By Kevin Yao and Liangping Gao
BEIJING, March 20 (Reuters) – China’s long fight with deflation risks morphing into something harsher, with economists warning the war in Iran could spark “bad inflation” at a time when chronically weak consumption and fading external demand leave the economy with little cushion.
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 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.
At a Beijing job fair in mid-March, 25-year-old Justin Zhang, looking for marketing or tech consulting roles, said he received no job offers after 700-800 online applications.
“It feels like they disappeared into a void,” Zhang said. “It’s been really hard.”
EXTERNAL DEMAND SHOCK?
China is better shielded against the crisis than much of Asia or Europe, but it still needs a strong global economy to hit its 4.5%–5% growth target this year without resorting to unplanned stimulus.
Much of China’s 2025 expansion was underwritten by trade, with the surplus jumping a fifth to a record $1.2 trillion – roughly the size of the entire Dutch economy.
“For China, the main threat from the Iran conflict is that it could retard consumption globally, with obvious consequences for Chinese exports,” said Alicia Garcia-Herrero, Asia-Pacific chief economist at Natixis.
“This will further reinforce the weakness of domestic demand in China, with less investment from profitless companies and deceleration of consumption” as wages come under further pressure, she added.
Garcia-Herrero cited models showing a 25% rise in oil prices would shave 0.5 percentage point off China’s GDP growth.
Still, she noted, the energy shock that followed Russia’s invasion of Ukraine in 2022 weakened Western production relative to Chinese exporters, which retained access to cheap oil from Venezuela, Iran and Russia – with only the latter now still guaranteed to flow.
Fred Neumann, chief Asia economist at HSBC, says China’s wide electric vehicle adoption, and high capacity in solar, wind and batteries further bolster its global competitiveness.
“However, even if China in this scenario gains global export market share, it would still face weaker overall external demand growth, leaving it with persistent headwinds to GDP growth,” he said.
China’s latest five-year plan, drafted before the Iran war, charts a future driven by industrial and technological muscle, not consumption.
With the Middle East conflict now threatening external demand, that calculus may need a rethink.
“The only sustained way to realign supply and demand in China is to support household incomes through long-term fiscal support,” Neumann said, describing this as “a monumental task.”
(Additional reporting by Ellen Zhang in Beijing; Editing by Marius Zaharia and Shri Navaratnam)
