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Another False Alarm? Do Recent Price Increases Portend Inflation?

With its four years of double-digit growth, the debate about whether the Chinese economy is overheated is likely unavoidable. Some believe China’s economy has a light fever, a conclusion based on factors like excessive investment, huge trade surplus and soaring property price; while others have a more optimistic view that the economy is quite healthy, an inference primarily supported by a crawling CPI (consumer price index), a key indicator of the inflation level in an economy.

However, this seemingly ideal model of development with “high growth and low inflation” appears to have run into rough weather as the CPI in May 2007 rose 3.4 percent, crossing for the third straight month the 3 percent alarm line. Central Bank Governor Zhou Xiaochuan had earlier said that a decision on whether to raise interest rates will be made after the May CPI figures are released. Speculation has thus been rife about a possible interest rate rise.

“A Pork-Induced CPI Rise

The wave of price increases that started after the spring festival was stimulated by a fast-climbing pork price and that of many other foods like chicken and eggs. Unlike the usual drop in demand and price after the Lunar New Year holidays, the price of pork has been relentlessly rising since March 2007.

 After two consecutive months of growth in March and April, the average price of pork in 36 cities in May rose another 10.8 percent to 8.7 yuan (US$1.13) per jin (0.5 kilogram). In Beijing, pork prices rose almost every other day, an average annualized growth in pork prices of 30.5 percent. The most sought-after meat pieces were sold at 12 yuan (US$1.56) per jin, a 10-year record high.

Price increases also spread to other food products. Prices of eggs in the same period saw a 28 percent increase over 2006. Peanut oil rose by 5.9 percent in May. Beef and mutton prices also rose. 

In a market near Hepingli in Dongcheng District, only half of the 25 pork stands are still in business. “People are still buying pork, but on an average, one-third less than before,” said a pork vendor. 

“Pork has become too expensive,” said a Beijinger in her 50s. “I could buy nearly two jin of pork last year with 10 yuan (US$1.30), but the same money now isn’t even enough for one jin.”

Experts have attributed the unusual movements in meat prices to the chain effect from costlier crops that are used as animal feed as well as a pig epidemic a year ago. Corn prices rose by 20 percent in 2006, which led to a 50 yuan to 100 yuan increase in the cost of raising a pig. The “blue ear” epidemic also hit the industry hard. Pig raisers’ confidence has been severely damaged. Research by a Ministry of Agriculture working group showed that there was a 7 percent year-on-year decrease in the number of pigs in 10 major pig-raising provinces in May.

 “Save? Spend?

Food product price increases have not gone unnoticed. In a recent survey by the People’s Bank of China, the public’s satisfaction index of prices dropped another 5.2 percentage points, following the 20-point slide in the first quarter, to a historic low of -21.1 percent. Some 29.5 percent of the respondents thought the prices are “too high to accept,” while the proportion of respondents from low-income families (with a monthly income of less than 2,000 yuan or US$260) harbouring the same view reached 40 percent. 

With a 3.4 percent inflation rate, the current 3.06 percent interest rate for bank savings (which is subject to a 20 percent tax) hardly means anything in real terms. It’s thus hardly a surprise that in the face of a feverish stock market, more and more money is flowing from banks into stocks.

Statistics from the People’s Bank of China show that savings accounts drained 278.4 billion yuan (US$36.19 billion) in May, compared with the 17.4 billion yuan (US$2.26 billion) increase in the same period in 2006. And despite the much higher risk, much of the money flowed into the stock market, which has seen an unprecedented bull run in the past year.

In a recent survey of the central bank, citizens’ willingness to invest, for the first time, surpassed that of saving and consuming, a momentous change.

A sustained negative real interest rate is definitely not good for the economy, according to Yi Gang, assistant governor of the People’s Bank of China. “We will try to make it a positive number,” Yi said during the recent World Economic Forum Asia Conference. But he didn’t say when exactly the central bank will step in.

“No Hurry

Aside from closely monitoring market movements, the central bank seems to be in no great hurry to use monetary policy to address the price problem, mainly because of the view that the current CPI growth does not constitute inflation. This view is mostly supported by the fact that food accounts for one-third of China’s CPI calculations, and that there is a sufficient food supply in China.

Because of the high proportion of food products in the CPI basket, meat, egg and edible oils contributed a 73.5 percent of the overall CPI growth in May, according to a report of the research group of the central bank. 

“Currently, the supply of meat, eggs and milk is sufficient, and therefore, it is not likely that the price of food products will rise significantly,” said Zhou Wangjun, deputy director, Department of Price of the National Development and Reform Commission.

He also noted that aside from food, prices of industrial products have been falling, while prices in the services industry, especially public utilities, are controlled by the government. Therefore food price increases can hardly cause serious inflation.

Zhou’s views are echoed by Wang Beiying, deputy-director of Market Operation Regulation Department, Ministry of Commerce, who also believes the recent CPI growth is normal. “It’s understandable that prices of agricultural products rise with the improvement of people’s living standards and it is beneficial to farmers,” said Wang. “Inflation usually brings about social problems, but the current situation is far from that.”

Experts also believe the faster-than-expected CPI growth is caused by seasonal factors and limited categories of CPI components, and therefore won’t be long-lasting.

“We believe that the CPI will reach its peak around October of 4 percent and then enter a period of decline. By the end of the year, it will return to about 3 percent, maybe less,” said Zhang Yongjun, senior economist at the National Information Centre.

Although interest rates have not been raised in addressing the current inflation, the government still uses many administrative measures to ensure normalcy by maintaining a regular supply of basic food products. On June 29, the State Council was granted the right to adjust the bank savings interest tax, which indicates the possibility that the 20 percent tax will be eliminated in the near future.  

What’s more, the Ministry of Commerce has been monitoring market movements and releasing guidelines for pig raisers so that they can timely know the changes in the market and increase the number of livestock accordingly. Special groups of officials from the Ministry of Agriculture have been sent to 10 major pig-raising provinces to help the industry.

The Ministry of Finance announced on June 22 that it will allocate 6.5 billion yuan (US$845 million) to subsidize pig raisers in the form of insurance and direct subsidy.

For vulnerable groups like low-income families, the Ministry of Finance has announced in its recent circular that it has allocated 470 million yuan (US$61.1 million) to subsidize them and that it will also provided 280 million yuan (US$36.4 million) to help university and vocational school students from poor families.