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Markets brace for China's bid to rein in hot economy

In this photo released by China's Xinhua news agency, staff members count bank notes at a rural credit union in Xinjiang County, north China's Shanxi Province, on Friday Jan. 14, 2011.


As Chinese workers demand higher wages to offset ever-higher prices, the rest of the world is hoping the country's increasingly urgent attempts to curb inflation won't threaten the nascent economic revival elsewhere.

China's rip-roaring economic growth accelerated in the fourth quarter of 2010 despite such recent measures as domestic interest rate hikes, increased bank reserves and price controls on staple goods.

On Thursday, global commodity prices and risk-related equities swooned on fears that Chinese policy makers will take more extreme measures to reduce runaway lending, combat speculative asset bubbles in real estate and curb rising prices for consumer goods - all of which are pushing wages for Chinese workers higher.

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The concern is that a sharp slowdown in the world's second-largest economy, which has been the primary engine driving much of the global economy, would extinguish the still-fragile economic renewal in North America, Europe and the rest of Asia.

"The fact is, we are in a period of monetary tightening in China right now and it is going to continue because it is very much needed," Sacha Tihanyi, currency strategist at Scotia Capital, said in an interview.

China's gross domestic product expanded by a stronger-than-expected 9.8 per cent annual rate in the fourth quarter last year, bringing full-year GDP growth to 10.3 per cent in 2010, up from 9.2 per cent in 2009, China's National Bureau of Statistics said. The consumer price index, a key measure for inflation, came in at 4.6 per cent in December, down from 5.1 per cent in November but well above economists' expectations and government targets.

For the year, consumer prices increased 3.3 per cent, higher than Beijing's 3 per cent target. Economists expect inflation to continue to rise in coming months. Food prices in China have jumped nearly 10 per cent in the past year, putting further pressure on consumers, and prompting a series of minimum wage increases across the country.

Just this week, the manufacturing-heavy province of Guangdong boosted its minimum wage by between 18 and 26 per cent, the second increase in less than a year. The city of Beijing also increased its minimum wage by 21 per cent this month. While higher salaries for workers will help spur domestic demand and help rebalance China's export-driven economy, a major short-term concern is that increased labour costs will harm China's key manufacturing sector and drive production to cheaper regions such as Southeast Asia.

China's economic challenges stand in sharp contrast to those faced by the United States and other major Western economies, which are still grappling with high unemployment and tepid economic growth.

While the U.S. Federal Reserve has attempted to stimulate the economy through its quantitative easing program of buying bonds and other government-backed securities, China's central bank has been trying to prevent its economy from overheating. Beijing has, however, been reluctant to significantly increase lending rates or the value of its currency, the yuan, due to concerns about the weak global economy.

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In response to rising inflation, China has raised interest rates twice in the past year, including a surprise hike on Christmas Day. It has also implemented several increases in the percentage of deposits banks must hold in reserve, in hopes of controlling rampant lending that has fuelled a surge in China's real estate market; housing prices in some major cities have doubled in the past three years. To directly combat rising consumer prices, it has also imposed price controls on a number of staple goods.

"The concerning thing is perhaps [Chinese policy makers]waited a bit longer to get into their tightening cycle than they would have otherwise if the U.S. Federal Reserve wasn't also in a very loose monetary stance," Mr. Tihanyi said.

Prices for oil, copper, gold and most other commodities fell sharply Thursday and investors dumped risky mining stocks on concerns that China's demand for resources will fall if its economy slows. Most economists now expect China's central bank to raise interest rates by 0.75 percentage points this year in an attempt to quell inflation and prevent overheating.

Na Liu, founder of CNC Asset Management, which focuses on China's equity markets and the global raw materials sector, said that if Beijing can enforce a new lower loan quota for banks that has reportedly been set at seven trillion yuan ($1-trillion) in 2011, the Chinese economy "will surely slow down" because "loan growth is the ultimate fuel for economic growth in China."

Mr. Liu said policy makers should raise the 2011 inflation target from the current 4 per cent and pay particular attention to how inflation expectations are managed within China. According to the People's Bank of China, 82 per cent of Chinese households expect higher prices this year.

"The Chinese government should learn to tolerate higher inflation. However, this does not mean that the Chinese government can or should tolerate high inflation expectations. To the contrary, because labour costs are rising and inflation pressures are becoming structural in nature, it is even more imperative for the Chinese government to properly curb inflation expectations. Otherwise, a vicious cycle might occur and inflation risks might spin out of control," he said.

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