Week Ended: November 16, 2007

China's Inflation

China's consumer inflation rose 6.5% in October from a year earlier, garnering a great deal of global attention, not least because the figure represents the highest rate of inflation the country has seen in over a decade.

Inflation has been accelerating recently, driven mainly by escalating food prices. So far, many macroeconomic analysts are unconcerned by this trend, noting that "core" inflation (prices excluding oil and food) is relatively muted, running at about 1.1% per annum. Strong demand for many manufactured goods has not resulted in rising prices. For example, unit sales for cars are up 23% year-on-year, but their prices continue to fall about 3% per year. In sharp contrast to deflation in manufactured goods, food prices have seen dramatic increases, with inflation on foodstuffs running over 17% in October.

This divergence is mirrored in the views of inflation: while financial market participants have grown warier, but are not yet too concerned, middle and low-income families have been hard hit by the large price increases on basic staples and foodstuffs. China's authorities are increasingly attuned to the latter issue, as domestic disturbances have begun to capture headlines. Last Saturday, shoppers in Chongqing queued up in large numbers to buy cooking oil at a 20% discount; when the store opened for business, three shoppers were crushed to death in the rush. A similar incident occurred in Shanghai during October, though no deaths were reported. China's leadership is well aware that its mandate will be threatened if inflation severely impacts living standards.

The government faces particular issues as it grapples with rising inflation. Historically, the bulk of China's consumer prices were subject to either explicit or implicit direct administrative control. After a decade of rapid market reform, economists estimate that less than 30% of prices are now set by the government (some economists suggest even less than 10%). Thus, the authorities are increasingly dependent on their ability to indirectly influence prices through the supply of money and credit. But management of the monetary system is not an easy feat, given the recent and only partial privatization of the local banking system. China's central bank has worked to adjust both the price and quantity of money, repeatedly increasing interest rates (most recently in September), and directly rationing bank credit via administrative controls, to curtail growth in the money supply.

While China works to nip inflationary pressures in the bud, it must balance its actions with the need to sustain growth that will lead to better incomes and purchasing power - a tough act with the economy growing over 11% per year.

 

 

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The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews does not accept any liability for losses either direct or consequential caused by the use of this information.