Beijing is gripped by fears of inflation. The government responded to the consumer price index (CPI) hitting a 25-month high in October by introducing a fresh round of dampening measures. These include price controls, subsidies for poor households, reduced delivery costs, guaranteed fuel supplies and a crackdown on hoarding.
There will also be more support for agricultural production – food prices are the principal driver of overall inflation – with state reserves of grains, edible oils and sugar put on the market to ensure sufficient supply.
Beijing wants to be seen to address such a publicly emotive issue, but these measures alone may not be enough to prevent prices from scaling new heights.
The 4.4% year-on-year CPI growth seen in October is the highest since September 2008, when the index expanded by 4.6%. The October figure came on the heels of a 3.6% rise in September, and the government is highly unlikely to meet its full-year target of a 3% rise in the CPI. Food costs, which account for one-third of the CPI basket, jumped 10.1% in October while the non-food sector gained 1.6%.
Meanwhile, the producer price index, the factory-gate measure of inflation, climbed to 5% in October, from September’s 4.3%, indicating higher cost pressure as production becomes more expensive.
Many economists expect the CPI to accelerate in the next two to three quarters, driven by increasing costs of foods and raw materials as well as inflows of speculative capital. That could prompt the central government to introduce more aggressive interest rate hikes, allow faster renminbi appreciation, and further tighten credit conditions.
With the prices of necessities such as rice, cooking oil, clothing and certain fruit and vegetables all rising rapidly, many consumers in big cities have started stockpiling goods. It has also been reported that Shenzhen residents are traveling to Hong Kong, where prices are lower, to do their shopping.
Administrative measures aimed at controlling prices and ensuring supply may help ease this short-term panic, but they don’t solve the fundamental problem behind rapid price growth – excess liquidity. Unless the government takes more aggressive action to tighten domestic money supply and averts the flow of hot money from overseas, prices will just start to rise again after a short hiatus.
Mainland banks extended a higher-than-expected US$82.2 billion in new loans in October. M2, the broadest measure of money supply, jumped 19.3% in the same month, outpacing a yearly target of 17%. The full-year lending target for 2010 is US$1.1 trillion, down from a record 9.6 trillion in 2009, but banks had already passed US$1 trillion by the end of October.
China has already begun to rein in money supply. In October, commercial banks’ reserve requirement ratio was raised – which effectively limits how much they can lend – and interest rates were increased for the first time in three years.
More rate hikes are expected next year as strong figures for industrial output and exports offer Beijing more room for tightening. But at the same time, the government is in a bind: If it cuts money supply too much, there won’t be sufficient liquidity to feed existing investment projects and help export-oriented firms counter a potential slowdown in external demand.
As for hot money – whereby foreign capital enters China with the aim of profiting from interest rate hikes, currency appreciation and other mainland investment opportunities – the State Administration of Foreign Exchange has said it will tighten auditing of overseas fundraising and demand banks to hold more foreign exchange.
In particular, the regulator will strictly manage banks’ short-term foreign debt quotas and introduce new rules covering their exposure to currency risk. It will also more closely scrutinize Chinese overseas special-purpose financial vehicles and strengthen control on equity investment made by foreign companies in China. Limits have already been placed on housing purchases made by overseas interests.
The Ministry of Commerce has also vowed to combat hot money disguised as foreign direct investment (FDI). The risk here is that the clampdown will affect genuine as well as purely speculative capital inflows – this works against Beijing’s desire to maintain FDI levels and retain the confidence of foreign multinationals.
Regardless of the latest policy action, consumer prices will likely post strong growth in the first half of 2011, as economists predict. Even if this is followed by a period of easing, the specter of inflation won’t go away. A sudden spike in price growth and the government would respond with more administrative countermeasures, which may extend to temporarily price freezes for public utilities.