Beijing poised to announce fall in inflation

China is expected to buck international trends on Thursday and announce a substantial drop in monthly consumer price inflation. But economists warn that the country could face a second round of inflationary pressure.

A jump in food prices last year caused China’s consumer price inflation to surge to its highest level in a decade – well before food inflation picked up globally. According to leaks to news agencies, Chinese inflation fell from 8.5 per cent in April to 7.7 per cent in May due to more stable food prices.

While China’s inflation problem is not nearly so acute as that of many developing nations, economists say there are signs that pressures are picking up in other parts of the economy. “It is too early to say that the inflation scare is over,” said Mark Williams, economist at Capital Economics.

Figures for factory-gate inflation released yesterday showed an increase for the 10th consecutive month to 8.2 per cent, a reflection of rising raw material and other costs that could yet leak into consumer prices later in the year.

Moreover, recent figures published by the central bank showed that China’s gross domestic product deflator – another measure of price increases – was 8.2 per cent in the first quarter, a large jump from 5 per cent in the second half of last year.

Although economists caution that GDP deflator numbers often contain technical anomalies, taken together the two indicators suggest broader inflationary pressures. China’s petrol and energy prices, capped by the government, have not risen to reflect surges in global oil and coal prices, which could add a new source of inflation if the government has to adjust its prices.

Some economists are concerned about the potential inflationary impact from the pace of monetary expansion. According to local media, China’s already huge foreign exchange reserves grew by a record $74.5bn (€48bn, £38bn) in April, partly fuelled by huge inflows of speculative capital and adding to the liquidity in the financial system. “There are credit controls but it is becoming increasingly obvious that they are not working,” said Stephen Green, economist at Standard Chartered in Shanghai. “There is a lot more money floating around the informal banking system.”

A more prolonged burst of inflation would present a dilemma for the Chinese authorities. Obvious remedies would be higher interest rates and faster appreciation of the renminbi. But higher rates could attract more hot money, which would be partly self-defeating. More-over, tightening measures are politically harder to implement when the US and Europe, China’s main export markets, are slowing.

Trade figures released yesterday will provide some ammunition to those officials who want to take more aggressive measures against inflation. Chinese exports rose 28.9 per cent in May, up from 21.9 per cent in April, while imports surged 40 per cent. Although public holidays explain some of the acceleration in the growth rate in exports in May, the figures indicate that the global slowdown has not seriously hurt China’s export sector, even if individual industries, such as textiles, have been affected.

The big uncertainty about whether inflation can be controlled remains how wages will respond. Frank Gong, head of China research at JPMorgan, said salaries would not be rapidly bid up because there was no collective bargaining and plenty of people were still seeking work in factories.

But the authorities would have to accept an inflation level above their target of 4.8 per cent. “They need a higher tolerance for inflation, or it will create huge structural problems for sustainable growth,” he said.