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Be calm and cautious

(China Daily)
Updated: 2009-06-11 16:10

A continuous fall in both consumer and producer prices does not necessarily mean that deflation will take root in China because global commodity prices are climbing from last year's lows. Yet, it can serve as a check on optimism that takes recovery of the Chinese economy for granted.

China's consumer price index (CPI), the main gauge of inflation, fell 1.4 percent year on year in May. This is the fourth consecutive monthly decline since the index dropped 1.6 percent in February, the first fall since October 2002.

Related readings:  CPI and PPI fall, but deflation threat eases  China's CPI falls 1.4% in May  China's CPI falls, lending spree eases

Meanwhile, China's producer price index (PPI) - an important measure of inflation at the wholesale level - fell 7.2 percent year on year in May, compared with a 6.6 percent drop in April and a 4.6 percent fall in the first quarter from the same period last year.

For those who are worried about deflation getting entrenched and choking off demand, the latest price figures may appear to justify their concerns.

But, they should ignore neither the high price base that contributes significantly to the current year-on-year fall of prices nor the latest change in the trend of pricing.

For instance, the current steep fall of producer prices - an indication of future change in consumer inflation - is largely driven by a deep cut in oil prices and double-digit declines in the cost of iron ore and other raw materials. Though still way below the record highs (above $147 in mid-July 2008), international oil prices have almost doubled since last December. Other commodity prices are also rising rapidly.

In the circumstances, it is not unexpected that many observers foresee a return to inflation later this year. Given the government's strong stimulus package and the unprecedented credit support by Chinese banks, it is more likely that China may need to prepare for inflation returning before economic growth.

Since moderate inflation can help combat recession, a return to inflation might be welcome. After all, the country has targeted headline inflation of 4 per cent this year. However, while many other economic indices point to improving fundamentals, it is too early to take recovery for granted, especially when large deflationary pressures remain.

There are many optimistic notes being struck nowadays, such as the worst of recession being over in many major economies; and the Chinese economy rebounding strongly on an explosion of credit this year.

But falling prices indicate that the real economy is not performing as well as it appears. There is case for caution until prices return to positive territory and the economy regains momentum.