CHINA’S INFLATION PROBLEM GETTING WORSE

China’s central bank surprised the market on October 19 when it raised interest rates 25 bps in spite of a slowdown in GDP growth image to 9.6% in Q3 from 10.3% in Q2. Given that the previous 2002-2007 cycle growth averaged 10.3%, China’s economy is nowhere near overheating. The fact is that monetary policy remains very stimulative with real rates below 2% at a time when inflation is again raising its ugly head.

The CPI has shown a clear acceleration throughout 2010, rising to a 23-month high of 3.6% in September, up from 3.5% in August, 3.3% in July and 2.9% on average during the first 9 months of 2010. Meanwhile, the PPI has decelerated from +7.1% YoY in May to 4.3% in September. However, it jumped 0.6% MoM in September.

imageimage

It is true that the bulk of the CPI increase lately has originated from sharply rising food prices which have continued to rise in October. But other prices are starting to feel the pressures from rising commodity prices and higher wages. Markit’s China PMI Delivery Times Index suggests that supply shortages remain widespread, pointing to further price pressures ahead.

image

Recently released PMI reports for China revealed increasing inflation pressures. First from the October Manufacturing PMI:

According to the China Federation of Logistics and Purchasing (CFLP), six of the 11 sub-indices, including production, input prices and new orders, increased in October by a month-on-month basis. The input prices index rose the most, up 4.6 percentage points from a month earlier to 69.9 percent.  "China will face relatively high inflation pressure in the near future," said the CFLP statement.

And from the October Non-Manufacturing PMI:

Deputy Chairman of the CFLP Cai Jin noted that the index has stayed above 60 percent for four consecutive months, reflecting the steady performance of the service sector. Cai said the continuous rise in input prices will put further pressure on prices in the service sector, adding that the government should closely monitor the market and take measures when necessary.

The PBoC targets 3% annual inflation and it has just shown that it intends to take measures to reach this target.

China should shift its monetary policy toward a "cautious" stance to combat high inflationary pressure and the risk of asset bubbles, central bank advisor Li Daokui said on November 2nd.

In case you wonder whether Chinese authorities will seriously fight inflation, read Wen Links Inflation to Communist Party Future. On March 15, 2010, Wen Jiabao clearly stated: controlling inflation is the Communist Party’s top priority. At that time, inflation in China was but +2.7% but close enough to the 3% target and in sharp acceleration.

Wen Jiabao, the Chinese premier, put tackling inflation at the top of the policy agenda on Sunday and suggested that the survival of Communist party rule might depend upon it. (…)

“If there is inflation plus unfair income distribution and corruption, it will be strong enough to affect our social stability and even affect the stability of state power,” Mr Wen said in his annual press conference at the close of the national people’s congress, China’s rubber stamp parliament.

“It will be an extremely difficult task for us to promote steady and fast economic growth, adjust our economic structure and manage inflation expectations all at the same time, but it is imperative for us to accomplish these three tasks.”

It thus seems pretty clear that, barring a sudden and unlikely decline in inflation rates in coming months, China’s monetary authorities will keep ratcheting interest rates up towards the 4-5% real rate level. This will surely unsettle equity and commodity markets which will rightly fear a slowdown in China’s growth rate when Western economies continue to struggle. Furthermore, protectionism will return to the forefront as China will want to refrain from letting the renimbi appreciate while it is applying the monetary brakes.

 

One thought on “CHINA’S INFLATION PROBLEM GETTING WORSE

  1. Pingback: China’s Crazy Foreign Currency Policies | Tales of Two Nations

Leave a Reply

Your email address will not be published. Required fields are marked *