China: inflation ebb?

This week may reveal that Beijing's efforts to cool inflation are paying off.

Official data should show that China's consumer price inflation in December eased to 6.5% from a year earlier, off an 11-year high of 6.9% in November. Zhou Xiaochuan, China's central bank governor, has long expressed optimism that December's inflation data would moderate because of a high base effect from a year earlier. A pace of 6.5% would match October and August as the second fastest on the year.

Although it is too early to speak of a general downward trend similar to the one seen from mid-2004 onwards, the drop will hearten policymakers in Beijing, who have expressed concerns over rising prices.

Dramatic action taken to curb inflation has been continued into 2008. There were five interest rate rises in 2007, and a ten increases in banks' reserve requirements. And last week, Beijing tightened controls on food prices, requiring producers to seek government approval to implement any price increases. It also hiked banks' reserve requirement ratio by half a percentage point, to 15%, effective next Friday.

The National Development and Reform Commission, China's top economic planner, has announced price controls on a package of products, including grain, edible oil, meat, milk, eggs and liquefied petroleum gas, whose prices are normally set in the open market.

In the short-term, price monitoring and controls will continue in a bid to counter inflationary pressures, derived in part from high international oil and grain prices, but also supply-side problems in China. The government says it will not adjust energy prices in the near time, opting in effect for a price freeze. Price intervention could continue into March; Beijing has hinted that market supplies must be protected through the National People's Congress, the annual parliament that sits that month.

Yet holding down prices for basic necessities may not be a long-term solution, as it is difficult for the government to guarantee quality and quantity and to avoid shortage. Political pressure will increase on Beijing to ease inflation through credit tightening, agricultural subsidies and currency appreciation. China's trading partners will call for Beijing to allow the renminbi to appreciate more rapidly, which could tame the trade surplus and provide a counter-inflationary boost.