Beyond oil woes: Healthy price recovery matters

Recent tensions in the Middle East have been impacting global oil prices. WTI crude futures stood high above $98 per barrel on the woes haunting the Strait of Hormuz on Friday. Rising oil prices are bound to feed through to both China's producer price index and consumer price index. Based on historical estimates, every 10 percent year-on-year increase in oil prices could push up China's PPI and CPI by about 0.4 and 0.1 percentage point, respectively.

At first glance, this appears to align with the policy direction outlined in the 2026 Government Work Report, which calls for "turning the overall price level from negative to positive and promoting a moderate recovery in consumer prices".

However, it is important to clarify that oil-driven price increases do not equate to a "reasonable recovery" in prices. Inflation should not be pursued for its own sake. It is essential to distinguish between "good" and "bad" inflation, as well as between demand-driven and cost-push inflation, and to prepare policy responses accordingly.

The significance of macroeconomic targets lies not in the numbers themselves, but in the real conditions they reflect at the micro level.

The 2026 GDP growth target of 4.5 to 5 percent is not about generating output through inefficient investment or inventory buildup, but about encouraging enterprises to expand investment — and households to increase consumption — thereby restoring a genuine internal economic cycle.

Similarly, an inflation target of around 2 percent is not about simply raising prices, but about breaking the negative loop of "weak prices leading to delayed consumption and investment, which in turn dampens economic activity", and fostering a sustainable environment of improved corporate profitability and rising household incomes.

In other words, what matters is not necessarily inflation, but the underlying economic dynamics it reflects. The core policy objective is to rebuild and sustain a virtuous mechanism, in which businesses remain profitable, employment and incomes are stable, and confidence in the future is strengthened.

This makes it necessary to differentiate among sources of inflation. China does not need stagflation driven by supply shortages, nor runaway inflation caused by excessive monetary expansion, nor asset bubbles that inflate prices without supporting the real economy. What is needed is moderate, demand-driven price growth.

Price increases driven by supply constraints are not a sign of economic improvement; they often lead to stagflation, where prices rise but growth weakens. Inflation caused by excessive liquidity may create a short-term illusion of prosperity, but it typically ends in high inflation and wealth redistribution. Asset price surges without corresponding real economic growth can exacerbate inequality and accumulate various financial risks.

By contrast, moderate, demand-driven inflation reflects a fundamentally different dynamic. As demand recovers, enterprises typically expand production, profitability improves, and employment and incomes stabilize.

Restored confidence among market participants further supports consumption and investment. In such a virtuous cycle, moderate price increases are not artificially engineered, but rather a natural outcome of a healthy economic recovery. This is the true meaning of promoting a reasonable rebound in prices.

Against this backdrop, oil-driven increases in PPI and CPI may appear consistent with policy goals, but in reality, there is a clear mismatch.

China's current subdued price levels are primarily due to insufficient effective demand, whereas the desired price recovery is demand-driven. Oil price increases, by contrast, represent cost-push or imported inflation stemming from supply shocks, and may generate several adverse effects.

First, cost-push inflation raises living expenses, with a disproportionate impact on low and middle-income groups. Unlike demand-driven inflation, which is often accompanied by income growth, cost-push inflation directly increases household expenses, making the burden more acutely felt.

Energy and food account for a larger share of spending among lower-income households, meaning higher oil prices can significantly erode their purchasing power through increased transportation and food costs.

Second, downstream enterprises may face a dual squeeze from rising input costs and tepid demand, leading to shrinking profits and lowered expectations.

As oil price increases spread across the industrial chain, costs for transportation, chemical inputs and agricultural materials all rise. However, in the context of weak end-user demand, many firms struggle to pass on these higher costs, resulting in further margin pressure.

Third, imported inflation can weaken China's terms of trade and increase pressure on foreign exchange outflows, posing challenges for the stability of the renminbi.

As one of the world's largest crude oil importers, with imports reaching 580 million metric tons in 2025, China faces higher import costs when oil prices rise. This means more domestic resources and exports are required to sustain the same level of imports, while increased energy import bills may weigh on the current account and foreign exchange reserves.

Fourth, inflation driven by supply shocks may constrain monetary policy efforts aimed at stabilizing growth. With the economic recovery still on an uncertain footing, there are strong market expectations for further easing measures.

However, if rising oil prices push the CPI significantly higher — particularly above 2 percent — the central bank may face greater pressure to balance price stability with growth objectives, complicating policy implementation.

That said, under the current environment of persistently low inflation, imported inflation may also bring some unintended positive effects. It can help lift inflation expectations and break the self-reinforcing cycle of weak prices.

China has experienced subdued price growth in recent years, with the GDP deflator remaining negative for 11 consecutive quarters, the PPI for 41 months and the CPI staying well below the 2 percent target. Persistently low inflation expectations may lead businesses to delay investment and consumers to postpone purchases.

A moderate rebound in price indicators, even if driven by external factors, could help interrupt this cycle.

It may also improve conditions for upstream industries and lower real interest rates. While cost pressures weigh on downstream sectors, higher prices can support profitability in upstream industries such as energy and chemicals. At the same time, a rebound in the PPI helps reduce real interest rates, easing debt burdens and supporting credit demand.

In addition, rising prices can boost fiscal revenue and ease local government debt pressures. Tax revenues such as value-added taxes and resource taxes are closely linked to price levels. A recovery in prices expands the tax base and supports nominal GDP growth, which in turn helps improve the debt-to-GDP ratio and creates more room for proactive fiscal policy.

In terms of policy response, it is important to look beyond headline data and adopt a coordinated approach across supply-side measures, targeted support and macro policy stability.

On the supply side, strengthening energy security can help cushion the impact of global oil price volatility. This includes flexible use of strategic petroleum reserves, effective use of domestic pricing mechanisms and efforts to diversify energy imports while accelerating the development of renewable energy.

Targeted support should be provided to businesses and households. This could include temporary tax relief or subsidies for impacted industries, as well as targeted assistance for low-income groups to mitigate the impact of rising living costs and support consumption.

At the macro level, policymakers should maintain strategic focus, pay close attention to core CPI and output gaps, and strengthen expectations management. As long as supply shocks are temporary and do not trigger a wage-price spiral, there is no need for premature policy tightening.

Given that insufficient demand remains the key challenge, monetary policy should continue to support liquidity and reduce financing costs, while clearly communicating policy intentions to avoid market misinterpretation.

The writer is chief economist and head of the research institute at Yuekai Securities.

The views do not necessarily reflect those of China Daily.