Investors should pay close attention to the flurry of commentary from China suggesting that the fight against inflation has already gone too far.
“The anti-inflation policy is expected to soften,” said the headline of an 8 July article in ChinaStakes.com.
The policy may be tweaked after China releases second quarter gross domestic product statistics on 17 July, the article said, adding that controls on credit availability may loosen, and the yuan appreciation may slow. There might be something to that assertion.
The benchmark stock index, among the world’s worst performers this year, has risen 10% this week. Last week, Li Yining, one of China’s most influential economists, advocated a somewhat higher inflation tolerance for the sake of economic growth. The government’s target for price gains this year, set at the start of 2008, is 4.8%. Consumer prices rose 7.7% from a year earlier in May.
“The inflation rate, if controlled at about 60% of the growth rate, would be appropriate, such as keeping the rate at around 6% for 10% growth in the economy,” Xinhua, the official news agency, quoted Li as saying in a speech to the country’s top advisory group—the Chinese People’s Political Consultative Conference.
Michael Pettis, a Peking University finance professor, calls it a “worrying policy shift.” Policy makers, he says on his blog, are increasingly concerned about “a possible economic downturn.”
For now, investors may cheer the pursuit of growth. They may, however, react very differently if inflation—which probably slowed to 7.1% last month, according to media reports—shoots up again after controls on credit disbursals are relaxed. With annual money supply growth rebounding to 18% in May, from less than 17% in April, putting the lid back on inflationary expectations remains China’s primary challenge.
It will be dangerous to leave price gains uncontained when they may have begun to filter into wages. “Wage growth appears to have picked up since early 2007 and increases in unit labour costs in manufacturing have become more significant recently,” Louis Kuijs, a World Bank economist in Beijing, wrote in a quarterly report on China’s economy in June.
Costs are mounting at the factory level. The producer price index climbed 8.2% from a year earlier in May, the highest in more than three years. With domestic demand still very strong, a pass-through of inflationary pressures into consumer prices is quite likely.
Statistics don’t seem to support the hypothesis that the Chinese economy is slowing alarmingly.
Second quarter economic growth may have dipped to 10.3%, from 10.6% in the first quarter, according to the median forecast of 15 economists. Sure, the property market is cooling rapidly. Home prices are falling. But that was because the government pricked the real estate bubble by squeezing mortgage lending norms.
Chinese exports, too, have decelerated, as is to be expected in a slowing global economy. But shipments haven’t exactly ground to a halt. Compared with a year earlier, they grew 23% in the five months through May. In the same period in 2007, export growth was 28%.
Exports may have done worse this year than these figures suggest. Part of what’s classified as trade may be “hot money”—or capital entering China surreptitiously, betting on a yuan revaluation.
Discouraging hot money inflows might well be the reason why China is once again re-emphasizing growth. After all, if inflation control is no longer the main imperative, then there’s no urgency for interest rates to rise, attracting still larger quantities of yield-seeking foreign capital. Nor is there any reason, then, for the yuan to strengthen against the US dollar—beyond the 6.5% appreciation that has already occurred this year—to lower the price of imported goods, especially commodities.
If that’s the message the government wants to convey to the market, then it seems to be succeeding. The non-deliverable forward rate is now predicting the yuan to strengthen 5.4% in the next 12 months from its current price of about 6.86 to the dollar. On 30 June, traders’ bet was for a 6% gain; on 31 March, it was for 10% appreciation.
The Beijing Olympics, which begin next month, are the other reason that China will be reluctant to raise the cost of borrowing even though the one-year bank lending rate of 7.47% doesn’t even compensate for inflation.
“The central authorities will ensure no disruptions—including those from macroeconomic policy changes—to the Olympic Games,” says Moody’s Economy.com Inc. analyst Sherman Chan in Sydney. The securities regulator has even banned fund managers from leaving China for vacations or investor conferences before the games, the Oriental Morning Post reported.
Once the Olympics are out of the way, the vigil on inflation may have to resume. But unless China gets flooded by speculative flows, a one-shot revaluation will remain off the table.
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