The consumer price index (CPI) last month attracted wide public and
Its growth of 3.4 percent, though a record high for two years, and the third
monthly rise in a row of over 3 percent, was still within market expectations.
The unusual interest was due to several factors.
The market, especially the securities market, is trying to figure out future
moves by the monetary authorities, and the CPI, the key indicator of inflation,
is obviously an important factor in any decision.
government may also be under pressure. The CPI in rural areas is climbing more
quickly than in the cities. With the rural population lagging far behind their
urban cousins in disposable income, the more dramatic growth in the prices of
necessities may further lower the living standard of the rural population.
Admittedly, the current CPI growth is primarily driven by the rise in prices
of pork and grain. However, there is a possibility prices of more commodities
could be pushed upward, signaling runaway inflation.
With the banking sector controlling the majority of the country's financial
assets, the difference between the inflation rate and the interest rate is a
decisive factor in money flows between banks and the capital market. When the
CPI growth is close to the interest rate, more people could move their savings
from deposit accounts to securities.
The already excessive liquidity troubling the economy would be even harder to
Under such circumstances, it is only natural for authorities to tighten the
monetary policy. With higher interest rates and deposit reserve requirements,
the central bank has quite a few tools at its disposal.
Given the time gap between launching a tightening policy and it effects on
the economy, the earlier it is launched the more effective it will be.
However, tightening the monetary policy could cost China a lot more than it
would other countries because of China's heavy reliance on foreign trade and
foreign direct investment.
Both the market and businesses are seeing abundant liquidity, consumers have
a strong desire to buy or invest and the country's exports are primarily driven
by products from foreign-invested processing manufacturers. So tightening
monetary policy will have a limited effect on domestic demand and inflation
Furthermore, export-orientated manufacturers are capable of making up their
costs as a result of higher interest rates by selling more items at more
expensive prices. Thus, increasing the trade surplus and liquidity.
China is in the middle of a reform scheme involving the renminbi's exchange
rate against other currencies. The difference in renminbi interest rates against
other currencies is a source of profit for investors on the international money
If the monetary policy is tightened and the interest rate raised in China, in
other words, if the interest rate gap changes, or even if there is a possibility
of such a change, the Chinese monetary authorities would face huge pressure to
maintain the renminbi exchange rate and the smooth development of the reform
Different from the United States and European countries, China needs
reasonable economic growth, to help curb unemployment caused by economic
transition, and maintain relatively low inflation. It is not easy to kill two
birds with one stone.
It is not feasible to indulge inflation by keeping the monetary policy as it
stands for the fear of hurting economic growth.
Therefore, the central bank of China is facing a much more difficult task of
containing inflation compared to its counterparts in other countries.
The policymakers may have to resort to a complex set of tools to ensure
economic soundness against the problems.
Premier Wen Jiabao and his colleagues drafted a series of countermeasures at
a recent meeting of the State Council. And the measures are correct in tackling
inflation in all possible aspects.
Farmers and cattlemen are being offered special subsidies and favorable
treatment by the government so that they can stay in business.
Measures are also being taken to reduce the trade surplus, so inflation does
not get worse by the attendant liquidity. Export tax rebate rates have been cut,
some are no longer eligible for tax rebates, and import tariffs have been
Liquidity is being diverted into more financial products and the capital
market, so that inflation pressure on the commodity market is eased.
These measures will help achieve the dual target of containing inflation and
ensuring reasonable economic growth.
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