Inflation fight must come first

By Ma Jun

China Daily, February 10, 2011

The People's Bank of China (PBOC) announced on Feb 8 that it would raise the benchmark lending and deposit rates effective from Feb 9. The rate hike appears to be symmetric as both the benchmark 1-year lending rate and the 1-year deposit rate have been raised by 25 basic points. The PBOC also raised the demand deposit rate by 4 basic points, and aggressively raised the deposit rates of longer maturities. We think this is a de facto asymmetric rate hike, with average deposit rates rising more aggressively than market expectations.

The government and the PBOC are clearly concerned about the fact that negative real interest rates would exacerbate inflation, and the January CPI to be released around Feb 20 may look high.

It seems the PBOC has refrained from raising lending rates more aggressively partly because actual lending rates have gone up quite substantially in recent months, and the smaller move on benchmark lending rates can be seen as an effort to avoid over tightening. The other likely reason is that with the recently announced "third round" property cooling measures by the State Council, a sharp increase in long-term lending rates would be too harsh on the property market.

However, the rate action won't significantly affect overall market performance, as it had been expected. But the government does need to slow China's economic growth to combat inflation. This year China's GDP will grow at 9 percent or above. Such robust GDP growth will boost the country's employment, and might even exacerbate the labor shortage problem when the country's labor force supply is already on the decrease. But the big threat is inflation. The annual CPI inflation for 2011 will rise by 4.5 percent and close to 5-6 percent in the late second quarter, indicating the challenge of controlling price inflation to below 4 percent.

Moreover, China is facing more inflation pressures than the CPI indicates. According to a recent depositor survey by the PBOC, respondents' satisfaction with prices has dropped to a record low over the past 11 years, thanks to the leapfrogging commodity prices and the soaring house prices.

Taking commodity and house prices into account, China is probably under greater pressure.

To make things worse, unmanageable factors, such as inflation expectations and the international oil price, aggravate inflation.

For instance, inflation expectations can expedite capital flow by sparking inflation fears and thus cause greater inflation pressure.

Obviously, prevention of inflation and the pursuit of high economic growth are incompatible for the present.

China should worry about higher inflation rather than lower economic growth. The emphasis should be on anti-inflation with other goals, including economic growth, giving way. Otherwise, inflation will get worse in the following ways and ruin the country's economic and social prospects.