by Victor Mozambigue
Inflation in China has now reached a new high. Producer price inflation hit a 6-year high at 6.9% in January. Rising prices of raw materials, especially steel has pushed the figure higher this month. Consumer inflation gained momentum with robust spending during the Chinese New Year celebrations. Consumer inflation hit 2.5%, reaching a new 3-year high. The surge was fueled by travel costs and food prices which increased significantly during the festive season.
Is inflation a target for central banks?
Central banks ideally opt for tightening monetary policies during inflation. However, the People’s Bank of China is not targeting inflation directly. Here are 3 reasons behind it.
Inflation could be short-lived
The recent inflationary trends in the Chinese data may not sustain for long. The change in consumer inflation is highest in 3 years at 2.5%, but is still within the government’s comfort zone of 3%. Moreover, inflation in January was fueled because of a long New Year holiday, which is why we see travel and food prices as the main components driving the figures. Julian Evans-Pritchard, economist at Capital Economics China said, “We don’t expect such high rates of inflation to last.” He added that reflationary trend could also be a result of weak prices in early 2016. In the medium-term, the price pressure will be contained.
China wants to reduce debt
Debt in China has reached massive highs. In the next 2 years, China’s debt can grow to 300% of GDP. The central bank recently raised the short-term interest rates to curtail debts by banks. The Chinese debt bubble, created because of the government’s will to fuel growth by credit linked policies, may explode to cause slower growth, and lowering rates of investments. Evans-Pitchard said, “Inflation is not the main driver of monetary policy at the moment… the main driver is credit risk and concerns of leverage and what’s going on in the property market.” China is following the Goodhart’s law where targeting GDP numbers is primary policy goal which eventually loses steam.
PBoC’s tightening bias
The People’s Bank of China clearly has a tightening bias as revealed in their latest raise in interest rates. In December, the policymakers indicated a ‘prudent and neutral’ monetary policy in 2017 which shows that they will likely continue with interest rate hikes this year. Even though the property market is expected to cool down in 2017, home mortgages still have the biggest share of bank lending. This has created a domestic asset bubble. Nonbank lending has also increased. The interbank market has higher rates of interest and liquidity is restricted, leading to a contraction in bond financing.
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Huili Chnag, China International Capital Corp economist said, “As the policy focus shifts to ‘curb asset bubbles and guard against financial risks’ and inflationary pressures gradually become a policy constraint, the People’s Bank of China has started and will probably continue its tapering actions.” It is highly likely that policy tightening will continue this year as China plans to restrict its debt bubble.
The rise in inflation in China looks short term. As the January, festive spending wanes, inflationary trends will likely come to rest. Oil prices have helped in raising inflation in China. Even the PPI index is not significantly supported by rise in demand which means that chances of economic slowdown are still viable. The People’s Bank of China will continue to rein tighter as the year progresses to contain the domestic asset bubbles but credit-fueled growth in the country will need structural changes for a positive medium-term outlook.