China risks deeper deflation by diverting exports to domestic markets

As Sky-High Tariffs kills orders for Chinese products, the country has been striving to help exporters divert sales to the domestic market.

The local Chinese government and major companies have expressed support to help tariff-hit exporters redirect their products to the domestic market for sale. jd.com, Tencent Also, Doin, a sister app to China’s Tiktok, is one of the e-commerce giants that promotes the sale of these products to Chinese consumers.

Deputy Commerce Minister Sheng Qiuping described China’s vast domestic market as a key buffer for exporters weathering external shocks, urging local governments to coordinate efforts to stabilize exports and increase consumption.

“The side effects are a fierce price war among Chinese companies,” said Yingke Zhou, Chinese economist at Barclays Bank.

For example, JD.com has pledged 200 billion yuan ($28 billion) to support exporters, setting a dedicated section on the platform for original buyers’ products, and receiving a discount of up to 55%.

The influx of discounted products intended for the US market will also erode profitability for businesses, which will put pressure on employment, Zhou said. The uncertain employment outlook and concerns about income stability have already contributed to low consumer demand.

After slightly above zero in 2023 and 2024, the consumer price index slipped into negative territory, falling for the second consecutive month in February and March. The producer price index fell for the 29th consecutive month in March, down 2.5% from the previous year, marking the sharpest decline in four months.

According to Morgan Stanley’s team of economists, if the trade war cuts export orders, deflation in China’s wholesale prices could deepen from 2.5% in March to 2.8%. “We believe the impact of tariffs will be the most severe of this year as many exporters have stopped producing and shipping to the US.”

Shan Hui, president of Chinese economics at Goldman Sachs, predicts China’s CPI will fall by 0% from 0.2% year-on-year growth in 2024, and PPI will fall by 1.6% from 2.2% last year.

“Prices need to fall for domestic and other foreign buyers to absorb the excess supply left by US importers,” Shan said, adding that manufacturing capacity could not be adjusted quickly to a “sudden increase in tariffs,” and would likely exacerbate the issue of overcapacity in some industries.

Goldman predicts China’s true gross domestic product will grow by just 4.0% this year, despite Chinese authorities setting its 2025 growth target at “about 5%.”

US President Donald Trump ratcheted tariffs on imported Chinese goods at 145% this year, urging Beijing to retaliate with an additional tax of 125% this year. Tariffs at such exorbitant levels have resulted in serious trade in trade between the two countries.

Cooperative efforts from Beijing to support off-road goods for US tariff-affected exporters may not be more than a suspension, says Beijing-based boutique investment bank Changsung & Co.

Loss of access to the US market has deepened tensions with Chinese exporters, with weak domestic demand, augmented price wars, thin margins of razors, delayed payments and high rates of return.

“For exporters who can charge higher prices from American consumers, selling in the Chinese domestic market is just a way to clear unsold stocks and ease short-term cash flow pressures,” Shen said: “There’s little room for profit.”

Squeezed margins could force some export companies to close their stores, but others might choose to go at a loss to ensure that factories do not sit idle, Shen said.

As more businesses stop or shrink operations, fallouts ripple over into the labor market. Goldman Sachs’ Shan estimates that over 2% of China’s workforce are involved in the production of US property.

Last week, the Trump administration ended its “minimum” exemption that allowed Chinese e-commerce companies such as Shane and Tem to ship low-value parcels to the United States without paying tariffs.

Wang Dunn, China Director of Eurasia Group, a political risk consulting firm, said:

She estimates the city’s unemployment rate averages 5.7% this year, surpassing the official 5.5% target, Wang said.

The surge in exports over the past few years has helped China offset the real estate slump that has hit investment and consumer spending, the tense government finances and drag from the banking sector.

Tin Lu, Chief Economist, Nomura’s China Economic Director, Chief Economist, means that the property sector illness, coupled with banned US tariffs, “the economy is set to face two major drags at the same time,” and in a recent memo warns that the risk is a “worst demand shock than expected.”

Despite the demand for a more robust stimulus, many economists believe it is likely that Beijing will wait to see concrete signs of economic degradation before using fiscal firepower.

“The authorities don’t see deflation as a crisis. Instead, (they) framble low prices as buffers to support household savings during the economic transition,” said the King of the Eurasian Group.

When asked about the potential impact of increasing competition in China’s markets, Professor Justin If Lin of Peking University said that Beijing could use fiscal, financial and other target policies to increase purchasing power.

“The challenges facing the US are greater than China’s,” he told reporters on April 21 in Mandarin, translated by CNBC. Lynn is the dean of the new Institute of Structural Economics.

He expects the current tariff situation to be resolved soon, but he did not share a specific time frame. China maintains production capacity, but Lin says it will take the US at least a year or two to re-align manufacturing. This means that American consumers will face tentatively high prices.

– CNBC’s Evelyn Cheng contributed to this story.