Rising food prices could signal stubborn inflation in China

Zhao Lijuan, a retired accountant, picked through the vegetables at a downtown Beijing market on Tuesday with more than her usual care.

“The price of everything has gone up this year,” she says. “Before, if I bought too much, I would throw the leftovers away. Now I’m careful to buy only what I know my family will eat.”

Food prices in China have gone up by 11.7 percent in the past year, according to official figures released over the weekend, pushing overall year-on-year inflation to 5.1 per cent – a 28-month high.

If government officials are right to blame the unusual rate on bad weather that has pushed vegetable prices up, Ms. Zhao will not have to worry for long. The seasons will change.

But some economists point to deeper reasons behind the rising prices, which suggest that inflation could be a more stubborn problem.

A policy 'bound to create inflation'

High on the list of causes for many experts is the credit boom that the government has encouraged over the past two years to power China through the international economic crisis. Lending by largely state-owned banks nearly doubled last year from 2008, and has stayed almost as high this year.

“The major driving force for Chinese inflation is the extremely expansionary monetary and credit policy,” says Xiang Songzuo, senior fellow at the International Monetary Research Institute in Beijing. “That was bound to create inflation.”

After allowing the money supply to increase by more than 50 percent over the past two years, the government recently announced that from next year on it would replace its “moderately loose” monetary targets with “prudent” ones.

The authorities appear reluctant, though, to increase interest rates beyond the 2.5 percent they set in October. At the moment, inflation means that depositors are earning negative interest – losing money – and are less inclined to save. Higher real rates would encourage them to keep their money in the bank, instead of going out and spending it, further fueling inflation.

But higher rates would also make it harder for the state-owned enterprises and local governments – who have taken the lion’s share of the past two years’ credit – to pay their loans back, points out Paul Cavey, an analyst with MacQuarrie bank.

At the same time, he adds, “raising interest rates would make the RMB [the Chinese currency] even more attractive” to foreign investors, and might tempt in large amounts of speculative “hot money” that would only feed more asset bubbles.

Should China strengthen its currency?

Some local economists blame rising inflation on higher international prices for oil, minerals, and other raw materials that China imports in vast quantities to fuel its continuing double-digit economic growth.

One way of countering this impact would be to let the RMB strengthen, as the US and other governments are urging Beijing to do. A stronger RMB interests Washington because it would make Chinese exports more expensive, and imports from American manufacturers cheaper. But it would also make Chinese commodity imports cheaper, lowering inflationary pressure.

Few observers here think that will sway the government, though. “They have made up their mind to keep the RMB exchange rate stable” says Dr. Xiang. “They know there are negatives to not appreciating the currency quickly, but on balance they prefer stability” and the jobs that depend on cheap, fast selling exports.

Chinese consumers are sensitive to rising prices, which in the past have sparked social unrest.

Still, the country is far from its situation in 1989, when 18 percent annual inflation fueled the popular anger that fed into the Tiananmen Square protests, which nearly toppled the Communist Party government.

In those days, city dwellers spent half their income on food, prices for which were going up by more than 20 percent a year. Today they spend only a quarter of their money on food, and inflation is not biting as hard. Most can cope with the rising prices, and the 700 million Chinese who live in the countryside are actually benefiting from higher prices for the food they grow.

“The only problem is the urban poor,” says Mr. Cavey. “If things get worse, the government could probably subsidize their food.”