The job of a central bank governor is never done.
Just months after China eased worries of a hard landing, rebounding in the fourth quarter with gross domestic product (GDP) growth of 7.9% despite 2012 full-year growth of 7.8% - the slowest rate in 13 years - China’s central bank governor has moved on, declaring a war on inflation.
On March 13, People’s Bank of China (PBoC) governor Zhou Xiaochuan addressed China’s rising consumer price index (CPI) level and reinforced the need “to keep vigilant on inflation”.
“In the past some of us thought it was no big deal if inflation was a little bit high, growth will be a little faster and then we can control inflation afterwards...But international experience and our own experience here show that this thinking might not be correct,” Zhou reportedly told media at the PBoC’s press conference during the National People’s Congress this week.
This is especially urgent after February’s CPI level was higher than expected, rising to a 10-month high of 3.2%, up from the 2% in January and 2.5% in December. Even after taking the Lunar New Year holiday into account, which generally drives up the price of food, the figure outpaced forecasts in the 3% area.
Food prices specifically rose 6% in February, up from 4.2% in December. That month itself saw the highest price increase since May 2012, according to official data.
Inflation has been a niggling problem for China for years but solving it has been an impossible task. And rising inflation leads to the belief that the PBoC will tighten monetary policy, which in turn impedes the country’s growth prospects. This may include reversing some of the gains made last year, when the central bank cut interest rates twice, encouraged greater bank lending to key industries, invested billions into infrastructure and development, regularly conducted reverse repos, and decreased banks’ reserve requirement ratios (RRR).
These have helped put the country’s growth trajectory back on track, with Moody’s forecasting 7.5%-8.5% GDP growth in 2013. But the PBoC now has a dilemma, deciding whether to more aggressively quash inflation at the expense of growth, or supporting growth and kick the can to deal with inflation later.
The PBoC is expected to do the former, and for good reason. Despite global pressure to maintain stellar growth, China is also looking to close its gaping wealth rift and improve social welfare. Citizens nationwide – many of whom live well below the poverty line - are already feeling the pressure of inflation. These are the people the government needs to make a priority.
PBoC governor Zhou has been artful at striking a balance that has seemed to work, at least for now. Already to limit inflation in 2013, the PBoC has introduced tools such as repos every Tuesday and Thursday. This began around Chinese New Year, coming much earlier than many market participants anticipated, and market participants hope they will continue. The government also levied a property tax to help lower real estate prices, which have begun inflating again.
But the question remains of what Zhou and the PBoC will do in the long term. Weighing growth against inflation is a delicate balance, and one that requires give and take.
It’ll be a hard pill to swallow, but if China wants to achieve deflation in the long term, the PBoC needs to take a stronger stance at the price of growth starting now, rather than cushioning its efforts to maintain ultra-strong GDP.
For one, the PBoC has been helpful in announcing 13% M2 growth in 2013, down from 14% growth last year in an effort reign in liquidity. But as long as the country’s nominal GDP of Rmb51.93 trillion (US$8.23 trillion), M2 cannot grow faster – this will inherently lead to inflation. Zhou should be more hawkish and implement a 10% or 11% M2 growth rate at the very least. As of January 2013, China’s M2 level is Rmb99.21 trillion.
And while introducing repos has been effective at draining liquidity, China should take a page out of India’s book, which institutes repos daily. In the very least, China can add an additional day of repos, which will help drain further liquidity.
Repos additionally helps to keep a close eye on bank lending to ensure debt doesn’t pile higher. And as repos are reactive tools, they can be tweaked affording to foreign exchange inflows and necessity of bank lending. China is starting to rely on repos, but the PBoC can go further than the irregular twice-weekly schedule.
These are targets that China is surely working towards, and they will take time. And while the industry may applaud Zhou and the PBoC for stepping up to more aggressively tackle inflation, it is possible to do more and send a stronger message early.
The PBoC has set a CPI growth target of approximately 3.5% this year, which analysts believe China will meet. However, while this is lower than the 4% set for 2012, inflation in 2012 actually reached 2.6%, well below the benchmark. Analysts doubt this will be the case again this year.
The biggest advantage the country has is its tremendous growth prospects, which is entering a period of transition from an investment economy into a consumption-based one. Economist are confident that, even when boosting inflation-combating measures, the country will see 8%-plus GDP in 2013. And in the future, slightly slower growth is an acceptable solution to get inflation under control.
As much as the PBoC wants to maintain growth, it has to take the long-term balance between GDP and CPI into question, and create the solution that works best for its own citizens as it re-jigs its economy toward consumerism. The first steps may be difficult to take, but cheaper goods for the people who need it will go a long way to making the country stronger.