Analysis: China’s super-hawks come to terms with inflation

By Simon Rabinovitch

BEIJING (BestGrowthStock) – China is striding into an era where higher inflation will become a more permanent feature of its economic landscape, a shift that the government, long assumed to have zero tolerance for rising prices, is showing signs of accepting.

That would be a good thing.

A little bit of inflation would go a long way in China, providing lubricant for reforms from higher wages to more market-based resource pricing that are essential to restructuring the economy along consumption-driven lines.

But the ride will be bumpy, testing the government’s nerve and its ability to leave room for prices to rise while still anchoring inflationary expectations.

“This is not a crisis situation that requires bringing the big guns out,” said Andy Rothman, China macro economist with CLSA in Shanghai.

“We will have slightly higher structural inflation in the next few years than we have had recently, but not dramatically higher,” Rothman said, noting that increasing labor, energy and land costs would keep prices on an upward trend.

Chinese consumer prices rose 5.1 percent in the year to November, a 28-month high. Though well below an 8.7 percent peak in 2008 during the country’s last bout with inflation, the pace of increase is well above the 1.9 percent rate averaged over the past decade.

RISING TOLERANCE

Inflation touches a raw nerve in Beijing. A trigger of unrest throughout China’s history, rising prices added to discontent in widespread anti-government protests in 1989.

That sensitivity has led to steadfast hawkishness on prices and, as an offshoot, inflation regularly running below the 4-5 percent rate common in developing countries.

But evidence has accumulated in recent days that Beijing is more relaxed — or at least less panicked — than in the past.

First, the government has held off increasing interest rates since October, despite a jump in inflation that many analysts thought would trigger an automatic interest rate rise.

Second, it has raised next year’s inflation target to 4 percent from this year’s 3 percent. This in part is a realistic outlook based on price trends, but it is also an indication of what policymakers see as the “new normal,” in the words of Ting Lu, an economist at Bank of America-Merrill Lynch.

Third, official media has worked to counter expectations of aggressive policy actions.

“No comprehensive tightening is needed now” was the top economic story on Wednesday in the overseas edition of the People’s Daily, the ruling Communist Party’s main newspaper. “Monetary conditions will not be tighter next year” said the front-page editorial in the China Securities Journal on the day of latest upside surprise in inflation data.

Gao Shanwen, chief economist at Essence Securities, said policymakers were aware that the causes of inflation this time around were different and related to specific issues, especially higher wages. That was making them wary of raising interest rates, he said.

“Compared to previous episodes of inflation, the current one is the first not associated with economic overheating,” he said.

STRUCTURAL ANALYSIS

Still, the government has certainly not been complacent. It has raised banks’ required reserves six times to a record high and has also steered lending growth back on a path toward the country’s long-run average below 20 percent.

An open question, though, is whether this mix of medicine stems from a careful diagnosis or simply indecision.

Fan Gang, a former adviser to the central bank, believes it is the former.

“We need controls that are targeted at excess liquidity,” Fan said in the People’s Daily on Wednesday. Quantitative measures, not interest rates, are the right tools, he said.

Gao is not so certain.

“They are wavering and haven’t made up their minds. The tone creates enough room for maneuver for next year,” he said.

In other words, the softly, softly approach to tightening may be a passing phase. It could yet morph into harsher tactics if the expected slowdown in inflation in the coming months does not materialize, said Ken Peng, a Citigroup economist in Beijing.

“This is the policy thinking at the moment. It will remain the policy thinking until we have another surge in inflation,” he said.

(Additional reporting by Kevin Yao; Editing by Neil Fullick)

Analysis: China’s super-hawks come to terms with inflation