China plays down deflation fears

China’s consumer price index, its main inflation benchmark, fell to minus 1.6% in February, but officials downplayed the risk that the country is succumbing to a potentially debilitating deflationary spiral.

A 1.9% decline in food prices, a major component of the index, and declines in international commodity prices helped to drag the index below zero, the National Statistics Bureau reported today.

The data – the first negative reading since December 2002 – suggests China can afford to cut interest rates further to help spur economic growth, analysts said.

While falling prices might seem welcome to consumers, a long spell of deflation can drag on economic growth by cutting profits and increasing debt burdens, prompting companies to slash jobs and investment.

“Deflation is the symptom of a weak real economy and industrial overcapacity, which has left companies with little pricing power,” Jing Ulrich, JP Morgan’s chairwoman of China equities, said in a report today.

But she said that the deflationary trend was likely to be only temporary and should be reversed as the impact of government spending to stimulate demand takes hold.

Last year, China had the opposite concern about accelerating inflation, which peaked at a 12-year high of 8.7% in February 2008, amid shortages of grain and pork.

But it has since eased as the economy slows, raising worries that deflation might sap China’s ability to bounce back.