Is China about to become a source of global inflation?

David Rees, Senior Emerging Markets Economist at Schroders

With inflation riding high in many developed and emerging markets, we assess the potential risks emanating from China.

The recent period of red-hot goods inflation has snapped decades of disinflationary pressure since China emerged as a low-cost manufacturer. The nature of the recovery from the Covid-19 pandemic has of course contributed to rampant goods inflation, given that lockdowns skewed demand into the goods sector and interrupted supply chains.

Goods inflation should come down in the near term as these frictions ease. However, it is hard to shake the nagging feeling that we may have reached a turning point and stand on the verge of a new inflation regime. After all, China’s workforce is becoming more expensive, and is set to shrink over the coming years. And supply chain disruptions as a result of China’s zero-Covid policy have only caused trade hawks to call even louder for a reshoring of production.

What could this mean for South Africa?

South Africa’s goods trade deficit with China has averaged about 1.5% of GDP over the past decade, the bulk of which has been made up of manufactured goods. This leaves South Africa vulnerable to a structural increase in the price of manufactured goods from China, as its workforce shrinks and wages increase. All else equal, higher goods import costs would see South Africa’s external position deteriorate, adding to pressure on the rand. Firms would face the tough decision of absorbing higher costs into their margins, or passing on price hikes to consumers and fuelling inflation. So, should we worry about a wave of higher prices from China unsettling South Africa’s economy and markets in the years ahead?

The evolution of inflation over the last century

The global economy has been through many regimes of high and low inflation over the past century as economic booms and busts, wars, and changes in policy regimes, have exerted pressure on prices (chart 1). The Covid-19 pandemic has brought to an end a particularly long period of low inflation that began in the 1990s as a confluence of factors weighed on price pressures.

Central banks made controlling inflation their primary goal, commodity supply shocks during the 1970s eased while tighter policy and the breakup of trade unions helped to stem second round effects from prior price increases. The global financial crisis was a major deflationary bust, while reforms in emerging markets (EM) have brought to an end periodic currency crises that often fuelled bouts of high inflation.

Click here to read more...