Deflation in China is causing pricing in some sectors to wane in 2024

China’s economy is suffering on multiple fronts, including falling housing and real estate values, increased foreign investment outflows, high debt, population decline and low consumer demand. One way China is dealing with its softening economy is by exporting its massive excess production capacity of goods at lower prices to keep its economic engine running. The knock-on effect may further lessen inflation in the U.S. and other countries that import goods from China, but the impact may be muted.

Less-expensive Chinese exports to the world may not equate to a broad deflationary lever in 2024 for countries with higher inflation, considering those exports were not the principal cause of inflation. The ultimate price the consumer pays in an end market includes costs for transport, warehousing, tariffs, and wholesale and retail profits. However, because China is a leader in so many sectors, Chinese deflation could put pricing pressure on certain global industries such as steel, electric vehicles (EVs), batteries and solar products wherever they may compete with imports. Middle market businesses should expect to see falling prices for some of these inputs and margin pressure wherever they compete directly.

A whirlwind 2023

In January 2023, China’s economy reopened after being shut down by the pandemic. This reopening happened as the rest of the world’s appetite for goods had waned and spending shifted to travel, leisure and services. Throughout 2023 most supply chains normalized, leaving China with excess capacity it had to export. 

China’s woes in 2023 were compounded by Russia’s invasion of Ukraine the previous year and China’s subsequent alignment with Moscow, coupled with the saber-rattling with the U.S. over governance of Taiwan. Investors were further spooked when Chinese police raided foreign-invested consultancy firms in China and by China’s stagnating growth of 5%, low by historical standards. These factors caused the biggest exodus of investment from China in history. By the third quarter of 2023, investment outflows exceeded inflows, turning the country’s financial and capital accounts to a deficit for the first time on record.

Even with these pressures, China remains a world leader in many sectors. In 2023, China led the world in EV battery production by a wide margin, producing nearly four times the gigawatt-hour capacity of the U.S., which ranked second, according to Adamas Intelligence. China produces 55% of the world’s steel, per the China Iron and Steel Association, and it exported more steel in 2023 than in the previous two years. China exported more automobiles than former leading country Japan in 2023, and China also manufactures 80% of the world’s solar panels—far more than any other country in the world.

China invested heavily to create these dominant global positions, and in times of low demand and excess supply, the country is incentivized to cut prices to move products. A final measure of deflationary pressure can be seen in China’s export prices for goods produced domestically and sold abroad. Export prices fell sharply from a high in July 2022 and have been contracting since June 2023. They are at their lowest levels in 14 years, since the global financial crisis. 

China is working now to stimulate investment by announcing a raft of stimulus policies to attract foreign businesses. However, much of the damage to investor confidence and market certainty will take time to recover. Countries like Mexico, India, Vietnam and the U.S. are benefiting from investment dollars flowing into their countries. 

Prices in 2024

The U.S., Europe and much of the Western world continue to experience inflationary pressures, and central banks are signaling they will keep interest rates higher for longer to cool economic demand and bring inflation back to targeted levels. China is experiencing the opposite, where rates will be lower for longer and deflation is taking hold. Prices paid at the factory gates, as tracked by China’s producer price index (PPI), have fallen into negative territory, and this trend runs the risk of continuing in 2024. (China’s inflation tracker includes China’s official monthly PPI inflation, ANZ bank’s China commodity index, spot prices for Chinese cold rolled steel and Asia Pacific crude oil spot prices to estimate the trajectory of producer price inflation.)  

It’s important to remember that China continues to be a major trading partner of the U.S., dominates multiple global markets and remains a global competitor in many sectors. But multiple U.S. industrial policies that started with the 2021 Infrastructure Investment and Jobs Act, the 2022 CHIPS and Science Act and the 2022 Inflation Reduction Act—which together total more than $1 trillion in government commitment to industrial policy—are having a positive impact on U.S. growth.

Businesses are indeed shifting investment back into the U.S. A recent study conducted by the National Institute of Standards and Technology surveyed manufacturers about why they are investing in the U.S. The No. 2 reason given was government incentives, second only to closer proximity to customers and markets. In 2024 we can expect to see the trend of U.S investment continue.

U.S. businesses in highly competitive sectors with exposure in China will need to gird against downward pricing in the year ahead and focus on making operations more efficient. Ways manufacturers can prepare include:

• Evaluate strategies to source and manufacture goods in other, lower-cost markets.
• Assess ways to bring operational excellence and resilience to the business.
• Determine ways to optimize business costs.