The war involving Iran is creating ripple effects far beyond the Middle East, with economists warning it could push China out of deflation and into a far more damaging phase of “bad inflation.”
For years, China has struggled with weak demand, falling prices and excess industrial capacity. Now, a surge in global energy costs risks reversing that trend not through stronger growth, but through rising production costs.
While Beijing has some protection thanks to large oil reserves, a diversified energy mix and tight market controls, the scale of the shock is testing those buffers.
Producer Prices Turning Point
Rising oil prices are at the center of the shift.
Brent crude has jumped about 45 percent since the conflict began on February 28, sharply increasing input costs for manufacturers.
Economists estimate that a 10 percent rise in oil prices could push producer price inflation up by 0.4 percentage point, potentially turning it positive as early as March after more than three years in negative territory.
But this is not the kind of inflation policymakers want. It is driven by higher costs rather than stronger demand, meaning companies face pressure without the ability to raise prices significantly.
Why This Is ‘Bad Inflation’
The risk lies in how the shock spreads through the economy.
China’s manufacturing sector, the largest in the world, already operates on thin margins. About a quarter of firms are reportedly running at a loss due to overcapacity and intense competition.
Higher energy and raw material costs will likely squeeze profits further. Instead of passing those costs on to consumers, many firms are expected to absorb them, cutting into wages and hiring.
This explains why consumer inflation is expected to rise only slightly, even as production costs surge.
The result is a damaging combination: rising costs, weak demand, and pressure on jobs.
Strain on Workers and Demand
The impact is already visible in the labor market.
Income growth is slowing, and more than half of workers did not receive a pay raise last year. Some even took pay cuts. Youth unemployment remains elevated, with many struggling to find work despite hundreds of applications.
As wages stagnate or fall, consumer spending weakens further, reinforcing the very deflationary pressures China has been trying to escape.
This creates a cycle where businesses face higher costs but weaker demand, limiting growth prospects.
External Demand at Risk
China’s economy still depends heavily on global trade.
A slowdown in global consumption triggered by higher energy prices could hit Chinese exports, which have been a key driver of growth. Economists warn that a sharp rise in oil prices could shave noticeable points off GDP growth.
Even if China gains some competitive advantage due to its investments in electric vehicles and renewable energy, weaker global demand would offset those gains.
Analysis
This is a classic case of a bad exit from deflation.
In a healthy scenario, prices rise because demand is strong and incomes are growing. In China’s case, prices risk rising because costs are increasing while demand remains weak.
That distinction matters. Cost driven inflation erodes profitability, discourages investment and puts pressure on employment.
China’s structural issues make the situation more fragile. Years of overproduction, price wars and reliance on exports mean the economy has limited resilience to absorb external shocks.
The Iran conflict adds another layer of uncertainty. It threatens energy supply, disrupts trade routes and weakens global demand, all of which feed directly into China’s vulnerabilities.
The bigger question is whether this moment forces a strategic shift.
China’s growth model has long relied on manufacturing and exports. But with both under pressure, economists argue that boosting household income and domestic consumption is the only sustainable path forward.
That transition, however, is complex and slow.
If the war driven energy shock persists, China may find itself caught in the worst of both worlds: not deflation, not healthy inflation, but a prolonged period of weak growth with rising costs.
With information from Reuters.
