By Hu Shaowei (China Daily)
Updated: 2008-03-25 07:30

A recent report by the National Bureau of Statistics contained several figures that caught one's attention.

The total volume of imports and exports was $166.2 billion in February. The trade surplus was $8.6 billion, a dramatic decrease from the surplus of $19.5 billion in January. The producer price index (PPI) grew by 6.6 percent in February over the same period last year, which is higher than that in January, 6.1 percent. And the consumer price index (CPI) jumped by 8.7 percent in February over the same period last year, a record high for a monthly rise in 11 years.

All these figures caused worries about stagflation, a situation where slow economic growth and high inflation happen at the same time. This led to speculation over possible changes in economic policies, especially monetary.

As a matter of fact, the essential elements supporting long-term prosperity here have not changed. The economy might slow down a little this year, but it is still too early to say it will be threatened by stagnancy, although inflation pressure is considerable high at present.

Looking at the whole range of factors that influence price levels, those pushing prices up are much more significant than those pulling them down.

The United States Federal Reserve has lowered interest rates several times, and this has weakened the US dollar against other currencies. This in turn, has caused the price of petroleum, and other major commodities, to keep rising on the global market. With an increasing reliance on imported petroleum and other products, China is vulnerable to price rises around the world.

Meanwhile, the productive factors in the country - energy, raw materials, land and labor - have also become more costly, pushing up the price levels of all industrial products accordingly.

The CPI was driven up by price rises in upstream products, while the PPI growth has been on an upward curve since late last year.

The snowstorms that hit the central and southern parts of the country in the winter made it difficult to boost the supply of several major industrial commodities, especially coal and steel, and to transport them to regions with the most demand.

When the PPI and CPI develop a correlation of pushing up each other, further inflation pressure emerges.

More importantly, the recent change in prices has led to strong inflation expectations, which could result in further price increases in the future.

Effective control of inflation is now the most urgent task of the administration.

In the Government Work Report to the 11th National People's Congress, Premier Wen Jiabao stressed that governments at all levels should put the issue of rising prices at the top of their agendas. The heads of the provinces and the cities are required to ensure the supply of staples.

CPI growth might ease later in the year, so the target of keeping the annul inflation rate under 4.8 percent is a challenging one.

The unique character of this round of price rises is the fact it is primarily driven by the higher costs of manufacturers rather than a boost in demand for commodities. It is not easy to contain within a short period by administrative measures.

The most effective solution to curb inflation is no doubt a tight monetary policy, which would also help reduce the excessive liquidity. Yet this policy also faces some challenges.

When US interest rates are cut repeatedly, the renminbi sees a larger interest rate gap with the US dollar. If the central bank of China further raises the interest rate of the renminbi, more speculative money would be drawn into the country, posing extra appreciation pressure on the renminbi.

As the Chinese economy is restructuring and the financial market becomes more mature, the central bank has to consider the impact to the financial sector posed by the continuously tightened monetary policy. After all, manufacturing would also suffer if the financial sector is rocked.

Under the premise that the monetary policy should be tight, the decision-makers should have more flexibility in choosing specific policy tools.

The central bank could resort to open market operations or adjustment to the deposit reserve requirement to bring down the liquidity.

Economic restructuring can also be assisted through rules governing bank loans.

Manufacturers with high energy consumption, heavy pollution emissions or redundant capacity should not be permitted more bank loans. And the tertiary sector, the energy-efficient enterprises, and those contributing to narrowing regional disparity should enjoy preferential treatment from the authorities regarding bank credits.

In short, it is necessary for us to have a proper expectation of the role of the monetary policy, especially in curbing inflation.

There are several other choices besides the monetary policy. With a proper fiscal policy, enterprises could pay less tax, and the local governments' desire for investments could be curbed. With a change in the income distribution policy, salaries would be able to grow in tandem with that of the national economy.

A coordinated adoption of all these policies, with patience and skill, would help keep inflation at a reasonable level.

The author is an economist with the State Information Center

(China Daily 03/25/2008 page8)