China faces 'the spectre of deflation'

Chinese economist warns that China faces the spectre of deflation within the next two years:

China faces the spectre of deflation within the next two years, a government economist warned on Wednesday, if overcapacity continues to swamp domestic demand, State news agency Xinhua reports.

Japan had experienced deflation for years following the bursting of its property bubble in the early 1990's. Prices only began to rise there in the past 12 months.

Raw materials and power prices are rising but downstream demand is insufficient to satisfy the excess supply from the industrial sector, said Zhang Hanya of the Academy of Macroeconomic Research at the National Development and Reform Commission (NDRC), China's top economic planning body.

"If the contradiction between the rising prices of raw materials caused by upstream monopolies and the inability to raise downstream prices due to competition is not resolved, CPI will continue to fall," Zhang said in a report published in the China Securities Journal yesterday. "Drops like this will lead to deflation within one or two years."

The NDRC has repeatedly warned over the last year of overcapacity in about a dozen sectors, including property, cement, steel, autos, and metal smelters. Rapid expansions have raised the prices of commodities world-wide, while increasing the toll of pollution in China, and the struggle to sell the resulting output has caused trade disputes, eroded profit margins and the risk of defaulted loans, bankruptcies and unemployment.

On Tuesday, the academy's deputy head said consumer prices in China were unlikely to rise by more than 2 percent in 2006, but forecast that China would avoid both high inflation and deflation. Annual consumer inflation in China was 0.9 percent in February and 1.9 percent in January.

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