How China is Using Its Excess Capacity to Drive Global Deflation

How China is Using Its Excess Capacity to Drive Global Deflation


5 min read

Last time, we left off the story at an inflationary note, let's try something new this time. Currently, China is lumping as the domestic demand is low and China has excess capacity to produce. Till now we have covered the background of this story, but let's come to the present times. A small period of in-activity in China could cause so much havoc in India, but what happens if something opposite were to happen? By opposite, we mean what if China comes guns blazing, and started utilizing its over-capacity in various sectors. What then? Well, this is exactly what we are facing now.

If we go by common knowledge, then high inflation is considered to be one of the worst enemies of an economy. So logically, the opposite of Inflation - Deflation, should be a boon to economy? Not quite, infact in some cases, deflation has hit countries so hard, they were printing money just so they can invite inflation (Japan).

China is going through a similar phenomenon and its again causing havoc in Indian markets. Let's start where we left our story and understand how China is affecting Indian markets, yet again.

So, as we know, the housing crisis and the Covid pandemic, both occurred around 2020, but this was coupled with already slowing GDP, politically unrest, ageing population and various other domestic factors in China. All of this led to a huge dip in Chinese consumption. Various key categories, such as EVs, textiles, durables, household electronics, transportation and most importantly housing, saw a decline in demand. This affected various industries, with big names including steel, chemicals, batteries, electrical components, automotive components etc.

This resulted in two things. Firstly, lower consumption led to a huge problem for industries which had existing over-capacity for production, who now also had to face lower demand for goods. Goods such as EV battery saw a price decrease up to 50%, while the raw material - Lithium Carbonate prices in China declined around 70%.

And secondly, it hurt the tax collection of government, who now had less money to pump in the system and revive the industrial demand.

But now let's get to the question of, how did it affect Indian companies? If we look at the commodity side, such as Steel, Chemicals and Sophisticated capital goods, you will see similar looking graphs. A huge increase in the price slope, almost like a plateau between 2021-2022 and a sudden decline around 2023.

This is because, the supply chain issues during Covid lockdowns, resulted in lack of supply of commodities and specialized equipment. The lack of supply led to increase in core goods prices. Indian companies pounced on this opportunity by increasing their exports to fill the gap in the market. Thus, revenues and profitability for Indian chemical and steel companies improved during this phase. This period also coincided with the recovery of western world and healthy foreign demand.

But post-covid, the surge in western demand had stabilized, and that's when China's manufacturing companies started pressing the gas. What also didn't help was the domestic demand, as Chinese consumption had not recovered post-covid. Thus, when China restarted its industrial production, they were catering to non-existent demand. These goods slowly found their way to global markets, and cheap Chinese exports flooded the market. The global prices of many commodities, electrical equipment, computer components etc. fell to record lows.

Even today, China is flooding cheap commodities into the global markets and is driving the prices down. This is also coupled with weak Chinese yuan which is also elevating the pressure. One might think, a situation like this may seem bad for chemical and steel companies but should be a blessing for companies manufacturing final goods and sourcing raw material from China. Well to some extent yes, but the problem is, China has a good backward integration setup. So they are not only flooding cheap OEM parts, and commodities, but also exporting lower priced final products such as electronics and automobile. Thus, companies in Germany and other parts of Europe are facing stiff price competition in automobile segment.

All this chaos has been because of a deflationary cycle in one country, which shows the important part a country like China plays in the global economy. Many countries have opted for dumping duties against China, giving a breather to domestic players. Indian government also went ahead with a detailed list of anti-duty items which included things such as metals, tiles, specialized machineries, construction equipment, solar cell materials, certain chemicals and various other items. As far as India is concerned, thanks to our GDP growth, domestic consumption and good supply capacity, we are able to fight the current deflationary cycle in China.

So, what now? We expect China's deflationary outlook to continue for this year, until there is a major policy shift. To improve the situation, government will have to increase the domestic consumption by increasing the household income. The housing crisis mess also needs to be cleared for a swift revival in the economy. Till then, the global markets will be in pressure. The global core goods inflation is already sliding down, thanks to the over-supply from China and devaluation of yuan.

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