China's consumer inflation will exceed the government's alarm level this year as housing and food prices rise rapidly, fuelled by aggressive fiscal stimulus. The severe inflation could destroy the country's hard-won growth and lead to the bursting of a massive asset bubble followed by years of decline, several economists warn.
China's growth-driven policymakers should slam on the monetary brakes and slow the growth down, some observers suggest. However, a sudden shut-down of credit could trigger a short circuit in the recovery, potentially negating the results of the stimulus efforts so far.
The country's consumer price index (CPI) is likely to grow by 4.9% (year-on-year) in 2010, exceeding the government's alarm level of 4%, which will prompt the central bank to increase interest rates, according to BNP Paribas' Beijing-based economist, Chen Xingdong.
January CPI, which is due to be announced today, is expected to have increased by 2.2% year-on-year, supported by a near 7% jump in prices of non-agricultural products, Chen said.
Other market watchers project a 1.8% to 2.1% year-on-year increase in last month's CPI, but they all concur that inflation at the beginning of 2010 has increased the most since 2008. During his visit to Sydney this week, People's Bank of China governor Zhou Xiaochuan was quoted by media as saying that China needs to "closely watch" the inflation rate.
"Inflation is now among the biggest concerns for the Chinese government," said Morgan Stanley's China strategist Lou Gang.
Manufacturers from various sectors increased their product prices last month, citing surging material costs. Aluminum Corp of China, the largest aluminium producer in China, on January 4 raised alumina prices for the third time in five months. And the following week, Beijing Yanjing Brewery raised prices for some of its beer by about 10%, blaming growing prices in materials and fuel.
"The current CPI is at a relatively low level but it has shown signs of accelerated growth," said Vincent Chan, head of China research at Credit Suisse. "In the property sector, there are definitely asset bubbles in the high-end market, and they are getting serious. The central bank can't let the year pass without increasing interest rates once or twice," Chan said at a press conference in Hong Kong yesterday.
Chan was referring to skyrocketing house prices in the Southern China province of Hainan. Some properties on the island have risen 200% in value triggered by an announcement that Beijing intends to make the region a world-class premium tourism destination. Property transaction volumes exceeded the 2008 total in just a few days following the announcement, Chinese media reported.
Even so, when interviewed by China's official media, CCTV, a Hainan government official said "there is no bubble in the market; the buying frenzy is simply because people are rich now."
Presuming tightening measures are imminent, China's banks have sought to get ahead of a credit clampdown. Lenders in the country issued Rmb1.45 trillion ($212 billion) of new loans in the first three weeks this year compared to Rmb1.62 trillion last January, according to HSBC.
Regulators hope to tighten credit to stave off asset inflation. However, the interruption of capital flows may lead to project defaults, which in turn could cause bad loans. Rising house prices are also not necessarily an accidental consequence of loose fiscal policies but are in fact one of the government's goals.
The government needs a prosperous housing market to support the economy. This creates jobs, spurs private-sector investment in construction, and encourages spending on furniture and electrical goods by new homebuyers.
"Domestic consumption will be China's next growth driver (but) Beijing's policies to slow down housing inflation could be a source of risk later this year for personal consumption," Goldman Sachs' chief economist Jim O'Neil said at a briefing earlier this week.
Maybe the bubble is no trouble at all. Some observers argue that the fear of inflation is exaggerated because there is much idle supply due to excessive bank lending that produces extra inventory.
Chinese Academy of Sciences (CAS), a Chinese government think tank, suggests that inflation is not as bad as expected. Excessive production capacity, sufficient supply of farm products and the government's price controls will restrain the sharp rise of prices, the institute said in a report.
It predicts that, in 2010, China's housing prices will remain stable in general. The supply of commercial residential buildings will increase rapidly and, therefore, although the prices of such buildings may increase, the increase will be smaller than that of 2009.
That view is shared by Yifan Hu, chief economist of Citic Securities. "I think this year's inflation will be moderate overall. The fear of inflation is exaggerated," she said.
According to Citic Securities, the CPI and PPI (producer price index) this year will be 2.6% and 3.5% respectively, while the government's acceptable maximum inflation level is 3%.