Last year, at the end of the National People’s Congress, Wen Jiabao used powerful imagery to describe what he believed to be China’s chief economic concern.
“Inflation is like a tiger,” he said, “once it gets free, it is difficult to put it back in the cage.”
The latest data suggests that this beast might have been tamed. The consumer price index in February was up 3.2% year-on-year, a significant drop from 4.5% in January, and much lower than the peak increase of 6.5% reached last summer.
With inflation at a 20-month low, “the inflation story is over,” according to HSBC research. A poll conducted recently by Reuters was also optimistic – the consensus was that inflation will stay below the government’s annual target of 4%.
The swift drop in the CPI can be partly explained by a seasonal fluctuation in food prices. Demand for food during Chinese New Year typically helps push inflation upwards in January, and this pressure on prices often disappears over the following month.
This was the case this year, when food inflation in January shot up 10.5%, compared to 6.2% in February.
Other economists warn that it is premature to pronounce that the battle with rising prices is over. The rising cost of oil, for example, could force prices upwards once more. But the HSBC view is that China will be able to cope with costlier oil, as long as a prices don’t increase by more than 10%.
Another argument is that inflation settling at a lower level could also be symptomatic of a more general slowdown in the economy, in line with Beijing’s lower targets for economic growth (7.5% for 2012: see last week’s Talking Point).
This weekend China also posted a $31.5 billion trade deficit for February, larger than the estimates of most analysts. The news accompanies disappointing data that saw slower growth in retail sales and industrial production, as well as a broad decline in the property market.
The advantage of lower inflation is that it gives policymakers more opportunity for monetary easing. Although HSBC’s economists believe that it is unlikely that the government will reduce interest rates, they do think that reserve ratio requirements (RRRs, or the amount of capital that banks must hold in cash deposits) will be cut at least twice in the first half of the year.
Another policy implication of lower inflationary pressure is that there will be more leeway to accelerate reforms on the pricing of key resources, such as electricity, petrol and natural gas. Looser monetary policy should also be good news for Chinese businesses, especially small-and-medium-sized exporters, many of whom have been squeezed by a lack of access to bank loans and diminishing external demand.
Last year, the authorities tried to improve conditions for SMEs by starting a new cycle of RRR reductions.
But in February, new loans amounted to Rmb710.7 billion ($112 billion), well below market expectations, reports International Business News. That was a concern, the newspaper thought, as it seemed to indicate that corporate demand for credit wasn’t as “urgent as imagined” and probably suggested instead a shrinking economy.
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