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Chen used to go to the shopping malls around her. And she buys a lot. These days, she stays home. Her house is not completed, and she’s paying an arm and a leg for it. The developer just said they might be going bankrupt because they ran out of funds. She curses them and goes every day to their office to demand her money back. She doesn’t have enough now to even buy her necessities.

To me, that pretty much sums up what’s happening in China. A severe property market crash saps the life out of most consumers in China. After all, almost 70% to 80% of Chinese household wealth is in properties.

And as consumer confidence crashes into the deep abyss, China has tipped into deflationary territory. I have previously written about this here whether China might enter a lost decade like Japan did.

Deflation is dangerous. It caused Japan to stagnate for 20 years. China is at risk with the latest January 2024 data showing a deflation of 0.8%.

So, what can China do to fight deflation? The key lies in reviving its economy. But what are they? Let’s get into 4 things that I think it can do!

#1: Aggressively cut interest rates

I have previously written about China’s policy supports here, and argued that they are not effective. Hence, there is a need to be more aggressive in cutting its interest rates to have the desired impact.

Theoretically, a cut in interest rates increases consumer spending and makes it cheaper for businesses to invest. But what’s more important is its impact on consumer confidence and expectations about inflation.

Here is the reality. China has been cutting interest rates but at a slow pace. Consumer confidence continues to be weak so it is not working.

Hence, inflation has turned to deflation despite the decrease in interest rates because Chinese consumers just don’t believe China’s policies are effective.

So, I argue – go ham in reducing interest rates. Its loan prime rate now is at 3.45%. Reduce that aggressively to 2.50% in one shot. Make consumers and businesses believe that the government is serious about stimulating economic activity and fighting deflation.

#2: Expand stimulus aggressively for consumers

Cash transfers. China spends a lot of money on the economy. Just the wrong things. Building infrastructure and properties are great but they are just building too much of them without high returns.

It should consider taking that money instead to put into cash transfers this year. I think they will yield a much higher return to the economy.

Since consumer spending is so subdued, any increase in consumer spending will send signals to businesses that activities could be improving. In economics, it’s called setting expectations for consumers and businesses.

If the government doesn’t seem serious about addressing problems in the economy, consumers and businesses won’t believe any of its fiscal policies and stimulus.

Building infrastructure in my opinion, doesn’t build confidence. It does increase long-term growth but what China needs now is short-term confidence.

And I think using aggressive cash transfers achieves that. It tells consumers “Hey, we are serious about the state of consumption. So, we are pumping cash directly to you to buy necessities and anything that you need”.

#3: Reform the philosophy it’s regulating its industries

This stems from two actions. One, it restricted the time that youths could spend on video games. The rationale – youths were too addicted to games. Two, it clamped down on the tuition industry which drove most of them underground.

While this may seem to be centered on only some industries, it has effectively instilled fear into many businesses around China.

“They could be next”, is the overarching mantra of such actions by the government.

Since December 2021, the business confidence index only breached the 99 level in February and March 2023 when reopening confidence was at its highest. Other than that, most of the time, it stood at below the 99 level.

China needs to reform its stance and philosophy regarding the regulation of industries to restore business confidence.

This will cross over into the political science realm. The Chinese government is known for implementing a top-down philosophy regarding policies. President Xi Jinping will state his ‘thoughts’ and ‘views’, and ministers will implement them in accordance.

There are essentially no firm guidelines and standards when it comes to regulations, leaving most industries fearful of the central government’s whims.

My recommendation – establish firm laws and guiding principles rather than ‘thoughts’ and ‘views’ regarding regulation. That way, businesses can learn to expect what the government will tolerate and what they will not.

#4: Shift to a consumption-led economic model

This is easier said than done. China has been trying to do this since 2010. It knows that it has the highest population in the world at 1.4 billion. And the domestic market is big.

However, an over-reliance on exports and investments to drive growth in the past drove many Chinese households to save rather than spend. What’s even worse, they saved most of their wealth in properties which has since crashed.

This requires a shift in mindset. How do you convince 1.4 billion to spend more? You provide them with more and higher quality jobs. It might sound like an ‘I could have thought about that too’ idea but it is the most straightforward one.

The youth unemployment rate is at an all-time high of over 20%. The reason – they can’t find jobs that match their expectations and skills.

It is no secret that most of the jobs in China are provided by state-controlled or -influenced companies that offer low-paying jobs. They are kept alive constantly by funding from the government and banks, leaving them to be zombie companies. Career progression is non-existent.

The private sector could fill in these gaps but #3 emphasises the realities of most private companies in an ever-changing regulatory environment. Hence, they are not willing to take risks that could leave them exposed to the whims of the central government.

Conclusion

If you are an investor, you should keep track of inflation and the policy announcements by the Chinese central government. There have been some attempts to reform and provide more policy support recently but it remains lacklustre.

You can’t influence how the government do things but you can evaluate whether the actions taken by the government are in the right or wrong direction.

Keep these 4 steps in mind that the Chinese government can do to help in your decision-making!