Inflation is not a threat to China, says CLSA

However, China will have to stomach higher structural inflation in the next few years as the nation gets wealthier and wages increase at a double-digit rate, the brokerage firm argues.

Runaway inflation is not a serious problem for China and soaring food prices will subside in early spring this year. Therefore, the Chinese government's policy response will be moderate, said Andy Rothman, China macro strategist at CLSA.

He made the comment one day before China's central bank ordered lenders to hold more deposits as reserves for the fourth time in two months to stop inflation from growing too fast. The People's Bank of China (PBoC) announced on Friday a 50 basis point reserve ratio hike for all banks, effective January 20, sending the reserve ratio to a new record high of 19% for big banks and 17% for smaller banks. The move is likely to prevent Rmb350 billion ($53 billion) of liquidity from flushing into the market, according to HSBC.

Shanghai-based Rothman believes Chinese policymakers are “not too worried about inflation” and will keep a “mildly accommodative” monetary policy. “China will have to become accustomed to a slightly higher level of structural inflation in the next few years. This is due to China getting wealthier and wages increasing at a double-digit rate,” he told reporters on a conference call.

The primary driver of inflation last year was bad weather, which led to a sharp fall in the supply of fresh fruit and vegetables. Food alone accounted for 74% of the 5.1% year-on-year rise in the consumer price index (CPI) in November and most of that was fresh fruit and vegetables, which contributed a quarter of the food inflation during that month, according to CLSA.

The brokerage expects wages in China will increase by at least 10% this year, compared with an estimated 4.5% increase in CPI during the year. Inflation-adjusted income rose by 7% or more in each of the past 10 years in China’s cities, and in each of the past five years in the countryside. Rising wealth will enable Chinese consumers to better handle the rising costs, the firm said.

However, other economists think the stubborn inflation is a more compelling problem and that Beijing will likely battle rising prices wholeheartedly.

“For China, this year will be a year of inflation. Decisive and forceful tightening measures are needed to combat inflation. Friday's reserve ratio hike is a good start, but more still needs to be done,” said Qu Hongbin, co-head of Asian economic research at HSBC.

Qu estimated that consumer price inflation will accelerate to 6% in the coming month and that banks will need to get ready for more hikes, both in the reserve ratio and interest rates in the next six months.

Chinese lenders are estimated to have issued Rmb500 billion of new loans in the first 10 days of January. Although the new lending can be attributed to pent-up demand accumulated towards the end of 2010 and the usual Chinese New Year lending rush, Qu thinks this is worryingly high even compared to a typical January and historic seasonal highs for the first quarter.

New lending in China will be around Rmb7 trillion to Rmb7.5 trillion this year, while economic growth will slow to 9.5% in 2011 from 10.2% in 2010, Rothman predicted. Chinese banks issued Rmb7.95 trillion of new loans last year, data from PBoC shows.

Fixed asset investment (FAI) is going to continue to be the main driver of Chinese economic growth in 2011, which will support the demand growth for global commodities, CLSA projected.

Last year, FAI grew at 25% and Rothman said he expects the growth to be the same this year. There is still plenty of need for public infrastructure in China. For example, about 115 million Chinese don't have access to clean drinking water. A lot of projects are still underway and will be worked on this year and some projects are shovel-ready, Rothman said.

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