The major indicator of deflation - the consumer price index (CPI) - registered a year-on-year drop of 0.8 percent in the first five months of this year, and the rate is 1.9 percentage points higher than that of the same period last year.

Urban consumer prices declined by 1.1 per cent year-on-year, rural prices fell by 0.2 per cent, and the trend is expected to continue into the second half of this year.

Statistics show that in the first six months of this year, the overall CPI might fall by 0.9 per cent, further adding deflationary pressure.

Although the CPI last year showed a slight rebound, rising 0.7 per cent, a downward trend began in the fourth quarter. In the first two months of this year, generally a busy season for domestic consumption, the CPI continued to fall, registering a drop of 0.5 per cent year-on-year.

Insufficient demand remains the major reason contributing to the decline in consumer prices, while the lowering of tariff levels following China's entry into the World Trade Organization (WTO) and a soft world market also fuelled the drop in prices.

In the first five months, total consumption volumes nationwide rose by 8.6 per cent year-on-year. The growth was encouraging, but the rate was 1.7 percentage points lower than in the same period last year.

Considering the massive salary hike public servants received last year and the growth of residents' income in 2002, the slowdown in the growth rate is quite noticeable.

In the first quarter, per capita disposable income of urban residents rose by 16.2 per cent to 2,126 yuan (US$256.1), and per capita cash income of rural residents grew by 7.2 per cent to 682 yuan (US$82.2).

The fact that income growth did not greatly stimulate consumption suggests reduced demand among Chinese residents.

The lowered tariff rate for imports, which was reduced from 15 per cent on average to 12 per cent this year, also played a part in the decline of consumption prices.

The slowdown of the country's economic growth further exacerbated the problem. The continuous decrease in the economic growth rate in the four quarters of last year has led many to lose their confidence in fast economic growth. And dampened confidence has curbed consumption.

On the other hand, holiday consumption, which used to be effective in fighting deflation, also lost some of its strength.

While certain conditions contributing to dwindling consumer prices are to remain unchanged in the second half of this year, other factors are expected to worsen the overall price situation.

With the arrival of the harvest season, the oversupply of agricultural products will become more striking in the later half of the year, since it will lead to price declines of agricultural products.

Slim enterprise profits have caused a decline in residents' incomes - a bad situation made worse by a rising unemployment rate. The urban unemployment rate is estimated to reach 7 per cent in the next three years. By 2005, a total of 50 million new labourers are expected to enter the job market in China, with the amount of newly created jobs unable to keep up with the pace.

Reduced incomes coupled with rising unemployment have changed the consumption habits of residents. A large number of residents are choosing to save their money in case of a rainy day.

At the beginning of this month, total bank deposits in China surpassed 8 trillion yuan (US$963 billion), rising 16.2 per cent over the same period last year.

Due to the rise in savings and drop in consumption, prices in the third quarter are expected to keep falling.

If the world economy improves in the last quarter of this year, consumer prices could see a slight recovery, but the CPI for the whole year is estimated to fall by 1 per cent.

To curb declining prices, powerful economic policies are urgently needed.

The author is a senior analyst with the National Bureau of Statistics.

(Business Weekly July 10, 2002)