China's deflationary trap: which companies and industries will fall into it?

The Chinese economy, which never tires of impressing with its achievements in a number of technological sectors, is actually standing on the edge of a dangerous precipice: it is slipping into a deflationary spiral. What is the danger?

The producer price index in China has been falling for three years. In summer, the rate of decline reached 3.6% per month, in October it amounted to 2.1%. The consumer price index has not risen above 1% since March 2023 and fluctuates around zero, in October consumer inflation amounted to 0.2%.

The IMF estimates that China's consumer inflation will be zero this year, the second from the bottom out of nearly 200 countries (only Panama is forecast to have deflation of minus 0.1%).

But the real picture for China is much worse, Bloomberg writes, based on an analysis of prices in 36 major cities in the country for food, consumer goods and services, cars of certain Marks, housing costs and so on.

Official information on inflation is opaque: the National Bureau of Statistics of China (NBSK) does not disclose detailed data, and many indicators in recent years and ceased to be published at all, notes Bloomberg. The agency's analysis shows that from the first half of 2023 to the first half of 2025, out of 67 goods and services, prices fell for 51. And some of them very significantly, for example, on residential real estate in large cities and BYD cars - by 27%, on potatoes - by 17%, eggs - by 14%, on rental housing - by 9%, on washing machines - by 4%.

The country is being sucked into a deflationary spiral that could lead to stagnation for years, if not decades. As a result, China may repeat Japan's post-1990 fate: at first there was talk of its lost decade, but it ended up being three. Only in recent years has Japan been able to deliver on inflation and its stock market has returned to its pre-crisis peak 35 years later.

Deflation is a sign of an unbalanced economy, a significant excess of supply over demand. Companies fight fierce price wars for customers, which undermines their profits and forces them to cut wages and staff. Employees, who have lost their earnings and are also consumers, buy fewer goods and services and put off purchases until prices fall. As consumption weakens, companies further reduce spending, capital investment falls, economic activity slows, and debts rise.

Breaking out of this cycle is exceptionally difficult. One of its striking evidences is the growth of savings in China this year to 110% of GDP - the highest level in history. For five years now, the country has been experiencing a crisis in the real estate market: housing is getting cheaper, and it was the main object of investment for the Chinese.

Zhu Tian, an economics professor at the China Europe International Business School, believes the country is on the brink.

Four years ago, Cao Zhi, 27, took a job as a food delivery boy in Shanghai. Today, he has to work an hour longer a day to earn the same amount, he told The New York Times. "It's like this everywhere," he complained, adding that many of his friends have also lost money.

It's not just low-paying jobs that cause people problems. Erica Chen, 40, earned $333,000 a year in 2023 working for a large Internet company. Her husband earned $142,000 a year at an international technology company. The couple bought a second home to rent out, their son went to a private international school, and three hired women helped around the house - cooking, cleaning and babysitting, Bloomberg reports.

In 2024, Chen lost her job (with severance pay) - her entire department was downsized as the company tried to reduce losses incurred due to price wars and falling consumer demand. The husband also lost his job, also with severance pay. The couple had to reduce the cost of their rental housing as market prices fell, their domestic workers had to be laid off, and their son had to be transferred to public school.

Companies are cutting costs in order to survive in a situation of the strongest internal competition. Out of about 6,000 public companies analyzed by Bloomberg, more than 25% will have a loss in the first half of 2025 - the maximum for at least a quarter of a century. Problems are observed in almost all sectors - industry, real estate, energy, technology, consumer goods. At least a third of profitable companies have seen their profit margins fall. In the economy as a whole, corporate profits are down 1.8% compared to the first half of 2024.

Companies are reducing investment in business development: capital investment in fixed assets fell by 1.7% in the first 10 months of 2025, a record for the period, the NBSK reported on Friday, November 14. The drop was 12% in October, according to Bloomberg Economics estimates, and has lasted for five months.

Retail sales show a deterioration in the consumer sector as well, rising at a 2.9% annualized rate in October, but the pace of that growth has declined for five consecutive months, the longest period since pandemic 2021.

Following the data release, China's CSI 300 stock index fell 1.57% on Nov. 14 after rising 1.2% on Thursday.

The situation in the economy is partly explained by the actions of the authorities, showed the study "Decoding Chinese Industrial Policy" by economists from the University of Pennsylvania and the Chinese University of Hong Kong in Shenzhen, who analyzed nearly 800,000 documents with industrial policy measures.

Incentivizing market entry through subsidies and allocation of sites at low prices leads to a large number of new companies. Even inefficient ones can continue to operate for years due to state support or proximity to local authorities, which must report to Beijing on meeting targets for employment, investment, construction, etc.

As a result, competition for limited resources intensifies, overcapacity occurs, and overall productivity levels decline, the study said.

One striking example is the situation in the electric vehicle sector. China has emerged as a world leader in this sector, but government support and incentives have provoked fierce competition among hundreds of companies, which is now undermining their business.

In late Ma, BYD announced a 34% price cut, followed by Zhejiang Leapmotor Technology and Geely Automobile. After that, state media, departments and industry organizations, fearing the unwinding of a deflationary spiral, lashed out at the automakers. "Renmin Zhibao," the mouthpiece of the Communist Party of China, criticized what it called "rat race competition" and warned that price wars could undermine supply chain reliability. The China Association of Automobile Manufacturers also warned against "vicious competition."

BYD's profits in the April through June quarter fell for the first time in more than three years, and by 30% at once. The company's shares in Hong Kong have plummeted 35% since the price cut was announced.

At the end of last year BYD became the largest seller of electric cars in the world, overtaking Tesla, and this year it began a large-scale international expansion. But the enthusiasm of investors, which boosted the quotes until the end of Ma, evaporated. As a result, the growth of shares over the last year amounted to less than 15%.

The situation in the banking sector is no better. The government is trying to stimulate consumer demand and capital investment, including by giving state-owned banks targets for lending. They are told to issue at least the same volume of loans as last year, two dozen bankers told Bloomberg. They fear that the number of borrowers will shrink by the end of the year - and this in a situation when banks' profit margins are already at record lows and bad loans are growing.

The reluctance of potential borrowers to take out loans forces banks to resort to deceptive schemes. Bloomberg cites several such examples. A bank offers a company to take out a loan, place it on a term deposit and repay it next month, while the borrower will be compensated for interest payments. Under a similar scheme, a consumer loan for a few days is offered to an individual, and there were cases when bank managers offered to compensate the interest out of their own money - just to fulfill the goal set from above. A person who wants to repay a loan early is paid money equivalent to the amount he would have saved if only the loan had remained on the bank's balance sheet.

Even with such tricks, the volume of loans issued in the non-financial sector grew in China in September by only 6.4%. That's the worst performance since data began to be collected in 2003, Bloomberg notes. Growth rates have been falling almost continuously since early 2021. Before that, they were 12-14%.

"Not meeting a target is a quick way to lose your job," Jon Treacy, publisher of investment newsletter Fuller Treacy Money, says of Chinese bankers. He believes that in such a situation, banks will almost certainly take more risks, which will gradually accumulate in the financial system.

For now, the FTSE/XinhuaChina A600 Banks index of publicly traded Chinese banks has been in a fairly steady uptrend since the start of 2024, although it experienced a roughly 15 percent correction in July-September, notes Treacy.

Shares of the state-owned Industrial and Commercial Bank of China, the largest bank in China, have grown by 26% in Hong Kong since the beginning of the year. Shares of China Construction Bank and China Merchants Bank rose by almost 30%, Agricultural Bank of China - by 39% (all are in the top 5 in terms of assets).

This article was AI-translated and verified by a human editor