Strategizing an Inflation Fight on All Fronts_English_Caixin
Strategizing an Inflation Fight on All Fronts
Much can be done to counteract inflation in an environment of excess liquidity, rising food prices and QEII
The People's Bank of China raised the deposit reserve ratio requirement for mainland lenders by 0.5 percentage points November 12 – the second increase in 10 days and the fifth so far this year. Analysts say the move will lock about 350 billion yuan in banks with only a limited impact on the real economy.
It's clear the central bank and the central government are not indifferent to rising inflationary pressure, and are adopting measures reflecting progressive macroeconomic policy.
They are aware that China's inflation risks are tied to excess money supply. A significant, external cause of inflation is the U.S. Federal Reserve's quantitative easing policy QEII, which takes aim at the ailing U.S. economy but is creating a huge bubble and badly damaging emerging markets such as China's, which will be QEII's most likely victim.
But even if we discount foreign capital inflows, we find inflation rates rising on the mainland. Many academics think the central government – intentionally or not – has been underestimating inflation for months. They say rising prices in certain sectors, such as the services industry, were not factored in by official statisticians. Meanwhile, authorities have followed their usual course by trying to play down inflation expectations.
Given that consideration, official reports still say China's consumer price index has been escalating all year, hitting 3.5 percent in August, 3.6 percent in September and 4.4 percent in October. It could reach 5 percent or more by the end of the year.
The situation is serious. Month-on-month, inflation rose much faster from August to October than during the same period last year. Thus, the central bank's goal of a 3 percent annual inflation rate for 2010 will likely be missed.
All this points to the need for the central government to make inflation control its top priority. Inflation fighters should target short- and long-term problems – the symptoms as well as underlying causes.
Current monetary policy in China is too loose and could contribute to more inflation. Evidence can be found in rising food prices, which shot up 10 percent in October, far outpacing overallCPI.
Wages have increased as well due to a shortage of migrant workers and friction between employers and employees. Prices for other production inputs such as electricity, water and natural gas are on the rise, too, adding to inflationary pressure.
And the impact of bank lending and related liquidity cannot be overlooked. Banks wrote new loans worth 9.6 trillion yuan last year and could well hand out another 7.5 trillion yuan this year. Meanwhile, interest rates on bank deposits have hovered below CPI rates for months.
External factors also affect domestic conditions. Thus, the Fed's quantitative easing has threatened to push inflation higher on the mainland.
Because of the dollar's special status as a global currency and macroeconomic relations among nations, excess dollar liquidity will flow into emerging economies. In the early 1990s, loose U.S. monetary policy triggered a huge flow of capital to Southeast Asian nations such as Indonesia, Thailand and Malaysia, which were then dubbed "low-lying economies." This paved the way for the 1997 Asian financial crisis.
While China can criticize the U.S. move, Beijing's opinion will not alter Washington's decision. Instead, China must learn from the past and take direct action by fighting inflation with higher interest rates, appreciating its currency and strengthening capital controls.
The government has prepared a strategy with anti-inflation policies included a so-called "pool" plan for liquidity. The pool concept was recently unveiled by Zhou Xiaochuan, governor of the People's Bank of China.
China should also rethink its refusal to increase the value of the yuan – an issue that's been widely misunderstood domestically. Public opinion has rejected yuan appreciation calls from other countries based on the mistaken belief that China should refuse whatever rivals want.
But this has had serious consequences. For example, holding down the yuan's value has delayed implementation of an independent monetary policy and led to further imbalance for the mainland's economic structure. QEII is hitting China harder than it would if we had a flexible yuan exchange-rate mechanism.
China's policymakers did the right thing, however, by restarting exchange-rate reform in June, letting the yuan appreciate steadily within a set framework.
Raising interest rates is another macroeconomic means of tackling rising asset prices and cooling bubbles, although that could attract an inflow of more speculative money.
Since the yuan is not yet convertible, the government for now should consider measures to increase liquidity flow costs and thus control hot money inflows in the short term, thus paving the way for higher interest rates and yuan revaluation.
Of course, capital controls should only be a temporary measure until the situation stabilizes. Then, China must gradually begin opening its capital accounts and setting up a flexible yuan exchange rate, as well as interest-rate mechanisms, to meet the needs of a market economy.
For now, China must weather the storm while battling inflation, and look forward to a time when our economy emerges more stable than ever.
