Business

Inflation remains key threat

By Xin Zhiming (China Daily)
Updated: 2010-12-17 15:11

Inflation may break 4 percent next year, caused by price increases in consumables, such as cooking oil. Xu Congjun / for China Daily

Rising inflation, rampant liquidity, hovering home prices and growing trade friction - Chinese policymakers wrapped up their key Central Economic Working Conference from Dec 10-12 amid intensified concerns about these immediate challenges.

The nation also faces mid-term tests - no less tough than fighting inflation - that could determine its development path in the following decades, starting with the 12th Five-Year Plan (2011-2015).

The three-day, high-profile economic conference, formally shifted the country's monetary policy to a "prudent" stance while prioritizing the fight against inflation, which surged to a 28-month high of 5.1 percent in November, compared with 4.4 percent in the previous month and 3.6 percent in September.

"Controlling inflation is set to dominate next year's policy agenda," says Zhang Xiaojing, senior economist of the Institute of Economics at the Chinese Academy of Social Sciences in Beijing.

To that end, interest rate hikes will be unavoidable, economists agree. They still remain divided on how the authorities will use quantitative tools such as the reserve requirement ratio, or proportion of money banks must keep in reserves, which was raised by 50 basis points on Dec 10 to mop up market liquidity.

"China is entering an interest rate hike cycle," Zhang says.

China has raised the reserve requirement ratio three times in a month. "It has had some results, but given rising inflation, the public may have thought that the authorities are unable to control it effectively, leading to further rising inflationary expectations."

Interest rate hikes will be a more effective tool, the report says.

The reserve requirement ratio has risen to 18.5 percent for big banks. "The room for further adjustment is very limited," says Chen Yongming, analyst of the Beijing-based Unbank, a banking information consulting firm. "Instead, the interest rates could be raised early next year to hold back lending enthusiasm of financial institutions."

However, Dong Xian'an, chief economist of Industrial Securities, says the reserve requirement ratio could still be raised twice or more next year to combat inflation. Economists generally predict that it could break 4 percent for the whole of 2011, with a higher reading appearing in the first half.

While inflation could continue to rise, economic growth may not be a serious concern of policymakers. China has set the target for GDP growth next year at 8 percent. Analysts, however, generally predict that it could reach 10 percent, making it possible for policymakers to pay more attention to structural reforms.

"The conference has reinforced the message that anti-inflation measures will be the main policy focus in the near term, while at the structural level, policies will provide strong support for consumption, services, new energies and higher-end manufacturing," says Deutsche Bank's Greater China Chief Economist Ma Jun.

The meeting pledged to increase jobs, restructure the economic growth pattern, and improve social services next year, all aimed at achieving a more balanced development, economists say.

Despite strong expansion, the Chinese economy suffers from inadequate consumption and overdependence on investment and exports, which often lead to such problems as asset bubbles and trade friction. The new five-year plan maps out concrete measures to reduce that dependence on investment and foreign trade and increase the role of domestic demand in driving economic growth.

"Central Chinese policymakers and planners have a correct reading of the challenges they face and policies to stress, but there are persisting difficulties in implementing any such policies in the five-year plan or other instruments," says David Fouquet, director of the Brussels-based Asia Europe Project Information Service.

China's GDP growth could remain at an impressive 8.5 percent annually during the next five years, which would lay the foundation for the country's structural reforms, says Louis Kuijs, senior economist at the World Bank office in Beijing.

"Looking at the fundamental drivers of growth, namely investment, growth of the labor force and productivity growth, trend growth is likely to ease somewhat in the next five years, compared to the pace of the previous five years, from around 10 percent to around 8.5 percent," Kuijs says.

"Such a pace of growth is still solid enough and should also be consistent with making some progress with rebalancing."

He calls for "vigorous" attention to economic restructuring despite the necessity to deal with short-term challenges, such as inflation.

"It is always tempting to deal with the short term-issues first and to deal with the medium-term issues later. However, the risk of this approach is that the mid-term adjustment keeps being postponed as new short-term challenges emerge," he says.

"It is necessary to normalize the monetary policy stance in order to manage inflation expectations and prevent spillover from food prices into other prices and wages, and interest rate increases would best be part of this move to normalization. However, this can be combined with vigorous attention to structural reforms in order to change the pattern of growth."

While priority has been given to control of inflation, the issue of the yuan appreciation took a second seat at the economic conference.

National leaders reiterated their longstanding policy of keeping the yuan "basically stable" at a "reasonable and balanced" level next year. "We will further improve the yuan exchange rate formation mechanism and keep the yuan exchange rate basically stable at a reasonable and balanced level," a statement released after the annual meeting said.

Part of the factors behind rising inflation is the so-called "imported element", or inflation caused by loose external monetary conditions following the US quantitative easing policy. The US has made it clear it would buy $600 billion (450 billion euros) worth of government bonds in the next six months to bolster its sagging economy and could expand that plan if the economy fails to improve.

The US policy is expected to make the dollar even weaker, driving international capital to other parts of the world, mainly emerging market economies like China and leading to rising inflation in those countries.

"The best option for China is to temporarily hold the yuan appreciation process, which will help stem influx of capital," says Dong.

The yuan appreciation has been seen as an important move coupled with China's ambition to internationalize the currency. But any move to increase the international role of the yuan should be rooted regionally at first, says Fouquet.

"China should be extremely cautious in seeking a more global role for the yuan and avoid the possible temptation to increase its role to reflect the country's growing international importance, especially in view of the difficulties the US and Europe have experienced in seeking such global monetary and currency identities," he says.

The conference also encouraged expansion of imports and more investment from foreign countries in China's emerging sectors, such as advanced manufacturing and high-tech sectors.

"(China will) optimize the structure of imports and expand the scale of imports and encourage foreign investors to invest in advanced manufacturing, high-tech, modern services, energy saving and environmental protection industries and the central and western regions," the meeting statement said. "(China will also) actively and cautiously expand opening up of services sectors, such as finance."

"The European Union Chamber of Commerce in China would like to state its support for a number of the 2011 priorities announced at the Central Economic Work Conference," says Dirk Moens, secretary general of the chamber in China, in a statement.

"In particular, we welcome the strategy of continued opening-up and encouragement of foreign investment in China is recognized as an important priority in the ongoing development of the Chinese economy."

"Certain China policies and initiatives have already been of tremendous aid to Europe since the beginning of the international financial crisis in 2008," says Fouquet.

Ding Qingfen in Beijing and Fu Jing in Brussels contributed to this story.