Chinese inflation has abated and credit expanded, contributing to optimism that a revival of economic fortunes is underway. But the central authorities will have to make some difficult choices.
Chinese inflation has declined. The government reports that, in March, consumer prices were up only 2.1 percent from a year earlier. A decline in food price inflation was the principal reason. This is good news for the new government as it opens room for more expansive monetary policy. Recently credit market policy had been somewhat restrictive due to concerns about inflation. Monetary policy has been on hold due to worries about inflation, and there was fear that the central bank might raise interest rates or boost reserve requirements. Now those fears seem to have dissipated. Still, one month does not make a trend. The central bank will monitor inflation in the coming months to decide if a shift in policy is needed.
China’s money supply and local currency lending both grew faster than expected in March, contributing to optimism that a revival of economic fortunes is underway. The trick for Chinese policy makers is to keep credit flowing while avoiding inflation and asset-price bubbles—especially in the property market. It is a tough balancing act.
One reason for the expansion in credit is that there has been a flood of capital into the country from overseas. The result is a boost to credit expansion and a big increase in the size of China’s foreign currency reserves. These stem from central bank purchases of incoming currency, which is done in order to prevent the renminbi from rising in value. The rise in credit, however, could be worrisome in that local governments especially have taken on a considerable amount of debt. In early April, ratings agency Fitch lowered its rating of Chinese debt, largely due to the precipitous increase in the volume of local government debt. Fitch noted that China’s ratio of credit to GDP has risen from 125 percent in 2008 to 198 percent today. The concern is that local government investments are not generating a sufficient return to service these debts. Moreover, local governments have relied on the sale of land to finance government services. If land prices fall, or the demand for land declines, this could be problematic for local government finances.
China’s central authorities are caught between a rock and a hard place. They want credit to expand, but they don’t want to fuel inflation and they don’t want to foster conditions for credit crises in the future. They want inbound investment, but they don’t want more upward pressure on the currency. They will have to make difficult choices.
China’s trade data for March was good enough to spark a global rally in equities. China reported that, in March, imports were up a surprisingly large 14.1 percent over the previous year.
Slowdown in consumer spending
One major effort of the new government of President Xi Jinxing is to fight corruption, which President Xi has publicly warned could undermine support for the Party and government. Specifically, Xi has cracked down on the massive amount spent on entertaining officials, advocating that official banquets should consist of “four dishes and a soup” and should not include extremely pricey Chinese liquors. The government’s officially published retail sales numbers, especially sales at high-priced restaurants, describe a tapering off, consistent with the goal of the campaign. The decline in luxury spending across the board is consistent with several trends and drivers in the economy evident for several quarters, including high levels of debt and liquidity issues in many local governments, that have led to similar events such as auctioning off city-owned luxury vehicles.
Boost to trade
China’s trade data for March was good enough to spark a global rally in equities. China reported that, in March, imports were up a surprisingly large 14.1 percent over the previous year. This suggests strong domestic demand and bodes well for the strength of exports in countries that trade with China—which is just about everyone. In addition, the government reported that exports increased 10 percent, more than the market expected. The end result was a modest trade deficit for China.
A report from the Asian Development Bank (ADB) says that rising wages in China threaten the competitiveness of the country’s exports. The report noted that inflation-adjusted wages have more than tripled in the last decade. If productivity does not keep pace with rising wages, then the country loses competitiveness. Already the rise in wages is leading to a shift of low-wage manufacturing out of China and into lower-wage countries such as Vietnam. The ADB report says that Chinese labor productivity has grown, but remains roughly 10 percent that of the United States. It also says that the sharp rise in wages has been largely due to changing demographics, leading to a decline in the size of the labor force. Indeed the number of 15- to 39-year-olds has declined from 557 million five years ago to 525 million today. This decline is expected to continue. The ADB also says that China’s system of residence permits, known as the hukou system, has exacerbated wage gains by restricting internal migration. The ADB urges that China do more to boost productivity and allow greater flexibility in the labor market. Increases in productivity will require more investment in human capital, more investment in information technology, and more efficient use of labor. The latter requires a more competitive business environment.