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 Annual consumer inflation eased to 1.2 percent in May thanks to a
sharp drop in food costs, particularly pork, National Bureau of
Statistics data showed on Tuesday, lower than a forecast 1.3 percent
and the previous month's 1.5 percent.
The producer price index (PPI) stayed unchanged at a negative 4.6
percent, meaning that Chinese factory pricing power is sliding
deeper into its fourth year of contraction.
"We are basically in the midst of a balance sheet recession with
Chinese characteristics," said Andrew Polk, economist at the
Conference Board in Beijing. "Companies and banks are busy repairing
their balance sheets, and that suppresses borrowing appetite."
Polk said that the solution requires both a "dramatic" reduction to
interest rates combined with more government spending.
Economists say weak producer prices are of particular concern as
commodity prices - a major deflationary force at China's industrial
heavyweights - are recovering yet producer prices remain depressed.
"We think the reflationary pressure in China is still remote and the
CPI is likely to stay low," wrote Xie Dongming, economist at OCBC
Bank, saying this offered ample room for further adjustments to
interest rates and bank reserve requirements.
China cut interest rates for the third time in six months in May -
on top of two reductions in the amount of money banks must keep in
reserve, with little impact on deflation. Some economists believe
China may be headed into a "liquidity trap" in which additional cash
supply fails to translate into productive investment.
BOOM TIMES OVER
In an environment where returns on investment are usually lower than
the nominal 5.1 percent lending rate for one year - and actual
long-term lending rates generally far higher - company executives
say there is little incentive to invest.
Indeed, some say the only measurable impact the easings have had is
in the stock market, which has more than doubled since China began
cutting interest rates in November.
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Beijing has stepped up support for local governments as the economy
confronts its worst year in a quarter century. It is engaged in a 1
trillion yuan debt swap intended to shore up finances at heavily
indebted local governments, by exchanging their high-yield debt for
low yielding municipal bonds.
The central government also has plenty of firepower left, including
1.7 trillion yuan of fiscal deposits. But deploying those funds, in
particular given China's clunky budgetary process, will take time.
A Reuters poll suggested May indicators will do little to change the
broad picture of an economy struggling under the weight of a
property downturn, widespread factory overcapacity and local
government debt.
"The heavy industrial sectors that have led the economy since the
early 2000s are mired in excess capacity, and producer price
deflation is entrenched," Arthur Kroeber of Gavecal Dragononics said
in a research note.
"Clearly the boom times are over, and much more pain lies ahead."
(Additional reporting by Kevin Yao, Nathaniel Taplin, Samuel Shen
and the Shanghai Newsroom; Editing by Jacqueline Wong)
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