China’s Record Deflation Finds Dangerous Cure in Oil Shock

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‘Cost-Push Inflation’ 

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A more immediate risk for China is what economists call “cost-push inflation” that further hurts factories. In the absence of stronger demand, manufacturers may find it difficult to pass on the higher costs to buyers and end up with even thinner profits. 

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“It is not necessarily beneficial for China,” said Ding Shuang, chief economist for Greater China and North Asia for Standard Chartered Plc. “The type of inflation China needs is not cost-driven inflation, but rather demand-driven inflation, supported by improved income and employment, leading to stronger demand and a better balance between supply and demand.”

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Sectors most exposed to the upheaval include oil extraction and processing, chemicals, fibers, plastic and rubber manufacturers — industries hit by US tariffs last year and now struggling with higher costs and export curbs imposed by the government after the war.

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It’s a worry given official data shows the share of loss-making industrial companies in China climbed to 24% in 2025, the highest this century. 

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A 20% increase in imported oil prices would reduce overall margins in manufacturing by up to a percentage point, according to Gavekal Dragonomics, after the profit rate for onshore-listed firms fell to 4.5% last year.

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“Manufacturing profits and investment would be hit, notably carmakers focusing on traditional fuel cars, and a broad range of downstream manufactures using plastics,” said Duncan Wrigley, chief China economist at Pantheon Macroeconomics. 

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As China enters a new inflationary era, what’s clear is that the outcomes will vary across the economy. 

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Spillovers from the war are likely to have a more muted effect on the consumer price index, since oil-related items have a weighting of less than 2% in the CPI basket, according to Barclays Plc. Economists at the British bank estimate that even if crude averages near $100 this year, China’s consumer inflation will likely stay below or around 1%, far below the goal set by the government.

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On the bright side, some economists expect even a temporary price jolt to reset inflation expectations among households and businesses. If successful, that may pull China from a spiral of falling prices and weakening demand.

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Japan’s escape from decades of deflation and stagnation is a precedent cited by those upbeat about the outlook. 

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In 2022, Russia’s invasion of Ukraine sent global energy prices soaring, helping spark inflation in Japan. As a result, Japanese companies such as rail operators hiked prices for the first time in four decades, the stock market rallied and the Bank of Japan ended 14 years of negative rates.

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But the differences between Asia’s biggest economies are equally striking. In Japan, the yen’s depreciation and years of policy stimulus were in place, with its property sector already on the mend and shortages widespread in the labor market.

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Still, the parallels offer a hint of how a spike in oil prices may play out in China. For economists at CF40, a Beijing-based think tank, China similarly stands to benefit given improving domestic demand and healthier household balance sheets. 

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A supply-driven acceleration in prices could help China “enter a positive feedback loop,” they said. “It won’t necessarily be ‘bad’ inflation if the oil price hikes are temporary.”

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—With assistance from Chien-Hua Wan and Yian Lee.

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(Updates with economist comment in 12th paragraph.)

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