Reading China’s inflation data

As the bears gather in advance of this week’s data download from Beijing, a ray of light breaks through the lowering clouds of falling growth, declining industrial production, weak demand for electricity and hesitancy in the PMI. The cooling of consumer price inflation (CPI) to 2.2 per cent in July was a fresh reminder of how dangerous it is to leap to conclusions about where China’s economy is heading in the medium term and to draw knee-jerk lessons.

Exports hold up, import growth drops. The trade figures for June issued this week did not bring the gloom on the export front which had been widely expected as the US and EU slow down. The surplus was up 43 per cent year on year to US$31.7 billion. It is always possible of course that as consumers in the West spend less cash they will go increasingly for cheap goods from the Mainland.

A bigger element in the surplus number was the drop in imports (plus only 6.3 per cent year on year or half the consensus expectation. That certainly reflected reduced demand for hard commodities but there is also an unknown factor in the shape of inventories with anecdotal reports suggesting that China has been stockpiling iron ore and other inputs and it may be drawing on these as it awaits falls in world prices.

New drivers. As we have argued, new drivers of growth will emerge in the second half of the year as newly installed local government officials launch infrastructure projects in transport, water and housing. These will not grab headlines in the manner of the high-speed train expansion in 2009-11 but will be multiplied many, many times across the country. Importantly, the projects are needed not for their return on capital but as part of the ongoing urbanization drive – ghost cities will be able to attract residents when roads lead to them, flats have clean water and sewerage is installed.

Inflation relief. The authorities have been far more cautious about monetary easing this year than markets had expected. Now, the rapid drop in the CPI numbers means that they have the advantage of retaining weapons (more interest rate cuts after the two recent ones and reductions in the reserve ratio requirement for banks) while being able to ease credit without fuelling the kind of inflationary push seen in 2009-10. But whether they will react in this way is open to question. Regaining control after the runaway experience of two years ago is at the core of government and central bank policy, and they will not want to hit the accelerator until they have to. On the contrary, they are likely to see the low CPI figure as proof that policy has worked and so should not be given up.

The Party’s worries. The likelihood of maintaining current policy is increased by the leadership’s bottom-line target: the achievement of a more stable growth pattern enabling it to carry out the rebalancing at the heart of the current Five-Year Plan and to consider the future on the lines of the debate presaged in recent official media and by the Communist Party Central Committee Plenum statement last year that the reform and development agenda has reached a critical stage involving “the future and destiny of the Chinese nation, the life and death of the Party, as well as the lasting stability and prosperity of the country... We must develop a stronger sense of crisis, draw experience and lessons from the success and failure of other ruling parties in the world, and enhance our governance capability in a more earnest and conscientious manner,” the Plenum concluded. But its recipe for doing so was unforthcoming on the kind of reforms China requires if it is to continue its upward trajectory.

The pork factor. So, while a reform debate does appear to be taking shape in this year of transition, the leadership is left with short-term data for its guidance. The latest CPI figure – down from 3 per cent in May and almost half the annual 4 per cent government target − is very welcome. But, as always, the vital role of food prices, which fell in June with pork down 12 per cent compared with the same month of 2011, could mean that the inflationary respite will be limited in time. It is likely to end when the pig breeding cycle kicks in next year, sending meat prices up once more.

Fine-tuning. Given the mixed picture likely from the upcoming data, it is not surprising that Premier Wen Jiabao, while noting “a generally stable” economic situation, points to “relatively huge downward pressure”, meaning that Europe remains a preoccupation for policymakers. In those circumstances, no big programmes on the lines of 2008 can be expected, but “fine-tuning” as the leadership picks its way through the undergrowth and waits for an upturn by the end of the year as the Fifth Generation steps up to the plate.