China’s economy on cusp of a deflationary death spiral

China is sliding deeper into economic weakness that is being worsened by its response to external shocks. 

Tariffs are drying up international demand for Chinese goods, and in a bid to keep factories alive, Beijing is urging exporters to turn inward. However, that pivot is compounding the very problem it aims to solve.

Chinese authorities have been positioning the domestic market as a pressure-release valve for the manufacturing sector. But the influx of export-grade inventory is creating excess at home in a consumer environment that is already highly restrained. 

This is accelerating a destructive process: prices are falling, and not because productivity is rising or technology is improving. They’re falling because companies are desperate to shift stock and survive.

Deflation isn’t an abstract threat in China anymore—it’s visible across the economy. After barely holding above zero for much of 2023 and 2024, consumer prices have now dropped for two straight months.

Producer prices have fallen for 29 consecutive months. March’s figures showed the sharpest drop in four months, and forecasts point to an even steeper decline in April.

The problem is a lack of confidence and the mismatch between oversupply and tepid demand is becoming more entrenched. 

Redirecting unsold exports to domestic platforms at steep discounts might appear clever in the short term. But when that becomes a strategy, it turns into a liability. It breaks pricing power across sectors, weakens earnings and sets the stage for another round of cost cuts.

Major e-commerce platforms are fully behind this shift. JD.com has committed the equivalent of US$28 billion to boost domestic sales of export-surplus goods, offering discounts of up to 55%. The public message is one of resilience and opportunity, yet the underlying dynamic is more fragile.

The jobs market remains under pressure, with wage growth uneven. Consumers are cautious, not just about big-ticket items, but also everyday spending. The property sector is still under strain, dragging on household wealth and appetite. So even as goods pile up and prices drop, buyers aren’t stepping in with force.

This results in companies slashing prices to levels that damage profitability. The impact cascades: lower margins, tighter hiring plans, smaller pay packets. These outcomes aren’t theoretical—they’re already showing up in China’s data. Businesses are operating defensively, households are holding back and the loop is tightening.

Exporters were already contending with major shifts in global trade patterns. Tariffs, once seen as a short-term bargaining tactic, are becoming a semi-permanent feature of the economic landscape. This has disrupted long-standing supply relationships and pushed many producers to suspend shipments altogether. 

As overseas orders fall, China’s policy response has tilted further toward internal absorption. The risk is that this domestic redirection goes too far, saturating the market and sending deeper waves of deflation throughout the economy.

In this context, Beijing’s measured approach to stimulus carries consequences. There’s been talk of support, but few meaningful steps. Authorities appear to be holding fire until they see more deterioration.

That caution may prove costly. Price declines that persist over time don’t simply correct on their own—they reshape behaviors. Businesses scale back. Households delay spending. Investment decisions drift. Momentum slips away.

China is not alone in facing economic challenges, but its size and centrality in global supply chains make its domestic policy choices a global concern.

If prices in China continue to fall across key inputs and finished goods, that dynamic will export pressure into other economies. For trading partners, it will raise competitive tensions. For investors, it clouds visibility and undermines forecasts.

There appears to be no containment mechanism here, meaning these developments can spill over across borders. Still, the story is not yet locked in. While China’s response has been slow, it’s not static. The capacity to deliver targeted relief exists. 

What matters now is the willingness to use it with precision. Sustaining growth doesn’t require a broad flood of capital—it requires decisions that address the pinch points: employment fragility, demand fatigue and collapsing margins.

This means supporting private sector confidence, not just issuing high-level directives. It means restoring price stability, not accepting a prolonged stretch of discounts as the new normal. 

Most of all, it means acknowledging that reshaping an export-driven model takes more than just redirecting trade. It demands a genuine recalibration of internal engines for domestic demand.

What’s unfolding now is the early phase of an economic transition that carries considerable risk, but the tools to manage it are available. But will Beijing use them before deflation becomes too deeply entrenched?