China may transition from deflation to a concerning form of ‘cost-driven inflation’ due to escalating global energy prices following the Iran conflict, as per a report. The surge in oil expenses is elevating production costs in China, despite subdued domestic demand, leading companies into a situation where they struggle to hike prices significantly, the report from EU-based Modern Diplomacy highlighted.
The report indicated that the heightened energy and raw material expenses are expected to further squeeze profits, with many firms likely absorbing these costs instead of passing them on to consumers. This could result in reductions in wages and hiring within these companies.
According to the report, China’s manufacturing sector currently operates on narrow profit margins, with approximately a quarter of businesses reportedly operating at a loss due to overcapacity and fierce competition. It noted a slowdown in income growth, with over half of workers not receiving pay raises last year and some even experiencing salary cuts. The youth unemployment rate remains high, with numerous individuals facing challenges in securing employment despite submitting numerous job applications.
With stagnant wages leading to a decline in consumer spending, the deflationary pressures that China has been striving to overcome are being reinforced, limiting growth prospects for companies. Although China’s economic growth has been primarily driven by exports, a decrease in global consumption resulting from higher energy prices could impact its export performance. Economists caution that a substantial surge in oil prices could significantly reduce GDP growth.
Even with China’s investments in electric vehicles and renewable energy potentially providing a competitive edge, weaker global demand may offset these advantages. The report also highlighted the potential risks associated with further disruptions in energy supply and trade routes stemming from conflicts in the Middle East, which directly affect China’s vulnerabilities.
If the energy shock from the ongoing conflict persists, China could face a challenging scenario characterized by weak growth and rising costs, without experiencing deflation or healthy inflation, as cautioned by the report.
