While most major economies worry that inflation remains above central bank targets, many investors worry that China’s inflation is too low and that the risk of deflation has not disappeared.

In China, consumer prices were up only 0.2% in June from a year earlier. This is down from 0.3% inflation in April and May. Prices were down 0.2% from May to June. In fact, in three of the last four months, prices fell from the previous month. Thus, deflation remains an issue. When volatile food and energy prices are excluded, core prices were up 0.6% in June from a year earlier.

What is driving very low inflation? It helps to look at the details. In June, food prices were down 2% from a year earlier. This included a 7.3% drop in the prices of fresh vegetables and an 8.7% drop for fresh fruit. On the other hand, prices were up 1.5% for clothing and up 1.5% for health care. Also, the government reported that factory gate prices (producer prices) in China were down 0.8% in June from a year earlier. This is the slowest decline since December 2022. Still, on an annual basis, factory gate prices have been falling in every month since September 2022. This likely reflects excess capacity as well as the impact of declining commodity prices.

China’s continuing weak inflation is, in part, a reflection of weak domestic demand. Chinese consumers have been hurt by the crisis in the residential property market, which has led a decline in property prices and, therefore, perceived wealth. In addition, weak activity in property seems to have stifled purchases related to new homes. Also, the job market is relatively weak, while private sector business investment has been stagnant. Plus, household savings has been high owing to consumer uncertainty about the economic environment.

At a time of weak domestic demand, the government has relied on exports to drive economic growth, especially exports related to information technology and clean energy. Yet China has faced a backlash from its trading partners who claim that China is competing unfairly through subsidies, a charge China denies. Yet the backlash is hurting China’s ability to boost exports. In fact, Chinese exports of electric vehicles (EVs) fell 13.2% from May to June. This follows action by both the European Union (EU) and the United States to restrict imports of Chinese EVs. Moreover, Chinese producers of lithium batteries are reported to be suffering financial losses.

Thus, stimulating domestic demand will likely be important to generate economic growth and reduce the risk of deflation. The government has taken modest steps including subsidies to complete unfinished home construction and modest declines in some interest rates. Yet more action is likely needed. This could entail strengthening the social-safety net to encourage less savings.

An important part of the growth strategy for China is to boost investment and exports in key technologies such as information technology, EVs, and batteries. Based on the latest data, the strategy shows signs of success. That is, exports grew rapidly in June, rising at the fastest rate in almost two years. However, China faces a growing protectionist policy against some of its exports, coming from Europe and North America as well as other locations. The risk is that such restrictions on trade will inhibit China’s ability to boost exports, thereby slowing economic growth.

Let’s look at the details. In June, Chinese exports (measured in US dollars) were up 8.6% from a year earlier, the fastest rate of growth in 21 months. It’s possible that some companies are frontloading exports in anticipation of higher tariffs. In fact, imports declined 2.3% in June versus a year earlier, the steepest decline since February. Given that a large share of imports are inputs used to produce export-oriented products, the drop in imports bodes poorly for future exports. The drop in imports might also reflect weak domestic demand.

For the first six months of 2024, exports were up 3.6% from a year earlier. By industry, this included an increase of 21.6% for integrated circuits, 18.9% for automobiles, and 85% for ships. On the other hand, steel exports were down 9.3%. Also, in the first six months of 2024 imports were up 2%. This included a 54% increase in imports of automatic data processing equipment and an 11% increase for high-tech products.

By country, exports in the first six months were up 1.5% for the United States and down 2.6% for the European Union (EU) and down 6.3% for Japan. However, exports grew more strongly for Southeast Asia and Latin America. Specifically, exports were up 10.7% for Southeast Asia and up 11.3% for Latin America. Meanwhile, imports were down 4.9% from the United States, down 5.7% from the EU, and down 3.9% from Japan. Imports were up from other parts of the world, including India, Russia, and Southeast Asia.

The shifting trade landscape is likely a reflection of the impact of trade restrictions as well as the shift in supply chain investment by large global companies. Going forward there is a risk of further trade restrictions by the United States and EU, thereby encouraging companies to reduce supply chain exposure to China and obtain more imports from other locations. For China, this would mean more exports of inputs to Southeast and more final assembly taking place in Southeast for export to the rest of the world. This process is already under way and is likely to accelerate.

The big question for China, given its massive investment in export-oriented production of high technology and clean energy technology, is whether export growth will be sufficient to justify that investment. Already officials in the United States and EU are complaining that China is subsidizing exports and selling products below cost. China denies this, but the result has been more restrictions on trade. If China’s exports do not continue to rise rapidly, it is not clear that China’s domestic market will be able to absorb the added output.