Here's why the rest of the world has to keep an eye on China's deflation story

China and economic data numbers. It always just tends to play out nicely for Beijing’s narrative and this is one of those times. Say what you want about the December CPI report earlier in the day but it kept the 2025 full-year CPI at 0%. As such, lawmakers and policymakers can attest to the claim that China is “not in deflation territory”. How convenient.As much as they can chalk this up as a win, deflationary pressures are going to be a mainstay problem for China in 2026. So, let’s look past what the numbers today said and look at the real story instead.It all starts with the real estate sector crash and property market slump in China since 2021. Households feel the pinch of the property market slump and have to tighten the purse strings and opt to save more, instead of spending.Then you have the push by Beijing to prioritise investment in key future industries, all as part of the green transition. That allows for factories to ramp up production at a pace that outweighs domestic demand, which has been hampered by the above development.And in turn, that has led to the “involution” problem in China in the past year or so. Overcapacity in production, particularly in electric vehicles and solar panels, leading to price wars among firms to aggressively clear out excess inventory.It has gotten to a point where Beijing has even stepped in to pledge “anti-involution” policies for this year in trying to steer China’s socioeconomic issues back into a healthier place. However, it will take time and some things are just hard to really force. You can’t just turn on domestic demand with a snap of a finger.The depressing price trend is clearly felt when viewing China’s producer price index, which has been in negative territory for 38 straight months now. The latest report shows a 1.9% year-on-year decline and while easing, it still reflects negative price developments as a whole.So when Chinese companies cannot sell out their goods at home, what happens next? They turn to the international audience. And this is where the rest of the world needs to step up and take notice.As Chinese firms look to stay competitive in bringing up their bottom line, they have to export their goods to outside of China. And besides just exporting finished goods, they are also exporting things like battery cells and power electronics at deflated prices. And this puts a deflationary anchor into the supply chains of other countries.Adding to that is a weaker Chinese yuan currency, which makes these goods even cheaper and more attractive for foreign buyers. Thus, amplifying the impact of the deflationary anchor. The yuan might have performed well in 2025 but is still more than 10% weaker than where it was back in 2022.For the better part of three years now, the focus of major economies has been on tackling stubborn inflation pressures. And to some extent, most have gotten that somewhat under control now with the potential for central banks to shift gears back towards rate hikes either later this year or perhaps next year.However, China exporting deflation to the rest of the world is perhaps a key risk factor that should not be overlooked as it could really strike deep and get embedded into other countries’ economies without much notice. And even more so, when it hits at economies which are starting to soften.The hope now is that Beijing’s “anti-involution” policies will come good and curb any disorderly price competition among manufacturers. But the key push by lawmakers and policymakers is to try and pivot towards a consumption-led model. However, I would argue that it isn’t so simple and it is the type of shift that could take years or even a decade.So, yeah. This may not be talked about all too much as the risk of the situation remains low. But the narrative of China exporting deflation is arguably one that could be a key macro risk for markets come what may this year (or next).
This article was written by Justin Low at investinglive.com.

🔗 Source