China’s prolonged struggle with deflation could turn into a harsher phase, with economists warning that the Iran war may trigger “bad inflation” just as weak consumption and slowing external demand leave the economy with little buffer.
Beijing’s deep strategic oil reserves, diversified energy mix and tightly regulated energy market give it a buffer few developed economies enjoy, particularly in Europe, where stagflation risks are rising.
Nonetheless, an input-cost shock to the world’s largest manufacturing base, which employs hundreds of millions, threatens to squeeze already thin margins, piling pressure on jobs and wages.
Producer Prices Poised To Turn Positive
Analysts at Gavekal Dragonomics and Soochow Securities estimate that a 10% oil-price rise could lift producer price inflation, currently at minus 0.9%, by 0.4 percentage point.
Brent oil prices LCOc1 have risen 45% since the U.S.-Israeli strikes on Iran began on February 28, putting factory-gate prices on course to turn positive as early as in March for the first time in over three years, barring a swift end to the Iran conflict and a recovery in energy supply.
Yet for Beijing, escaping deflation this way would be cold comfort.
“There is good inflation and bad inflation. Pure cost-push inflation is not what we want to see, as it can squeeze corporate profits,” said Shuang Ding, chief China economist at Standard Chartered Bank.
This shock to input costs – now spreading beyond energy as commodities bypass the Strait of Hormuz – comes as about a quarter of manufacturing firms are already operating at a loss.
Years of industrial overcapacity and steeper U.S. tariffs have gutted margins, driving relentless price wars on multiple fronts.
Chinese Firms To Absorb The Shock
Costlier energy and raw materials risk further squeezing jobs and wages, depressing consumer demand. This partly explains why economists estimate consumer prices would only rise 0.1-0.2 percentage point for every 10% increase in oil prices.
“With intense competition and limited pricing power, firms are more likely to absorb higher input costs through margins rather than pass them on,” said Michelle Lam, chief China economist at Societe Generale.
Per-capita disposable income rose 5% in 2025, slowing for a second-straight year, official data shows.
But a survey by recruitment firm Hays, released on Wednesday, showed 51% of employees in China did not receive a pay rise last year – the highest in Asia, where the average is 36%. A tenth even took a pay cut.
Half of the Chinese surveyed expect their salaries to stay flat or decline this year.
Some 16% of youth are unemployed.
(With inputs from Reuters)
