China walks a tightrope trying to tackle inflation

By Alan Wheatley, Reuters

BEIJING — For global markets that constantly fret whether China’s economy is either overheating or heading for the deep freeze, the ruling Communist Party seems to be getting the policy balance just about right for now. Whether it will get the benefit of the doubt for much longer is a different matter. Investors reacted enthusiastically to the People’s Bank of China’s decision late on Friday to raise banks’ required reserves — viewed as a technical liquidity management tool — rather than to reach for the heavy weaponry of an interest rate increase. Copper responded on Monday by scaling successive record peaks, while relief that China was not slamming on the monetary brakes also boosted global agricultural commodities.

But to some China-watchers, the markets are ignoring clear warning signs that the central bank is behind the curve. “The view that inflation is completely under control is complacent,” said John Woods, chief investment strategist for Asia at Citi Private Bank in Hong Kong. Woods cited fast-rising wages, mounting residential costs, a squeeze on arable land and increasing global commodity prices as reasons to be worried. The global deflationary shock imparted by the collapse of Lehman Brothers in 2008 halted the last bout of Chinese inflation in its tracks. Beijing this time might not be so lucky. “There’s a risk that inflationary pressures start to develop a structural bias,” Woods said. New Paradigm Jianguang Shen, chief economist at Mizuho Securities in Hong Kong, adds a shrinking output gap as well as rapid money and credit expansion to the list of structural factors that he says count for more than food prices in driving Chinese inflation. “China’s output gap or excess capacity is shrinking due to steadily increasing demand and the phasing out of obsolete capacity,” Shen said in a note. What’s more, China is depleting its pool of surplus workers, pointing to a steady climb in wages, while speculative bubbles in property and other assets are adding to price pressures. “We believe that a new paradigm of higher inflation has begun in China, and inflation will be a fixture in the medium term,” Shen and fellow economist Mingming Zhang wrote.