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China has strongly criticised companies and local governments for fuelling overproduction that it blames for driving down prices, as inflation figures this week are expected to show that one of the country’s longest bouts of factory price deflation is running unchecked.
Chinese producer prices have been mired in deflationary territory since September 2022, posing a challenge for policymakers accustomed to relying on manufacturing and exports to drive economic growth.
In articles across state and party media, Chinese President Xi Jinping and other leading officials have attacked what they call neijuan, or “involution”, meaning excessive price competition.
The statements suggest Beijing is growing increasingly wary that surging industrial output, coupled with weak consumer demand at home, is fuelling a race to the bottom in prices that is entrenching deflation and fuelling tensions with the country’s biggest trading partners.
Official data is expected to show on Wednesday that factory gate price growth remained negative in June for a 33rd consecutive month, one of the country’s longest such falls in decades.
Overcapacity is a sensitive issue for China, which has sought to dispel complaints that its industrial policy has flooded its partners’ markets with artificially low-cost goods
But last week, Li Lecheng, China’s minister of industry and information technology, exhorted executives in the hyper-competitive solar panel industry to “manage the low-price disorderly competition”, according to an article in state media headlined, “rectify this involution problem!”
The mounting chorus of official concern has stoked speculation that Beijing is preparing to unveil for a bout of “supply side reform”, or government intervention into industries to control prices and reduce capacity.
It also marks a stark turnaround for Chinese policymakers. As recently as last year, Xi insisted at a meeting with France’s President Emmanuel Macron and European Commission president Ursula von der Leyen in Paris that “there is no such thing as ‘China’s overcapacity problem’.”
The Chinese Communist party’s leading policy magazine Qiushi conceded last week that “overcapacity” was an issue.
“The imbalance between supply and demand at the macro level is mainly manifested in weak demand and overcapacity in some industries, which has forced existing companies to compete in a limited market space in order to survive,” it said.
Chairing a meeting of the party’s Central Commission for Financial and Economic Affairs last week, Xi said: “Efforts must be made to regulate enterprises’ disorderly price competition”.
The coming weeks are critical, as Chinese policymakers negotiate the details of a new trade deal with Washington and as EU leaders meet Xi in Beijing at the end of July.
Qiushi noted that the price slide was affecting not only traditional sectors such as steel and cement but also emerging industries such as solar panels, batteries, electric vehicles and ecommerce. It blamed local governments for crowding into hot sectors, offering incentives such as subsidies, land and tax breaks that encouraged over-investment.
Robin Xing, chief China economist at Morgan Stanley, said Beijing could include “consumption as a percentage of GDP” as a performance indicator in its next five-year plan, which is expected to be announced in March.
He added that reform of the fiscal system, which depends on value added taxes on production for revenue, would also be important. But it would be hard to break China’s reliance on investment for growth, with capital expenditure in manufacturing growing at 9 per cent year on year.
In the nearer term, economists said, Beijing was likely to force companies to cut capacity or shut down obsolete plants. The government could also tighten environmental or other regulatory standards, said analysts at Citi, or use financial tools such as limits on leverage to force low-end or weaker operators out of the market
Xi has also pushed a “unified national market”, or regulations that might help restrain local governments’ ability to offer market-distorting subsidies.
China had some success in 2015-18 introducing similar short-term measures to control overcapacity in steel. But this involved large state-controlled industries and was accompanied by huge fiscal spending, economists said.
“It took several years to achieve that, and this is arguably a challenge on a much grander scale” and across numerous sectors, said Frederic Neumann, chief Asia economist at HSBC.
However, economists warned that solving the problem by rebalancing the economy would be difficult, especially as geopolitical and trade tensions incentivised China to seize even greater global market share of manufacturing.
“After 20 years of China being so successful in using the supply side to generate growth, saying farewell is not easy,” said Xing. “In today’s fragmented world, a lot of people probably see supply chain dominance as more important than ever.”
