China fell into deflation at the consumer level last month for the first time in more than six years as ministers painted a gloomy picture of the economy's near-term prospects.
The 1.6 per cent drop in the consumer price index (CPI) in the year to February, which was bang in line with a Reuters survey of 26 analysts, gives the central bank ample scope to cut interest rates further if need be to boost the economy.
Goldman Sachs said now seemed a "natural point" to lower borrowing costs to ease the financial burden on firms, which are battling a slump in overseas demand and in domestic construction.
Commerce minister Chen Deming and Industry minister Li Yizhong, speaking at a joint news conference, both used the word "grim" to describe the immediate outlook for Chinese exports and the manufacturing sector.
Mr Li said he was encouraged that power consumption had declined at a slower pace in the first two months of the year. But he added, "The situation of industrial production remained grim."
The year-on-year drop in the CPI, reported by the National Bureau of Statistics, was the first since December 2002.
Economists worry that, unless China's 4 trillion yuan ($585 billion) stimulus plan kicks in soon, these deflationary pressures will intensify because the economy is saddled with excess capacity at a time of depressed demand.
By contrast, the government of Premier Wen Jiabao, who has sought to bolster confidence by talking up the economy's fundamentals, expects inflation to average around 4 per cent.
Protracted deflation is debilitating because it encourages consumers to delay purchases and increases the real burden on companies of repaying debts.
If the cost of money is already close to zero, deflation also makes it impossible for central banks to set negative real interest rates.
The government in Beijing, and some private economists, say China's circumstances are different.
The statistics office said the drop in the CPI was largely due to a high base of comparison: in the 12 months to February 2008, consumer prices were up 8.7 per cent, near a 12-year peak, as the cost of food, oil and imported raw materials soared.
Even if prices had not changed last month from the end of 2008, the bureau said, the statistical effect of last year's high inflation rate would have been to drive the CPI down 2.5 per cent.
Moreover, given rapid credit growth and ample liquidity in the banking system, it was not warranted to conclude that China had relapsed into deflation for the third time in a decade, the statistics office said.
Still, it drew attention to a sharp decline in prices of raw materials like crude oil, iron ore and metals due to the global economic slowdown.
This was the driving force behind an acceleration in the pace of decline in China's producer prices to 4.5 per cent in the year to February from 3.3 per cent in the 12 months to January.
In another ominous sign, Chinese urban property prices fell 1.2 per cent in February from a year earlier, the steepest annual decline since official records began in 2005.
Reuters