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Post-Olympics, China could face hangover

Post-Olympics, China could face hangover
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First Published: Fri, Aug 08 2008. 11 59 PM IST

Updated: Fri, Aug 08 2008. 11 59 PM IST
China’s inflation has been quiescent recently. That’s because food prices are controlled and fuel subsidies have been sharply increased. After the games, reality must return, meaning lower subsidies, higher prices and sharply rising interest rates. That could make for a post-Olympic hangover.
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The country’s inflation has declined from 8.7% annually in February to 7.1% in June, taking it just below the People’s Bank of China’s (PBC) one-year lending rate. That contrasts with rising inflation in other countries such as the US and India, where wholesale inflation rose from 7% in March to almost 12% in July. Since the principal driver of global inflation has been the sharp run-up in energy and commodity prices, China’s inflation moderation is anomalous.
Apart from any figure-fudging in the run-up to the Olympics, China’s apparently low inflation can be explained by increased state controls and subsidies. Rice and wheat prices have been controlled only since January, while energy subsidies have risen in 2008 from $22 billion (Rs92,840 crore) to $40 billion, as petrol prices are held down to two-thirds of the US level. Those effects alone would suppress inflation by perhaps 3-4 percentage points.
China has made every effort to produce a cooperative population and clean air for the Olympics. Once the Olympics are over, these Herculean efforts will not be as necessary.
That could mean an easing of food price controls and a reduction in energy subsidies. That in turn would lead reported inflation to soar into double digits.
At that point, PBC’s lending rate of 7.47% and deposit rate of 3.33% would be highly inflationary, as well as providing a substantial disincentive to saving. Since the Chinese authorities appear to understand the role of interest rates in controlling inflation, they might decide to raise rates sharply, to the point where they are positive in real terms.
Hence a possible post-Olympic credit crunch. For those Chinese small businesses and consumers that are over-extended, it may be an uncomfortable awakening from their Olympic dream.
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First Published: Fri, Aug 08 2008. 11 59 PM IST