China’s factories may be on the cusp of delivering a new shock to the global economy after years of undercutting rivals with cheaper costs. This time, increases in prices could reverberate around the world.
To understand why, consider the dilemma facing Jiangmen Luck Tissue Mfy Ltd., now caught in a squeeze between surging wages and tepid demand. The company has already slashed staff by half, shaved prices and automated production to survive. Now, with margins razor thin, it’s weighing the first price increases since 2010.
“There’s just no possibility for me to cut prices any more,” says deputy director Roger Zhao, 52, whose company is based in the city of Jiangmen in southern Guangdong province. “Because costs are already pretty high and I don’t see any possibility they’ll go down, I’m seeking opportunities to raise prices a little bit.”
That push to recover lost margins -- even as demand remains muted -- was shared by exporters of everything from clocks to hot tubs interviewed in Guangzhou last week at the Canton Fair, a biannual gathering where 25,000 exhibitors and 180,000 mostly foreign buyers ink export deals in booths spanning exhibition space equivalent to about 3,400 tennis courts.
For the world economy, decisions from companies like Jiangmen Tissue to stop cutting prices -- and even raise them where demand allows -- removes a source of disinflationary pressure. To be decided is whether China, the factory to the world, swings from becoming a drag on consumer prices to a source of pressure nudging them higher.
China’s manufacturing prices rose in September for the first time in almost five years and overall producer prices also clambered out of negative territory. Those likely to feel the biggest lift if Chinese export prices follow through with sustained increases would be the country’s top five markets: the U.S., Hong Kong, Japan, South Korea and Mexico.
“China’s return to positive growth in producer prices marks a very significant turning point in deflationary pressures both in China and globally,” said Shane Oliver, head of investment strategy at AMP Capital Investors in Sydney. “This is only step one, though. We are still waiting for step two: stronger global demand and trade.”
Countries where imports from China account for a large percentage of the total also will be affected, including Japan at almost 25 percent of total imports and Australia with about 23 percent.
“It will impact on Australian import prices, a lot of those consumer durables such as household appliances and big-screen TVs that we like to import,” said Michael Blythe, chief economist at Commonwealth Bank of Australia, the nation’s biggest lender. “It does add to that range of indicators that suggest we are round about the low point for inflation.”
China will probably let inflation run to overcome a high debt burden, as it has done in the past, and could start exporting price increases next year, according to Jefferies Group LLC strategists led by Hong Kong-based Sean Darby.
To be sure, headwinds to inflation remain strong, with global demand weak and the International Monetary Fund warning this month that the risk of persistent deflation in some advanced economies has risen. A 10 percent slump in China’s September exports underscored the funk while deflationary trends were on display Friday with data showing Japan’s consumer prices fell for a seventh straight month in September.
Sandy Chang, owner of bathroom-accessories maker Dongguan City XinChen Gift Co. in Guangdong, has felt that lackluster demand from her major markets in Japan, Europe and the U.S. acutely. Sales have slumped 30 percent since 2012. As wages surged as much as fourfold in the past decade, she responded by halving staff from 2014 levels to about 100 today. Now, the cost of core materials including marble and resin are climbing.
“It’s impossible to cut prices further,” she said, speaking at her booth at the Canton Fair, which has run uninterrupted since it was launched in 1957. “The only way out is to increase efficiency, reduce waste and to get ahead by selling more.”
It’s a similar refrain from small and medium-sized exporters across the vast avenues of booths hawking goods that’ll end up in your shopping trolley or under the Christmas tree.
Winmart Design founder Lin Haobin says his Shenzhen-based company has cut prices by 30 percent since 2013, helping sales of his decorative desktop pot plants surge 50 percent annually to markets including South Korea and the U.S. With wages double their 2012 level, he can’t go much lower. Jacuzzi maker Shenzhen Kingston Sanitary Ware Co. -- with profits down 20 percent in five years -- is no longer discounting.
Yet deflation remains a headache for some. At toy drone maker Shantou Chuangxiang Toys Factory in Guangdong, sales manager Sheila Yip says prices are falling on 90 percent of her products because of intense competition from new rivals. The company is only able to increase prices on products with innovative features, she said.
China’s producer price index will weaken again after the first quarter of next year because the “root causes of disinflationary pressures -- overall investment and excess capacity -- are still very much alive,” Morgan Stanley analysts led by New York-based economist Ted Wieseman wrote in a note Monday.
At Jiangmen Luck Tissue, Zhao is watching to determine whether the market can withstand a price hike. But in the tissue business, there’s not much room for innovation.
In the meantime, a depreciating currency is offering a buffer, helping exporters preserve some margin in local-currency terms even if they keep prices for their goods unchanged in dollars. That may slow any transmission to export prices -- historically closely linked.
The weaker yuan is also one of the driving forces behind the PPI turnaround as it pushes up input prices of the raw materials China’s factories need.
“It’s no coincidence that China let the exchange rate weaken last year when deflationary pressures were high,” said David Loevinger, a former China specialist at the U.S. Treasury who is now an analyst at fund manager TCW Group Inc. in Los Angeles. “While they may not have slayed the deflationary beast, they have at least wounded it.”