Guarding Against deflation With Reforms

Official data showed that commodity prices in China have been declining， arousing concerns over deflation risks. In response， there has been much outcry in the market that more monetary easing measures should be adopted to cope with the tendency. Deflation should be treated carefully and more emphasis should be put on bolstering reforms.

Several indexes point to the change in prices， including the bulks price index （BPI）， consumer price index （CPI） and producer price index （PPI）. Chinas BPI plunged to a record low of 780 points at the end of 2014， down 16.49 percent from the 934 points at the beginning of 2014. Chinas CPI， the main gauge of inflation， grew 2 percent in 2014， much lower than the governments 3.5-percent limit set for the year， whereas Chinas PPI， which measures inflation at the wholesale level， fell 1.9 percent in 2014.

As for economic fundamentals， the latest data from HSBC showed Chinas manufacturing purchase managers index （PMI） stood at a seven-month low of 49.6 in December 2014. The official PMI released by the National Bureau of Statistics slid to an 18-month low of 50.1 last December. Growth of industrial profit is slowing， with the profit growth of industrial enterprises above the designated size—principal business revenue of more than 20 million yuan （$3.22 million）—declining to 5.3 percent during the January-November period of 2014. Last November， industrial profit registered the biggest month-on-month drop in 27 months.

The above-mentioned indexes seem to indicate more downward pressure for the economy and impending deflation in the country. But whether deflation will occur in 2015 and how to treat deflation remain unanswered.

In 2015， Chinas economy will continue to be in the “new normal” featuring economic growth slowdown， structural improvement and a shift in growth points. In a time when new growth drivers replace old ones， a slowdown in growth rate is bound to happen， and sometimes a period of deflation is inevitable. The post-crisis eurozone， United States and Japan all suffered from economic downturn and deflation. Right now， the United States has defeated deflation and is on the trajectory of economic recovery， a sign that post-crisis reforms in the United States have been successful. On the other hand， the eurozone and Japan are still struggling to wrest against deflation and promote recovery.

In China， current economic growth and price changes are in line with government expectations as the government is comprehensively deepening reforms to make more room for economic rebalancing. No serious problems are predicted to occur in 2015 as long as the GDP growth rate reaches around 7 percent and the CPI growth falls within 1-2 percent. It is， however， unwise to expect the government to launch stimulus packages whenever theres any sign of slowdown.

Expecting the central bank to loosen monetary policies is indicative of nothing more than wanting interest rates cut and reduction in reserve requirement ratio to be common practices in China. As of the end of December 2014， M2， a broad measure of money supply that covers cash in circulation and all deposits， reached 122.84 trillion yuan （$19.77 trillion）， about two times the GDP in China， and its growth rate stood at 12.2 percent， 4.8 percentage points higher than the GDP growth. Since the monetary condition is quite loose， China should continue the prudent monetary policy that strikes a balance between tight and loose.

A proper mindset toward deflation should be established. Monetary balance is an ideal relation between supply and demand， whereas monetary imbalance—either supply outweighing demand or demand outweighing supply—can be reflected by fluctuations in interest rates and prices in the market. Theoretically， dealing with deflation risks means a country should lower interest rates by carrying out open market operations to increase money supply. However， what matters most is boosting market confidence. No matter how the environment changes， continuously bolstering reforms and accelerating structural adjustment should be the top priority in China.

Economic restructuring has reached a critical point in China， with relevant industries—strategic emerging industries， the Internet， upgraded manufacturing and modern services—all offering new investment opportunities to global investors. As long as China unswervingly adjusts its economic structure， the quality of its economy will be substantially improved in 2015， despite the economic slowdown. If so， some deflationary risks wont be a problem.

In 2015， China should stick to its prudent monetary policy， with frequent use of different monetary instruments to keep a reasonable level of liquidity in the banking system and to guide steady and appropriate growth in credit. More importantly， targeted macro-control should be adopted to increase financial support to key areas and weak links of the economy. The real economy should have better access to funding and the financing cost should be further lowered. With these policies being carried out， China will reduce deflationary risks in the near future.