Will China Curb Inflation?

The jump in China's inflation rate to a 12-year high of 8.7% in February could be a serious cause for concern. Will the Chinese government be able to control rising prices?

The task may not be as easy as it seems as the high inflation is mainly caused by soaring food prices. For instance, pork prices raised 63 percent from a year earlier, vegetables climbed 46 percent, and edible oil rose 41 percent. Moreover, supply shocks like blue-ear disease, which killed thousands of pigs and January's snowstorm, damaging crops and disrupting transport, pushed prices even further.

In addition, China remains very vulnerable to changes in inflation expectations because of negative real interest rates and policy of price control. For example, since last November the government has sold large quantities of its grain inventories every week to keep grain prices low. As a result, grain price levels are now only about half of the level in international markets and farmers are now reluctant to sell their grain inventories and less willing to keep production this year. Also, savings level are now really low since real deposit rates have been negative for more than a year, reaching more than -4 percentage points in recent months.

 Indeed, some economists believe that one of the ways to curb inflation may be the appreciation of yuan. A stronger renminbi would help to reduce the cost of importing products such as soybeans, 80 per cent of which are used in pig feed. Yet, the People's Bank of China is very reluctant to make significant changes in the value of Chinese currency. It is also expected that the PBOC will lift interest rates later this year, but is very doubtful if this will help the Chinese monetary authorities to curb inflation.  In fact, if China raises interest rates at the same time as United States is cutting them, this could attract bigger capital inflows and the extra liquidity could actually worsen inflationary pressures.

Anna Fedec, analyst@tradingeconomics.com
4/11/2008 9:37:04 AM