August 12,2009

China Inflation Expectations Building

By CSC staff, Shanghai

According to latest National Bureau of Statistics figures, China's July CPI dropped 1.8% year on year, 0.1 percentage point more than the decline in June, and PPI dropped 8.2% year on year, 0.4 percentage point over the decline in June. But from a month-on-month perspective, CPI remained unchanged in July and PPI grew 0.1% over June, the fourth month to see an increase. Judging from these figures, deflationary pressures seem to be increasing, and production surpluses continue to hinder pricing power. Inflation appears to be a distant risk for the macro-economy and this will continue to encourage the government in its moderate monetary and fiscal policy.

However, price information from the market does not support this judgment, and CPI figures contradict market predictions. CPI grew 7.10% and 6.30% in June and July, 2008, respectively, meaning CPI growth in July was lower than June's. If China's commodity prices have steadily climbed since May, this July's CPI growth should have been higher than in June. Then were commodity prices in July lower than they were in June? Take pork and agricultural products, which account for a large portion of CPI. The Ministry of Commerce launched the acquisition of domestic frozen pork on June 13. According to the National Development and Reform Commission, average live hog prices in big and medium cities stood at 11.23 yuan per kg on July 29, 9% higher than at the beginning of the month, and 15.8% higher than the price before June 23. Over 50% of edible agricultural products have seen a price increase. The Ministry of Agriculture said that domestic corn prices, stimulated by the government's acquisition policy, have been rising for five straight months. China's housing prices have also increased steadily. Housing prices in 70 major cities have seen month-on-month increase for five straight months and the price increase itself is growing.

PPI grew 8.80% and 10% respectively in June and July, 2008. Due to high PPI in July last year, a higher PPI decrease would be quite reasonable. However, pushed by a steep increase in international bulk commodity prices as well as domestic demand, China's steel, non-ferrous metals, and coal prices are again increasing rapidly. PPI, however, is not following this year due mainly to production surpluses common in all areas. What is worth attention is that year-on-year change is not reflecting the trend. In fact, prices for production factors are increasing quickly, and expectations that production surpluses will stop inflation are not reliable. Although surpluses do exist in China, it is against the policy to maintain prices and restrain production, and this will offset some negative factors to commodity prices such as lack of demand and high inventory. Excessive credit has led speculative capital into the bulk commodities area. For example, in July China's steel price increase reached a record high over the past eight years as the comprehensive steel price index grew 11.9%. As international commodity prices are increasing due to expectations of USD depreciation, international and domestic factors may lead to stagflation.

While current figures do not indicate inflation risk in China, this doesn't mean we can neglect inflation possibilities. First, China's huge money supply offers a basis for inflation. Tax policies are boosting the prices of some products. For example, China has increased cigarette and wine taxes, so producers have increased the prices so consumers will finally pay the tax increase. Second, agricultural product prices continue to rise. Pork consumption has entered a traditional third quarter peak season. Housing prices are still climbing. The proposed resource price reform will be implemented within this year, and these policies will certainly push up production and living costs. Although new lending subsided from 1.5 trillion yuan in June to about 360 billion yuan in July, in the same month resident and corporate deposits dropped by 19.2 billion yuan and 45 billion yuan, respectively. M1 growth is accelerating and has reached a new record high. Meanwhile, decreasing deposits mean more money is entering asset markets to beat inflation.


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