China's challenge: to contain inflation, boost the yuan

China's challenge: to contain inflation, boost the yuan

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When Premier Wen Jiabao presented his annual work report at the National People's Congress on March 5, he not only provided a comprehensive yearly update on the current situation of the country, but also its outlook. In maintaining the target growth rate of 8 percent, preserving its proactive fiscal policy and continuing its moderately easy monetary policy, it is clear that the pace of sustainable and stable growth in the past 12 months is still within the safety zone of the central government's gauge.

Managing an economy that consists of 1.3 billion people is no easy task, not to mention enduring the aftermath of the global financial tsunami and orchestrating it while leading the pace among the major global economies.  Behind Premier Wen's commitment to building a harmonious society, there are underlying uncertainties and risks in maintaining the target growth rate.

The problem lying ahead is clearly in the wake and potential consequences of the counter-cyclical stimulus. Take a glance at the recent Consumer Price Index (CPI) figures from November to January, running at a resilient pace of 0.6 percent respectively.  There are signs suggesting accelerating inflationary pressure.

The overheating property market also poses another strong sign that inflationary pressures exist, at least in certain segments within the economy.  In January, housing prices in the 70 major cities within China rose an average of 9.5 percent a significant increment compared with the 12 months' growth ending July 2009, which was only 1 percent Residential sales climbed a staggering 80 percent increase in 2009. Containing the heat without cooling of the sector will be the biggest challenges for the government. After all, the sector accounted for 8-10 percent of the nation's GDP.

Meanwhile, the manufacturing sector is ratcheting up into a higher gear. In certain cities in Guangdong, wages have risen as much as 20 percent in recent months.  These supply/demand imbalances and tide of rising wages certainly will inject further inflationary pressure into the system.

The "undervalued" renminbi is potentially another source of inflation.  The renminbi was pegged to the US dollar at 6.83 for the whole of 2009.  According to the People's Bank of China, it was a "special policy to weather the financial crises".  This special policy has been working well and sheltered exporters from the plunge of overseas demand on goods. However, the cost is the increasing supply of renminbi.  As there is no clear indication of a timetable for the renminbi to detach, and with the interest rate spread against the dollar increasing, renminibi assets will continue to attract investors and capital, and potentially create asset bubbles.

While inflation is an imminent threat, it is the systematic and structural risk that may impact the economy on a greater scale. After joining the WTO, the country has had as its objective the gradual opening of its markets, sector by sector and eventually the capital market as well. However, the momentum has been cautiously slowed down, as China has already developed into the world's second largest economy, while the renminibi has not yet become an international currency.  The longer the renminbi remains inconvertible, the imbalances and the disparities between China and the developed economies will accumulate, squandering the micro-management and adjustment efforts of the government, posting a potential threat by the time the government is willing to let the yuan become freely tradeable.

Even though the nation is now gearing up with more fortunes and widespread wealth than anyone could imagine 20 years ago, the road to opening up the markets has been paved with obstacles. The key is whether the government can contain inflation pressures for the lower- and middle-class population, and at the same time maintain order while establishing the renminbi as an international currency and further develop the structure of the existing fiscal and financial systems.

Professor Wang Guan Yi is a Visiting Professor at Asian International Open University, and a Commentator an international finance at NOW Business News Channel.  The views expressed are entirely his own.

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