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Drop in Chinese inflation opens new can of worms

A woman buys vegetables at a market Friday Dec. 9, 2011 in Shanghai, China. China's chronically high inflation rate fell to a lower than expected 4.2 percent in November, allowing wider leeway for Beijing to ease credit to support growth.


At first glance, news that China's inflation has slowed to its lowest level in over a year should be good news.

But economic analysts have warned that last month's consumer price index increase of 4.2 per cent, combined with warnings that Chinese exports are about to fall off a cliff as Europe slides into recession, is mounting evidence that economic growth is at risk of a hard landing. Policy makers are expected to begin further loosening of monetary policy and expansion of bank lending, despite the scores of bad loans and credit crises that are the hangover of the country's 2008 spending package.

"Ordinarily this would be excellent news, but in reality it underscores the very difficult bind that Chinese policy makers have got themselves into," researchers at GaveKal Dragonomics wrote in a note to clients, warning that even as the labour market tightens and drives inflation, the People's Bank of China is likely to further loosen its monetary policy to ensure economic growth stays above a general target of 8 per cent. "The weak CPI reading reflects that China's economic indicators are all heading south fast, in a manner reminiscent of early 2008, when excessive monetary tightening led to an investment crash, even before the global financial crisis hit."

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Evidence of that loosening began with a half-per-cent cut to banks' official reserve ratio requirement on Nov. 30, the first such cut from the People's Bank of China in three years.

Earlier this week, China's commerce ministry also warned of a "severe" foreign trade situation next year and said it hoped to focus more on exports to emerging economies. "There won't be fundamental improvement in Europe or the United States, and costs at home will stay as high as this year, so the foreign trade situation will be severe next year," foreign trade director Wang Shouwen said.

There are other worrying indicators which are likely to encourage Chinese leaders to modify their economic policies in favour of more spending. China's industrial output growth sat at 12.4 per cent in November, below expectations and the worst such showing since August, 2009.

And China's Association of Automobile Manufacturers has reported that wholesale deliveries were up just 0.3 per cent to 1.34 million units last month, the slowest pace since May. They blamed inflation, higher interest rates and the end of government incentives for purchasing, which had been part of the stimulus package designed to see China through the 2008 crisis.

Perhaps most indicative of the great concern among Chinese policy makers for their country's heavily managed economy is an apparent delay in the annual Central Economic Work Conference, which is to begin Monday. One regional newspaper said in the last decade, the conference has never begun later than Dec. 3, and speculated concern over the state of the global economy was to blame.

"With growth as its top policy priority, Beijing will need to adopt a pre-emptive policy stance to minimize risks: of a property price correction overshoot; from mounting capital outflow pressures; and of potential liquidity problems attributed to local government financial vehicles," wrote economists Qu Hongbin and Ma Xiaoping in a report for HSBC. "But while steady growth needs to be maintained in 2012, a careful eye must also be kept on the potential for a future inflationary buildup. Hence we do not expect a replay of the last 4 trillion [yuan, $642-billion]stimulus package."

Chinese GDP growth is widely expected to fall below 9 per cent next year for the first time in a decade. Beijing's leading government advisory body, the Chinese Academy of Social Sciences, this week released its 2012 Blue Book on the economy predicting inflation would average 5.5 per cent this year and 4.6 per cent next year, while GDP growth next year will slow to 8.9 per cent.

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Inflation in particular is still much higher than the government's earlier stated goal of 4 per cent for this year, and some warn the country is on a path to stagflation – in which the economy slows even as inflation increases – and ever-higher risk for a massive correction later if policy makers embark on another round of stimulus.

"What's going to happen now is they're going to say we need the growth, so let's open the credit spigots again," said Patrick Chovanec, an economics professor at Tsinghua University, who argues the country is already experiencing the bad hangover of too much economic manipulation. "There is a sense that the Chinese government is trying to run an economy with no losers … If you try to run an economy with no losers, you create massive distortions.

"I think those distortions are actually coming to roost and I think we are in a process of correction," he continued. "There's clearly something happening here that is new and different, and it's reflecting itself in people's concerns."

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