China Struggles to Tackle Inflation

Heda Bayron | Hong Kong 14 December 2010

A customer picks up a plastic bag of peppers at a fruit and vegetable market in Beijing (file photo - 17 Nov 2010)

Chinese economic authorities have signaled that fighting rising prices will be their top priority next year.

China's government set an average inflation rate target this year of 3 percent, but some economists expect the rate to top that figure. Last month, inflation rose to 5.1 percent from 4.4 percent in October.

Shen Jianguang, an economist at Mizuho Securities in Hong Kong, expects prices to continue rising.

"Likely November will see the peak of inflation for this year," Shen said. "But actually next year, in the first half, we're probably going to see even higher inflation."

Food prices jumped the most in November, partly because of bad crops and higher costs for transporting them.

At the end of a three-day national economic conference Sunday, the government signaled it would take more steps to tame inflation. No details were mentioned, but authorities could impose price controls on food commodities to help consumers, as they have done in the past.

But what policy makers seem to find harder to tackle is price pressure that comes from the banking side. In the past several months, China has been trying to undo the effects of runaway lending and investment that resulted from its massive economic stimulus package in 2009. That helped drive up prices of property, stocks and basic commodities.

China set a target of 7.5 trillion yuan, or $1.1 trillion, in new loans this year, much lower than it was in 2009. But in the first 11 months of the year, total new loans nearly reached that figure.

Banks have been told to hold more and more of their deposits as reserves to cut back on lending.

Shen says the central bank is likely to take a combination of actions, including more interest rate increases in the next few months and lowering the loan quota for next year.

But he says as long as Chinese savers get less for their money if they keep it in bank deposits than from investing in property or stocks, inflation will remain a challenge.

"We have inflation to 5 percent but the one-year deposit rate is only at 2.5 percent, so the gap is rising," Shen added. "So I think the most important thing is to close the negative interest gap so that people will be more comfortable in putting money in bank accounts rather than trying to find other types of investment vehicles like housing that actually fuel demand and stimulate further inflation."

Stephen Roach, the former head of Asia operations for the investment bank Morgan Stanley and a Yale University professor, says inflation distracts Chinese authorities from making the shift from an export-oriented to a consumption-led economy.

"The longer policy makers wait to address inflation the tougher it would be to deal with the structural issues," Roach said. "My advice is to move quickly and aggressively to deal with inflation so that you can get on with the most important transition in China, which is stimulation of private consumption."

The re-balancing of China's economy has long-term implications in narrowing its surplus with its trading partners, such as the United States, and ultimately in rebalancing the global economy.

Inflation presents not only economic risks, but also political ones in China. A sharp rise in prices for basic goods - such as food and housing could lead to public protests. China political experts say the ruling Communist Party is eager to make sure that does not happen.

But clamping down too hard to fight inflation could slow growth sharply, and lead to rising unemployment - also a political problem.

With the government tightening the amount of money for lending, China's economy is expected to slow in 2011. That too would have implications on economies that trade with China. On Monday, the South Korean central bank governor said he is watching China's inflation and its potential effects in his country.