China’s Industrial Profits Decline Sharply Amid Rising Deflationary Pressures

China Industrial

Industrial profits in China saw a significant drop in September, declining at an accelerated rate compared to the previous month. According to data released by China’s National Bureau of Statistics (NBS) on Sunday, large industrial firms reported a 27.1% decline in profits from a year earlier, compared to a 17.8% decrease in August. This data indicates that China’s industrial sector is grappling with deflationary pressures, weakening corporate finances, and facing slower-than-expected economic growth.

Over the first nine months of the year, profits in China’s industrial sector dropped by 3.5% from the same period in 2023. This ongoing slide in profitability has raised concerns among economists and policymakers who worry that the challenges facing China’s $18 trillion economy may worsen if fiscal and economic stimulus measures fail to take effect.

China’s industrial sector, including key industries such as manufacturing, mining, and utilities, has seen persistent declines in profitability. The recent data reflects a combination of structural and cyclical challenges that have been exacerbated by the deflationary environment. Since late 2022, China has experienced weak domestic demand and softening producer prices, with deflation in the Producer Price Index (PPI) reaching 24 consecutive months of negative growth.

The decline in factory-gate prices, which measure the cost of goods when they leave the factory, has posed additional challenges for industrial firms, as they face squeezed margins. Lower input prices are typically beneficial for businesses; however, a prolonged period of price deflation can erode profits and discourage investment in the industrial sector. According to analysts at Bloomberg Economics, producer price deflation was a primary factor in the September profit declines, offsetting marginal improvements in industrial output.

The NBS statement pointed to a “high base in the same period last year” as one reason behind the substantial decrease in September’s industrial profits. Last year, China’s industrial sector saw comparatively robust growth due to post-pandemic recovery measures, resulting in a stronger performance baseline. However, this year, as economic growth moderates, the base effect is magnifying the appearance of the slowdown. This issue, combined with cyclical downturns in specific industries such as real estate and construction, has contributed to profit declines.

Industrial profits are an important indicator of the financial health of China’s industrial and manufacturing sectors. Profits in these sectors directly influence investment decisions, affecting capital spending, hiring, and production plans in the months to come. As profits dwindle, firms may delay or scale back investments, posing risks for long-term economic growth.

With slowing growth and deflationary pressures weighing on industrial performance, Chinese policymakers have been taking incremental steps to stabilize the economy. One such measure was the People’s Bank of China’s recent decision to cut interest rates in late September, in an attempt to boost lending and stimulate economic activity. However, questions remain about the effectiveness of these measures in offsetting the current downturn in corporate profits.

Observers and investors are awaiting further policy announcements during a key legislative session scheduled for November 4 to 8, when China’s National People’s Congress (NPC) will convene to discuss economic priorities. Economists widely expect the NPC to unveil a plan aimed at addressing the fiscal health of local governments, which are grappling with high debt levels and limited capacity to fund new projects.

One proposed initiative includes refinancing local government debt and the issuance of sovereign bonds to recapitalize Chinese banks, a move intended to ensure liquidity in the financial system and stimulate credit growth. Many analysts believe these actions could provide much-needed support to local economies and help struggling firms remain solvent.

Investors and financial markets have been closely watching for additional fiscal stimulus, including potential measures like increased public borrowing, larger-scale infrastructure investments, and expanded social spending. Yet opinions are divided as to whether substantial new stimulus will be introduced this year. Some analysts argue that while targeted fiscal measures may be announced in November, China is unlikely to launch the large-scale stimulus seen in previous economic downturns.

Ding Shuang, an economist at Standard Chartered, suggested that policymakers may favor cautious fiscal management to avoid further increasing debt levels. “We may see the government approve some support measures, particularly for sectors facing acute stress, but a broad-based stimulus package may be held back until there are signs of deeper economic distress,” Ding noted. Others point to China’s emphasis on sustainable economic growth and concerns over accumulating unsustainable levels of debt, which could be limiting its policy flexibility.

China’s economic growth has slowed in recent months despite some positive indicators in September, such as higher industrial output and increased consumer spending. In the third quarter of 2024, China’s gross domestic product (GDP) grew by 4.6% year-over-year, marking the slowest pace of growth since March 2023. This moderation has dampened expectations of a strong recovery and underscores the need for additional policy interventions to sustain economic momentum.

Though China’s economy expanded in September, the growth rate fell short of the government’s initial projections, leading to renewed pressure on policymakers to implement supportive fiscal measures. Economists have warned that without meaningful stimulus, China’s economic expansion may continue to decelerate, given the headwinds in industrial profits, local government finances, and declining export demand.

China’s industrial sector has responded to the ongoing downturn by adopting cost-cutting measures, focusing on operational efficiencies, and prioritizing projects with higher return on investment. Large enterprises, particularly in the manufacturing and mining industries, have taken steps to streamline production and reduce expenses to maintain profitability in the face of slower demand.

However, there are growing concerns that these measures may not be sufficient to reverse the profit decline in the near term. Companies in the construction and infrastructure-related sectors, which have traditionally played a key role in China’s growth, are especially vulnerable. Many firms are increasingly looking to reduce capital expenditures, with some halting new investments until they see signs of stabilization in the broader economy.

The real estate and construction sectors have been among the hardest hit by China’s economic slowdown. The downturn in these industries has had a ripple effect, impacting related sectors such as steel, cement, and energy, which are closely tied to real estate development. In September, both the construction and property development sectors saw a sharp drop in new projects, leading to reduced demand for raw materials and lower industrial output.

In response to the downturn, the Chinese government has implemented policies aimed at stabilizing the property market, including easing restrictions on homebuyers, encouraging real estate transactions, and providing credit support to property developers. However, many analysts contend that these efforts may not be enough to turn around the real estate sector in the short term, as potential buyers remain hesitant and construction activity continues to slow.

China’s industrial sector remains uncertain. Deflationary pressures and weaker domestic demand present ongoing challenges for policymakers aiming to steer the economy back toward a stable growth trajectory. The outcome of the upcoming National People’s Congress session could play a pivotal role in shaping market expectations, as investors await decisions on fiscal policies that could bolster economic activity.

If meaningful fiscal measures are enacted, China’s industrial sector may see a modest recovery, especially in industries like manufacturing, infrastructure, and technology, which stand to benefit from increased public spending. However, if the government opts for a more restrained approach, the industrial sector could face prolonged challenges, with corporate profits remaining under pressure amid an uncertain global economic environment.

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