Taming the inflation tiger

Updated: 2011-06-17 11:56

By Lu Chang and Ariel Tung (China Daily European Weekly)

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 Taming the inflation tiger

A customer picks vegetables at a supermarket in Yichang, Hubei province. China's CPI rose 5.5 percent to a 34-month high in May. Liu Junfeng / for China Daily

Economic indicators allay hard landing fears, growth pressures

The flurry of economic indicators that came out recently indicates that inflation pressures may persist in the short term but will taper out in the long run.

The indicators also offer room for policymakers to tackle the fight against inflation without any further tinkering of the monetary policy, say experts.

China's inflation rose 5.5 percent to a 34-month high in May, from 5.3 percent in April.

The figure prompted the People's Bank of China, the central bank, to raise the reserve requirement ratio for commercial lenders by 50 basis points. It marked the sixth such change in recent times and took the total ratio to 21.5 percent, triggering fears of a funding crunch.

"The timing of the hike took the market by surprise," says Chang Jian, an economist with Barclays Capital.

"That means inflation still remains the predominant risk," Chang says, adding that slower growth may be necessary to combat inflation.

The producer price index, the gauge of factory-gate prices, rose 6.8 percent in May from a year earlier, which adds to the possibility of further monetary tightening policies.

Peter Pak, executive director of BOCI Research Ltd, an investment research firm, says inflationary pressure is likely to persist in both June and July.

"There is a chance for the CPI to hit the 6 percent mark this summer, and the central bank tends to use the reserve requirement ratio as a tool for controlling liquidity," Pak says.

Inflation in China has largely been driven by spiraling food and energy prices, triggered by short supply and extreme weather conditions.

Taming the inflation tiger

Prices of key agricultural commodities are expected to moderate over the next 12 months as weather patterns are expected to be normal this year. At the same time, oil prices are also expected to moderate over the next few months. With both these factors dropping out of the inflation purview in the longer term, the CPI is also expected to moderate further, say experts.

"China's economy showed a slight slowdown in two consecutive months under the tightening measures," said Sheng Laiyun, spokesman for the National Bureau of Statistics, at a news conference on June 14.

"Meanwhile, the slower-than-expected recovery and high unemployment in developed countries have reduced export demand. But China's economic growth remains stable and taming inflation is the government's priority," Sheng says.

Fan Ying, professor of economics at China Foreign Affairs University, says that an appreciation of the yuan is still on the cards, especially because the central bank just increased the reserve requirement ratio. "Raising the reserve requirement ratio means China is not likely to increase interest rates," Fan says. "That makes a faster appreciation of the yuan more likely because a rise in the value of the yuan will help tame inflation."

But Fan is worried that an appreciation of the yuan will spur more foreign investment to China, as overseas investors may capitalize on interest gains and this in turn would reduce local borrowing.

Yukon Huang at the Carnegie Endowment for International Peace says that he's not worried about China's inflation as long as the economy continues to grow. However, if inflation stays at 5 to 6 percent, it can create social problems because citizens will complain. On the other hand, inflation is not totally bad as it has an income distribution effect.

"The interesting thing is that higher prices will benefit the rural people who are agricultural producers. The income of those rural areas will be increasing faster. No one realizes that this inflation will help shift income from the urban people to the rural people," Huang says.

Li Quan, deputy director of the International Trade and Economics School at Peking University, says the inflation rate may further weaken demand for Chinese goods in Europe as the European Union continues to struggle with a debt crisis.

"As costs are increasing in China, its exports become more expensive and its imports cheaper. This will further slow down exports from China to Europe as demand has already been weakened due to the debt crisis," says Li. "As a consequence, it will reduce China's trade surplus."

China exported $48 billion (33.4 billion euros) to European countries in May, with a trade surplus of $10.56 billion shrinking by 12 percent from a year earlier, while imports from the EU surged to $18.72 billion in May with an increase of 35 percent compared to April.



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