CPI rise probably won't signal serious inflation

http://www.chinaccm.com 2007-6-15 16:19

The consumer price index (CPI) for May released on Tuesday did not 
come as a surprise. The 3.4 percent monthly rise, though a record high
 for the past two years, was within market expectations. 

CPI growth over 3 percent is usually regarded as a signal of inflation 
and of possible economic over-heating. Many institutions speculated 
that the central bank is considering raising the interest rate. 

Raising the interest rate following record CPI growth is a logical 
choice according to most economic theories. However, a close look into 
the CPI growth as well as the macro economy is necessary before the
 authorities take any move on the interest rate. 

According to analysis of the National Bureau of Statistics, the CPI 
jump in May was due to the rise in food prices, especially meat and 
eggs. 

The data for calculating the CPI can be divided into food and non-food 
commodities. Food prices account for 33.2 percent of the CPI and the 
prices of non-food commodities account for 66.8 percent. 

Among the seven categories of foods, meat and poultry products account 
for 8 percent; eggs, 1 percent; and grain, 3 percent. 

Meat and egg prices have nearly three times the CPI weight of grain 
prices. 

According to statistics from the Ministry of Agriculture, pork prices 
rose by more than 100 percent over July 2006 and were 70 percent 
higher than this past March. A natural consequence is the CPI 
increase. 

China has been a manufacturing base for the world for quite some time, 
so it has seen a balanced supply and demand for most commodities in 
recent years. The supply of several commodities even surpasses the 
demand. As a result, the prices of non-food commodities, except for
 housing, remain flat. 

The CPI is actually propelled by the price rise in meat and eggs. It 
is necessary to examine whether the price rise will trigger real 
inflation, which must be cushioned with a higher interest rate. 

If the price of pork and eggs rises too high, the common people will
 probably turn to other foods. 

The higher price for pork and eggs will only have a mild influence on 
the economy other than pushing up the price of animal feed and related
 products. It is different from the case in which grain prices rocket
 because pork and eggs are not used as widely as grain in industrial 
production. 

The CPI growth of over 3 percent in May will not put long-term pressure
 on economic growth. 

Judging from the current situation, we can conclude that the recent CPI
 growth is unlikely to lead to comprehensive inflation. 

The investment growth in industry is the major source for inflationary 
pressure in China, especially the investment in manufacturing iron, 
steel and nonferrous metals. 

The higher-than-normal growth rate of investment in these industrial 
sectors was not checked until the central government issued several 
policies against the production and export of energy-intensive and 
resource-intensive products and products with high emission pollutants.
 

With the policy tools taking effect one after another, we have full 
reason to believe that inflation is not going to be set off by the 
rapidly rising price of meat and eggs. 

As a result, the authorities may need more reasons to resort to an inte
rest rate hike at this moment. 

Moreover, if the interest rate is hoisted now, it involves a potential 
threat to economic soundness. 

The abundant, even excessive, liquidity in the Chinese financial sector
 is driving up prices on the stock market and the housing market. The l
iquidity originates from the method of foreign currency settlement and 
strict control over the capital account. 

The central bank has turned to several options including raising the re
serve requirement for commercial bank deposits, but these measures can 
only partly control the liquidity in the hands of commercial banks. 

Since the renminbi is constantly appreciating, more international hot m
oney will come into China for profits if the interest rate is lifted ag
ain, loading the country with even more excessive liquidity. 

The stock markets in Shanghai and Shenzhen dipped on Tuesday morning in
 anticipation of the CPI statistics, but soon picked up after the figur
e was announced. 

The market reaction indicates that investors saw that the CPI was merel
y driven up by the meat and egg prices, instead of forecasting overall 
inflation. The conclusion was that the much-feared interest rate hike m
ay not come so soon. 

As a matter of fact, investors should not interpret the central bank's
 
decision on interest rates as the authorities' current attitude toward
 
the stock market. The CPI growth should not be viewed in the traditiona
l sense, but with full consideration of the unusual price fluctuations 
in the last few months. 

The author holds a PhD in economics from the Chinese Academy of Social 
Sciences 

Source: China Daily