Asian Angle | What China must learn from Japan’s decades-long debt-deflation slowdown

At first glance, China’s first-quarter gross domestic product numbers seem to validate the state’s reliance on production to boost a slowing economy. Compared to the same period last year, GDP in the first quarter grew by 5.3 per cent, driven by a 6.1 per cent increase in industrial production and a 9.9 per cent increase in manufacturing investments.

But data from March points to the limits of relying on investment to sustain growth. The National Bureau of Statistics reported on Tuesday that industrial profits at large Chinese companies declined 3.5 per cent from a year earlier. This came after industrial profits in January-February had jumped 10 per cent, briefly raising hopes that the industrial downturn was over. Industrial revenue also fell sharply in March.

Meanwhile, the consumer price index fell to near zero last month and the producer price index remained firmly in deflation territory at minus 2.8 per cent. Exports were also down 7.5 per cent compared to a year ago. All this points to subdued demand. Above all, China’s unusually large property sector shows no signs of recovery: property investments fell nearly 10 per cent in the first quarter of this year.

China’s emphasis on production over consumption – boosting supply instead of demand – raises questions about what or who all this supply is ultimately for. If domestic consumption remains weak, the only option will be to export the excess supply. This is likely to provoke, if it has not already, a protectionist backlash from developed countries, and upset developing countries that are also looking to export-led industrialisation to drive growth.

Since the second half of last year, Chinese authorities have responded to the slowing economy in three main ways. The first has been to lower borrowing costs – but the problem in China today is not credit supply, it is the lack of credit demand. The second has been for the central government to borrow and invest in infrastructure development – but a 1 trillion yuan (US$138 billion) bond issue approved in October does not seem to have given the economy a large boost.

The third, unveiled most recently, has been to increase investments in “new quality productive forces” – a shorthand for China’s industrial policy to increase capacity in advanced manufacturing and achieve self-sufficiency in key technologies of the future. This strategy is likely to lead to excess capacity, generating more deflationary pressures.