Last week we mentioned that the Chinese character zhang had been selected by the country’s netizens in an online poll as the most representative word for 2010.
The term means ‘price rise’, and trumped a series of rather depressing candidates like yuan (meaning resentment), hui (grey), chai (demolish) and si (death) for first place.
And at the beginning of a new calendar year, there’s little doubt that zhang continues to strike a chord in the public mood. So this week WiC offers a recap of where China stands in inflationary terms, where it could be headed, and what it might do to counter rising price pressures for the remainder of 2011.
A year-end shock?
“Surprised on the upside” has been HSBC’s assessment of consumer prices since October last year. The most recent data – for November 2010 – saw the CPI hit a 28 month high, up 5.1% in year-on-year terms.
Food prices made up about three quarters of the overall increase, although there were also contributions from higher residential costs (rental and utilities) plus things like the rising cost of cotton bumping up clothing expenses.
That was enough of a trend for the State Council to put inflation at the top of its agenda for December’s Central Economic Work Conference, the annual (closed-door) session that hammers out the economic policies for the forthcoming year. The post-meeting communiqué for the same event in late 2009 didn’t flag inflation for standalone comment, although at the time WiC speculated that this might well change in the year ahead (WiC42). It turned out we were right…
What can the government do today?
One tactic getting headlines is price controls, especially on food, something we discussed at the end of the last year (WiC87). We also looked at efforts to hold down power prices (see WiC86 for some of the background here). In December an NDRC directive reminded that coal producers “should not raise prices in any form”.
Actually, it looks like December’s inflation numbers may slow a little (they’re due out next week), offering signs that some of the price caps may be getting traction (food makes up over a third of China’s CPI basket, and so has a huge influence on the top line number).
Still, economy-watchers will know not to celebrate on the basis of a single month’s data, especially as HSBC says that Chinese experience from similar campaigns in 2004 and 2008 suggests that prices stay high for at least six months after measures have been introduced.
Price controls also won’t work beyond the short term, says Patrick Chovanec, an academic from Tsinghua University’s School of Economics and Management who often appears on state broadcaster CCTV. He’s been cautioning against thinking that the battle is already won, and offers a comparison from last spring, when measures were taken to cool real estate prices, including instructions to developers to take some of their more expensive properties off the market. As a result, average prices did drop. But they recovered within a month or two. It was premature to declare victory then, and it is again today, Chovanec reckons.
China Energy Sector, an industry blog, is similarly pessimistic about the efforts to hold down coal prices. Many coal producers will simply not ship supply until additional fees are paid, it says, or will substitute lower grade coal or demand that power plants purchase through intermediaries who then charge additional fees. The measure’s worst possible outcome would be coal shortages, a situation that would lead to damaging power cuts.
Credit only where it’s due…
Another area for focus in 2011 is credit tightening. Simply put, too much money continues to slosh around the Chinese economy (19.1% growth in M2, a measure of money supply, in November, compared to a 3.3% growth in M2 in the US over the same period, worried the Southern Weekly).
Then on Tuesday the data for December was released, showing 19.7% growth for the month, overshooting official expectations by a “long mile”, noted Qu Hongbing, HSBC’s Co-Head of Asian Economics Research.
Although Washington’s latest round of quantitative easing has come in for criticism from the Chinese media, much of the loose credit stems from domestic lending. The country’s banks lent nearly Rmb8 trillion ($1.2 trillion) last year, down on the Rmb9.6 trillion the year before but still almost twice as much as any other year before that.
Others wonder if credit growth is more than reported, including ratings agency Fitch, which estimates that at least $450 billion has been shunted off bank balance sheets through the repackaging of loans as investment products (something first discussed in March last year in WiC53). “In reality lending has not moderated, it has been diverted into other channels,” Fitch concludes.
Of course, that raises questions about whether loan quotas are effective tools, and there has been no announcement of the usual system-wide quota for lending this year (in part, some suggest, to make it more difficult for banks to game the system, but also to give the central bank more leeway once it sees how growth and price levels are shaping up).
It also looks like limits will be set for individual institutions rather than at an industry level. Shirley Yam, writing in the South China Morning Post, says tougher monthly inspections on credit and capital levels will come to the fore, with regular usage of reserve ratio requirements. Previously, banks have often run short term offers with attractive rates of interest to pull in customer deposits immediately before an inspection period, but then withdrawn them once deposit-to-loan tests are completed. Still, HSBC thinks that Beijing’s efforts to rein in credit can work. There were six reserve ratio hikes in 2010, with every 50 basis point increase locking up Rmb350 billion of liquidity in the banking system, it estimates.
How about interest rates and exchange rates?
Generally, interest rate hikes have been less preferred to administrative measures, like raising reserve ratio requirements. Having said that, there were two hikes last year, one in October and one on Christmas Day.
The problem, say a number of commentators, is that real deposit rates are still well below headline CPI, meaning the Chinese have every incentive to take money out of their bank accounts and put it into other more speculative options.
The challenge is that rates can’t go up too much, as they would then attract further capital inflows. Others contend that rate hikes might undercut efforts to boost domestic consumption (i.e. increasing the incentive for households to save rather than to spend). Not necessarily so, says HSBC. Chinese households have nearly Rmb30 trillion in bank account savings, so each 25 basis point rate rise brings in an extra Rmb75 billion in interest income to families. Depositors would feel better-off and would probably spend more as a result.
Of course, critics of Beijing’s exchange rate policy argue that China has only itself to blame for creating excess liquidity at home by holding down the value of the renminbi. That then supports a run up in the trade surplus, as well as hot money inflows from abroad – both of which boost money supply. The PBoC reported on Tuesday that China’s foreign exchange reserves hit a record $2.85 trillion at the end of 2010. But it still looks unlikely that policymakers will deviate from a slow and steady appreciation of the yuan.
Would a stronger currency reduce the price of imports, pressuring local producers to keep prices low? Again, HSBC offers a word of caution, reasoning that China’s newfound buying power could well stimulate a spike in demand for commodities that would then push prices back up again.
Still, reports this week that a pilot scheme in Wenzhou may allow individuals to invest up to $200 million overseas annually suggest that policymakers are looking for new and creative ways to channel surplus cash away from the domestic economy. Currently, individuals can buy up to $50,000 worth of foreign exchange each year but Zhou Dewen, head of a prominent Wenzhou small and medium-sized enterprise association estimates that there is as much as Rmb1,000 billion ($150 billion) in private ‘floating’ capital in the city that could go offshore (a lot already has: see last week’s issue on Zhejiangers buying farmland overseas – that was mostly driven by Wenzhou, and indicates its citizens have a definite appetite to acquire abroad).
But Jamil Anderlini, writing in the Financial Times, notes (sceptically) that we have been here before. A similar scheme permitting investment in Hong Kong stocks was trailed in 2007 but never got off the ground, as rival departments clashed over implementation of the idea.
And HSBC’s predictions for the 12 months ahead?
If the analysts are to earn their bonuses, this is how the inflationary story should develop this year.
The early months will be frothiest, with the CPI exceeding 5% in the first quarter. In part that’s because the unexpectedly rapid pick-up in prices in late 2010 has created a higher base from which to begin the year. HSBC says “sequential” price rises could then have more of an effect, especially around Lunar New Year in early February. More severe weather than normal would also push prices upwards.
But by the second half of the year, prices won’t be increasing as quickly. The forecast is for a peak nearing 6% (year-on-year) by the end of March, which declines to closer to 4% by mid-year. That would be helped by credit growth of no more than 16% for 2011 (and preferably less). Mix in at least another 200 basis points in reserve ratio requirements, as well as another two hikes in interest rates (of 25 basis points each), and HSBC thinks that Beijing will manage to contain the worst of the inflationary excess.
But perhaps the bigger question: how much of Australia and New Zealand will the enterprising folk of Wenzhou be able to buy up by year-end?
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