While the eyes of the world are fixed on the US Federal Reserve’s policy meeting later this week and the trajectory of American inflation, observers of the Chinese economy are closely tracking a different metric: the producer price index (PPI).

For the world’s manufacturing powerhouse, factory-gate prices have long served as a key barometer of the country’s economic health, and early signs of a recent rebound have raised questions about whether it is a solid, sustainable recovery or a mere flash in the pan.

“PPI is one of the most important indicators for gauging China’s economic cycle,” said Raymond Yeung, chief Greater China economist at ANZ Bank.

“Over the past 10 to 20 years, movements in PPI have reflected the health of China’s economy more accurately [than gross domestic product].”A look back at the past decade reveals that China’s two major PPI upswings were driven by tangible improvements in supply and demand fundamentals – first during Beijing’s 2015 “supply-side structural reform” initiative, and later amid a pandemic-driven surge in global reliance on Chinese manufacturing.

In late 2015, Beijing launched supply-side reforms to cut excess capacity in industries, such as steel and coal, which propelled a jump in PPI. The index reversed from a 5.9 per cent year-on-year decline in December 2015 to 7.8 per cent growth in February 2017, according to data compiled by financial data provider Wind.

The next major PPI upswing came during the Covid-19 pandemic, when lockdowns disrupted supply chains across much of the world, while China’s vast and resilient manufacturing base helped meet surging global demand for goods, driving up factory-gate prices.

China’s PPI then climbed from a 3.7 per cent year-on-year decline in May 2020 to a peak of 13.5 per cent in October 2021, according to official data compiled by Wind.

Over the past few months, the country’s PPI is once again showing fresh signs of recovery, particularly following global energy market volatility and surging semiconductor prices amid an ongoing tech supercycle.

In March this year, as the US-Israel war on Iran drove up global energy prices, China’s PPI emerged from more than three years of negative territory and climbed to reach 5 per cent year on year in September, its highest rate since mid-2022.

But analysts are sceptical that the latest rebound signals a fundamental improvement in supply-demand dynamics, as seen in the previous two upswings.

“The situation this time is different from the past rounds, as it is primarily driven by imported inflation,” said Yeung from ANZ.

While upstream industries holding inventory might benefit from the surge in bulk commodity prices, Yeung cautioned that downstream companies are likely to suffer from rising costs.

David Zhang, a macroeconomics and policy analyst at Trivium China, said the latest rebound was “very different” from 2016, when supply-side capacity cuts were accompanied by a property and infrastructure investment boom that boosted demand.

“Today, domestic property and investment demand remain weak, while overcapacity has yet to be fundamentally addressed. It is difficult to interpret the rebound as a sign of a broad-based improvement in domestic supply-demand dynamics,” he said.

“Domestic end-demand [also] remains weak, leaving companies with limited room to pass on costs to consumers.”Meanwhile, Beijing’s campaign to curb “involution”, or cutthroat competition, has emerged as another key policy variable for economists to watch, though any meaningful structural improvement will take time to materialise.

“Using policy tools to reduce overcapacity and control cutthroat competition will take a relatively long time to actually reflect in the true PPI cycle,” Yeung said.

Zhang said the anti-involution campaign had made some initial progress, mainly in curbing disorderly price competition in the short term.

“Addressing the structural supply-demand imbalance – and actually getting excess capacity to exit the market – is much more difficult and will take longer,” he said.