China’s latest inflation data from the National Bureau of Statistics (NBS) highlights persistent disinflationary forces in the world’s second-largest economy.

In May 2024, the consumer price index (CPI) remained sticky at 0.3 per cent year-on-year, continuing a prolonged period of muted inflation below 1 per cent since March 2023, including a deflationary phase between July 2023 and January 2024 (see graph). Historically, CPI inflation has averaged 2.38 per cent since May 2007 and 1.55 per cent in the last five years.

Worse, the producer price index (PPI) fell by 1.4 per cent in May, marking the 20th consecutive monthly decline, reflecting intense deflationary pressures in China’s industrial sector. Arguably, the ongoing decline in factory gate prices has prolonged the disinflationary trend in consumer prices.

Structural factors

These trends suggest a structural rather than cyclical slowdown in China’s economic juggernaut.

Tailwinds from post-pandemic consumption surge and fiscal stimulus are waning. Years of debt-fueled investment have resulted in excess industrial capacity.

Additionally, an ageing population, labour market imperfections, and technological disruptions like automation are exerting downward pressure on prices. Challenges in the real estate sector are weighing on economic growth, with the IMF projecting China’s growth to decelerate from 5.2 per cent in 2023 to 4.1 per cent in 2025.

The deflationary pressures and slowing growth momentum in China could significantly affect India through multiple channels.

First, as per the latest Global Trade Research Initiative (GTRI) data, China is India’s third-largest export destination, accounting for 3.81 per cent of the country’s total merchandise exports in FY24.

A sustained slowdown in Chinese domestic demand, coupled with deflationary forces, will dampen China’s import appetite, eventually posing challenges for Indian exporters. GTRI data show that in 2023, China’s total merchandise imports declined by 5.5 per cent.

While China’s imports from India showed an 8.74 per cent y-o-y growth from $15.3 billion in FY23 to $16.7 billion in FY24, the levels are still lower than in FY19. The slower-than-expected revival of India’s exports to China has been largely due to a sustained fall in domestic prices (and output) in China since October 2022.

Second, China’s deflationary woes could undermine the competitiveness of Indian exports in third-country markets. Persistent deflationary pressures and overcapacity led to a 7.52 per cent decline in China’s export prices between April 2023 and March 2024.

Should this trend continue, Indian exporters could be disadvantaged, especially in sectors like textiles, clothing, iron and steel, and transport, where India and China rank among the top 10 global exporters.

According to the World Trade Organization Statistical Review 2023, India’s global export share in textiles (5.7 per cent), clothing (3.2 per cent), iron and steel (3 per cent) and transport (2.5 per cent) pales in comparison to China’s (with shares of 43.6 per cent, 31.7 per cent, 16 per cent and 10 per cent, respectively).

A deflationary vortex in China and a fall in its trade-weighted currency could exacerbate this competitive imbalance, affecting Indian exporters amidst a protectionist sentiment and sluggish global trade environment.

Commodity prices slump

Third, India’s commodity export revenues could take a severe hit due to subdued demand from a slowing Chinese economy. Per the latest data, China accounts for a substantial share of global demand for key Indian commodity exports like iron-ore (90 per cent), cotton (13 per cent), and copper (14 per cent). The ongoing downturn in China’s industrial activity, construction sector, and manufacturing output is triggering a broad-based slump in global commodity prices, including those in India.

The Bloomberg Industrial Metals Sub-Index, a benchmark for base metal prices, has declined by around 33 per cent since its peak in March 2022, substantially impacting India’s commodity export earnings and profit margins.

Specifically, iron ore exports, a crucial revenue stream, could be particularly vulnerable, given India’s overwhelming reliance on Chinese demand.

Fourth, a protracted slowdown in China’s economic engine could amplify global deflationary risks, potentially translating into dampened consumer demand and lower import appetite across nations.

Given China’s pivotal role in driving global growth dynamics, a significant downturn in its economic activity could have far-reaching consequences, including weighing on India’s export competitiveness and eroding its terms of trade.

Moreover, given the interconnectedness of the global supply chain, a slowdown in China could disrupt global manufacturing networks, thereby affecting Indian industries that are integrated into these chains. India’s pharmaceutical, electronics, and automotive sectors, which rely heavily on Chinese intermediate goods, could face supply bottlenecks and increased production costs, hampering their global competitiveness.

Indian policymakers must adopt a multipronged approach to address challenges emerging due to China’s slowdown and persistent disinflationary/deflationary trends. Diversifying export markets through strategic trade agreements, enhancing competitiveness through productivity improvements, and reducing import dependency could help insulate India from such external shocks.

Simultaneously, prudent macroeconomic policies aimed at boosting domestic demand through fiscal stimulus and an enabling investment climate would fortify India’s resilience against such headwinds.

Ultimately, India’s ability to weather the storm stemming from China’s macroeconomic woes will hinge on its policy agility and reform momentum under the newly-constituted NDA government.

The writer is an Assistant Professor in the Economics Area at the Indian Institute of Management (IIM) Ranchi. Views expressed are personal