A Day's Wages for a Loaf of Bread

China Vows to Tame Inflation

November 19, 2010

Reuters - China will intervene to control consumer prices if they rise too quickly, the government said on Wednesday, a move that will do little by itself to tame inflation but could foreshadow harsher monetary tightening.

Steps to cool demand in China, the world's fastest-growing major economy, could weigh on global markets at a time when recoveries in Europe and the United States remain fragile.

To begin with, the State Council, or cabinet, said it would aim to increase the supply of commodities, especially food, that have driven inflation to a 25-month high, while also clamping down on speculative demand that has lifted prices higher.

"We need to understand the importance and urgency of stabilizing market prices and take forceful measures," it said after a routine meeting chaired by Premier Wen Jiabao.

"When necessary, temporary intervention measures will be implemented on prices of some important daily necessities and production materials," it added in the statement.

The State Council singled out grain, oil, sugar and cotton as markets that it wanted to stabilize. It also vowed to intensify a crackdown on price speculation and to punish those found hoarding commodities and pushing up prices by illegal means.

The statement made no mention of monetary policy.

"I don't believe that they will just stop here," said Kevin Lai, an economist with Daiwa Capital Markets. "Many people in the government are capable enough to figure out that prices controls are not that effective."

"They really have to do something more about controlling liquidity and money supply growth if they are serious about containing inflation," Lai said, adding that he expected the central bank to raise interest rates for the second time this year over the next two weeks.

MORE TIGHTENING AHEAD

Worries that the government could start tightening more aggressively drove China's main stock index down by 1.9 percent on Wednesday to a one-month closing low. The index has dropped 11 percent over the past four trading days.

Shi Chenyu, an economist with the investment banking arm of the Industrial and Commercial Bank of China, said the sternly worded statement showed that inflation had reached the top of Beijing's policy agenda.

"The government often opts for iron-fisted administrative measures to control prices when inflation becomes a serious problem," Shi said. "However, harsh administrative measures may backfire as expectations of further price rises may intensify."

The State Council said it would hold provincial governors accountable for the prices of "rice bags" and make mayors responsible for "vegetable baskets," though it did not specify how it would implement these directives.

The world's major consumer of farm commodities including cotton, corn and sugar, China has been releasing state reserves this year but has failed to cool record domestic prices.

Sudakshina Unnikrishnan, a commodities analyst at Barclays Capital in London, said China was expected to release further reserves of commodities such as sugar, but could step up import demand, fuelling upward pressure on international prices.

"While such measures would cool domestic prices in the near term, the international markets are tight," she said.

"If the Chinese reduce domestic reserves, they will have to increase domestic reserves later, so Chinese demand on international markets will increase."

Other analysts predicted the government's statement would have little long-term impact on commodities prices, which have been rising sharply in China in recent months.

"Agricultural commodities price falls are likely to be moderate and regain upward strength if there aren't concrete measures such as tightening liquidity," said Lu Yun, an analyst with Shanghai JCI.

"There is nothing new in the statement, and the market has already anticipated such adjustment," added Lu.

Even if the government sold all its estimated 1 million tons of state sugar reserves, the market could soon digest it, said Liu Qiang, an analyst with Guohai Liangshi Futures Co.

GOOD FOR FARMERS

Apart from doubts about the effectiveness of price controls, Beijing may be reluctant to press down too heavily because more expensive food also supports one of its core policy objectives.

"The government has always said it wants to raise farmers' incomes and rising prices are a good way of achieving that," said Zhang Hanya, a researcher with the National Development and Reform Commission (NDRC), a powerful planning agency.

Instead of targeting food prices, the government should use part of its hefty revenues to subsidize city dwellers, he said.

Consumer inflation sped to a 25-month high in October, with prices rising 4.4 percent from a year earlier. Food, which makes up about a third of China's consumer price index, led the way, climbing 10.1 percent. Non-food items rose just 1.6 percent.

Unlike past bouts of food inflation in China, there have been no major droughts or diseases to stoke prices this year. Instead, fast money growth appears to be the primary culprit.

To that end, reports in the Chinese press on Wednesday pointed to interest rate increases, higher reserve requirements and more restrictions on bank lending as weapons in the government's arsenal against inflation.

Many economists also believe China will quicken the pace of yuan appreciation as inflation accelerates, because this would help to reduce the cost of imported goods.

China's futures prices for cotton, sugar and rubber have spiked in recent weeks, with analysts blaming excessive liquidity, supply disruptions, strengthening demand and a growing investor appetite for safe-haven assets.

A spike in demand for diesel-fired power generation has caused a supply shortage that could last into 2011, forcing Chinese refineries to import the fuel for the first time in nearly two years.