Report Interpretation

As people had expected, China's consumer price index (CPI) rebounded to 6.5 percent in October with the price of food jumping 17.6 percent year-on-year.

This growth rate came as no surprise as the producer price index (PPI) was up by 3.2 percent and the price of fresh vegetables rose sharply by 11.54 percent during the same month.

All these statistics have proved the warnings in the monetary policy report of the People's Bank of China for the third quarter: the pressure of price hikes is increasing to such a degree that the authorities and the market must keep a close watch on it.

Opinions are divided about the current CPI growth momentum. Some hold that the economy is seeing remarkable inflation pressure because the CPI has been strong since the start of the year and its growth rate has been climbing month by month.

Others think CPI growth is driven by the rise in food prices, and this can be remedied by boosting agricultural production.

Actually, the current method for calculating the CPI is not scientific enough to mirror the real economic situation.

CPI figures depend heavily on price changes in foodstuff, which means it would remain stable if food prices do not rise significantly.

In the public consumption sector, people spend most of their income on houses, education and medical care, but in the computation of the CPI, these factors are not given sufficient weight.

To make things worse, these consumption items have seen several price rises in recent years which have not been reflected in the CPI numbers, so economic growth in recent years has been lauded as a sound one.

Most countries set their annual inflation target at 2 percent, and this level matches well China's situation. The authenticity of the CPI figures aside, the CPI growth rate of 6.5 percent year-on-year is alarming enough.

The authorities should watch the situation closely and prepare for the further tightening of monetary policies.

Several factors are increasing the possibility of inflation, one of the most prominent is the steep rise in the price of resources on the world market, including gold, crude oil, grain and other minerals.

These hikes are not a result of a boost in demand against limited supply, but the depreciation of the US dollar in recent years. The exchange rate of the dollar has fallen from 121 on July 6, 2001 to 76 on November 6, 2007 against a basket of the world's major currencies. It is only natural that commodities, priced in US dollars on the international market, witness price rises.

The price hikes on global markets would sooner or later spread to our domestic market due to China's heavy reliance on trade.

It is common knowledge that the domestic economy has developed a lopsided structure because the pricing scheme of the production essentials is distorted.

Most of our production essentials are priced unreasonably low, like land and labor. As a result, our commodities are not fairly priced because manufacturers do not pay attention to social security, offer enough training to their employees, and do not treat the pollutants emitted from their factories.

This distortion is the root cause for the many defects in the economy, like the huge international trade surplus, gigantic amount of foreign exchange reserve and the accelerated growth in bank loans.

Therefore, it is vital for the country to correct this distortion so as to upgrade the economic structure. This correction will be a long-term effort for the authorities, and a factor that should not be ignored when discussing economic issues.

Inflation pressure has also been intensified by increased inflation expectations in the market, which is more challenging for policymakers.

Inflation expectation is the public's estimation of the possible range and direction of price changes in the future. This expectation bears direct influence on consumption, bank deposits and investments.

Inflation expectation is decided by multiple factors, including the real inflation rate, the current economic situation, current monetary policies, and the credibility of public policies. Central banks in many countries regard it one of their most important policy targets - to curb inflation expectation.

Boosted by economic over-heating and continuous CPI growth, the inflation expectation of China is at a relatively high level. This expectation drives the public to rush for bargains to avoid paying more for the same thing in the future.

The authorities should try to implement stronger policies to curb inflation expectation and maintain market prices.

A sound monetary policy that includes steady, moderate tightening might be the answer to guard against all-round inflation.

The author is a researcher with the Institute of Finance and Banking under Chinese Academy of Social Sciences

(China Daily 11/21/2007 page10)

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