China's producer inflation will retreat markedly in December, increasing the possibility of deflation, Liu Mingkang, chairman of China Banking Regulatory Commission (CBRC) said in Beijing on Saturday.
The producer price index (PPI) fell to 2 percent in November, down from 6.6 percent in October. It is at the slowest pace since May 2006, as prices in fuel and commodities declined.
"PPI drops more sharply than consumer inflation during economic slowdown and this will mercilessly drag down consumer prices," Liu said at the Caijing 2009 Annual Conference in Beijing.
The consumer price index (CPI), the main gauge of inflation, slowed to 2.4 percent last month, down from 4 percent in October.
"We expect the CPI to drop to about 1.2 percent in December and become negative no later than February 2009," Merrill Lynch said in a research note on Thursday.
Many major world economies have entered into a recession and this has a big impact on China, Liu said.
"It's a fairy tale to think China will remain immune from what's happening in the rest of the world."
Emerging economies face bigger challenges, including faltering external demand and outflow of capital, he stated.
The Chinese economy cooled sharply as growth in exports and property investment slowed. The growth pace was 9 percent in the third quarter, down from 10.4 percent in the first half.
Economic data released this week showed further risks to the economy. Exports in November slid 2.2 percent year-on-year, the first monthly decline since June 2001. It's down from 19.2 percent growth in October.
China is targeting around an 8 percent gross domestic product (GDP) growth rate for 2009 despite the challenges, Liu noted.
The GDP growth pace can't be allowed to slow to 6 to 7 percent as growth is needed to ensure sufficient employment and safeguard social stability, he added.
China has cut its lending rate four times since mid-September, with the latest reduction of 1.08 percentage points, and unveiled a 4 trillion yuan ($586 billion) stimulus package to avert an economic slump.
The banks are increasing loans to coordinate the fiscal stimulus package, raising worries this could lead to more bad loans when the economic growth slows.
Lenders should extend more loans to energy-saving and environmentally friendly sectors and help industries upgrade while improving risk control, Liu said at the financial conference.
The CBRC targets a lower non-performing loan (NPL) ratio next year, but it will "scientifically tolerate" any increases in the stockpiles of bad loans, he added.