery to overheating and then stagflation, with rising inflation expectations and structural asset price bubbles,” Ren warned. “We may be standing at a cyclical inflection point.”

Ren pointed to moves by Beijing policymakers to tighten credit policy, particularly in the property sector, as evidence that economic growth has reached its peak and is set to decline.

With the United States and Europe adding more economic stimulus this month amid the biggest virus-vaccination campaign in history, the outlook for a global economic recovery has improved significantly, causing a surge in commodities prices. Copper has hit a nine-year peak of above US$9,000 per tonne, while corn prices rose to an almost eight-year high of around 5.6 per bushel.

China braces for ‘turmoil in financial markets’ following new US stimulus

Last week, US President Joe Biden signed into law a massive US$1.9 trillion coronavirus relief bill, raising concerns in financial markets and among some economists that it could lead to an overheating of the US economy and higher inflation.

But Ding Shuang, chief Greater China economist at Standard Chartered bank, downplayed the chance of stagflation in China this year, calling it “quite low ”.

“To characterise an economy as being in stagflation, growth needs to be negative or significantly below potential, with unemployment remaining consistently high, while inflation is higher than normal,” he said.

China’s producer price index (PPI), which reflects the prices that factories charge wholesalers for their products, in February posted its highest rate since November 2018. However, China’s annual consumer inflation rate has remained weak, at least so far, easing slightly to minus 0.2 per cent in February from minus 0.3 per cent in January.

In 2020, China’s consumer inflation rose 2.5 per cent from the previous year, and the Chinese government has set a CPI growth rate target of about 3 per cent for this year.

Chinese regulators would, of course, make adjustments if they think there is stagflation

Yu Yongding, economist

There have been several rounds of debate in recent years about the possibility of stagflation in China. For example, as Chinese authorities started pumping money into financial markets in 2015 to offset the economic damage caused by the stock market crash that year, monetary indicators rose sharply, but most economists correctly predicted that this would not trigger significantly higher consumer inflation.

Yu Yongding, a prominent Chinese economist and former central bank adviser, said the recent rise in raw material prices does not support the conclusion that China is at risk of stagflation.

Yu said China’s monetary policy has historically focused on indicators of general inflation, rather than responding to structural or single-source price increases.

“None of the developed countries have reached their inflation targets yet, and we won’t see an immediate change in the [Federal Reserve’s] quantitative easing policy,” Yu said in reference to the Fed’s programme of buying US Treasury and mortgage-backed securities to pump liquidity into US financial markets in an effort to boost inflation to its 2 per cent target. “Chinese regulators would, of course, make adjustments if they think there is stagflation.

“Stagflation is not even a concern at this stage, the main concerns now are still the problems of insufficient effective [domestic] demand and slow economic growth.”

Given China’s rapid economic recovery, coupled with expectations that the US will soon follow and boost global demand, the price of Brent crude oil, the international benchmark, crossed US$70 a barrel this month – the highest level since late 2019, before the pandemic. The soaring price has triggered concerns that it could cause inflation to be “imported” to China.

But Deng Haiqing, chief economist with financial firm AVIC Fund, said the fear of higher oil prices is groundless because higher shale oil production and new energy sources will likely add to the overall oil supply, putting a ceiling on crude oil prices.

“Due to the low base in 2020, rising crude oil prices will push up the PPI in the short term, and we estimate it will reach a high of 5-6 per cent in the second quarter, but it will return to a downward trend afterwards,” Deng said in a note this month.

“China will enter a period of high-quality development in the next five years, shifting from investment-driven to innovation-driven growth, which means the cyclical fluctuations of the economy will ease,” he added. “Thus, the concept of ‘stagflation’ is not applicable in the context of China’s current stage of economic development.”

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