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China's Economy - No Quick Fix for Inflation Woes

Straits TImes  24 January 2011

OVER the past two years, China's money supply was boosted not only by the anti-crisis stimulus released in late 2008 but also by spikes in bank lending, which amounted to 7.95 trillion yuan (S$1.6 trillion) in 2010 and 9.6 trillion yuan in 2009, and by rising foreign exchange reserves which increased 18.7 per cent to $2.85 trillion in 2010 as a result of surpluses in both the current and capital accounts.


The confluence of factors caused money supply to rise by 19.7 per cent in 2010, exceeding the official target of 17 per cent. The surge in liquidity in the two years was thought to have fanned the flames of inflation. Despite various efforts to rein in inflation, property and food prices continued to surge.


Finally, when the consumer price index hit 5.1 per cent in November last year, policymakers switched their monetary policy stance from moderately loose to prudent to mop up excess liquidity in the market and to manage inflation expectation. All in all, China raised the reserve requirement ratio six times and interest rates twice in 2010. With the latest hike on Jan 14, the ratio now stands at 19.5 per cent with some analysts predicting it to hit as high as 23 per cent in 2011.


Given that both the domestic and external economic outlooks remain uncertain and that the Chinese economy is still very much investment driven, however, it is unrealistic to expect monetary policy to achieve the conflicting dual objectives of promoting economic growth and restructuring and at the same time reining in inflation.


Monetary policy instruments are also too crude to be able to tackle specific and complex market imbalances without inflicting collateral damage on other sectors.


Already, bond analysts are projecting that borrowing cost for China's banks will rise to 2.9 per cent in the first quarter compared to 2.75 per cent in the previous, while the corresponding one-week US dollar Libor remains at 0.25 per cent. With corporate demand for funds remaining strong, borrowing cost for businesses is set to rise.


Worse, some firms may even see their funding cut off as policymakers continue to scrimp on money supply and restrict bank loans. Furthermore, the widening spread between the United States and Chinese interest rates will lure even more capital into China, adding on to the inflationary pressure as well as the pressure for the yuan to appreciate.


More pertinently, both the core inflation and asset inflation in China may be more than just a monetary phenomenon and therefore cannot be effectively addressed by monetary policy tools alone. Instead, imbalances within different sectors may be more effectively addressed with other sector-specific microeconomic policies and administrative measures. In that regard, the practices of Singapore's policymakers in containing asset inflation and core inflation may offer some valuable insights.


Public housing development in Singapore went through various phases. In the 1960s and 1970s, the Singapore Government focused on providing the ballooning post-war population with decent public housing, most on a rental basis. By the 1980s, as income climbed, demand for better-designed housing rose. The Housing Board began building larger public apartments with better common amenities to meet rising expectations. Home ownership also became a norm. By the 1990s, property became more than just a roof over the head and more invested their excess savings in private properties.


Today, despite a vibrant private property market, public housing still accounts for 85 per cent of all accommodation. More importantly, the high-quality public housing serves as price benchmarks for private properties. By pegging the price hikes of public housing to income growth and the health of the overall economy, the Government sets benchmarks that effectively restrain price growth for similar types of private properties.


In the case of China, a critical shortage of public housing supply to meet an insatiable demand from young urbanites forming families and migrant workers flooding into the cities results in scheming and profit-maximising private property developers gaining control over the market.


One simple trick commonly employed by developers to drive up property prices, for example, is to bid up the price of land so that the value of other plots they acquired earlier also rises with the tide. As a result, developers hoard land and even completed apartments to profit from higher future land prices. While the local governments benefit from the higher revenues they receive from land sales, the true cost is transferred to society not only in terms of high property prices but also a concomitant rise in overall inflation. In the end, the runaway property prices and a shortage of public housing as an alternative stoke fear in prospective homeowners, who are forced to jump in despite the high prices. The free wheeling and dealing by speculators further accentuates that fear and accelerates the price rise.


Hence, in the absence of fair indicative prices, the combination of market imbalances, fear and greed sets in motion a vicious cycle of incessantly rising property prices, putting the dream of owning a house beyond the reach of the lower- and middle-income masses.


Benchmarking is again used by the Singapore Government in controlling prices of daily necessities. This is done through the setting up of a chain of supermarkets by the National Trades Union Congress (NTUC) in the form of non-profit cooperatives owned by working-class members. In Singapore, government-led trade union activities have gone beyond collective bargaining to actively improving the employability and living standards of the working class. Since its establishment in 1973, the supermarket chain FairPrice has set out to bring highquality daily fare to its members at reasonable prices.


Today, there is a FairPrice supermarket in every major housing estate around the island. By purchasing in bulk and bypassing the middlemen, FairPrice is able to make a profit while offering low prices to all customers as well as further discounts to members.


As a foreigner residing in China, it is bewildering that I have to buy some imported Chinese products from Singapore's supermarkets every time I return home and bring them to Nanjing. They are not only cheaper than what I have to pay in Nanjing but also of better quality. Chinese consumers are not only deprived of better quality foreign goods but are also paying a higher price for inferior domestic products. Many of these products got onto the shelves simply because the manufacturers have agreed to pay a host of exorbitant fees charged by the supermarkets. In the end, these fees either result in declining product quality or higher prices for the consumers. Indeed, studies have shown that, in China, the greatest increase in prices takes place on the last rung of the distribution chain, that is, the retailers.


In Singapore, the benchmarking effect, in terms of price, product quality and operational efficiency, provided by FairPrice proves more effective than any combination of policies and rules to regulate the industry and to bring down prices of daily necessities. At the very least, it forces all competitors to be as cost efficient as FairPrice in order to remain in the market. Clearly, the problem of rising core inflation in China is again more than just a monetary phenomenon.


The practices of benchmarking adopted by Singapore in trying to keep both asset inflation and core inflation at bay may not be relevant to China given the complexity of the Chinese economic environment. Notwithstanding, they do demonstrate that by acting both as referees and players where needed, governments have the unique opportunity to introduce best practices and set benchmarks that can help markets function in an orderly and efficient manner.


In the case of China, inflation can be attributed not only to an oversupply of money but arguably more to other factors that lead to imbalances and inefficiencies. Given the sizeable excess amount of liquidity in the market, monetary policy actions are indeed essential but insufficient to address those imbalances.


As China transits into a more refined, not necessarily slower, stage of differentiated growth, the use of broad monetary policy tools increasingly needs to be complemented by coordinated changes in other policy areas to resolve those imbalances in order to achieve lasting results.


In short, quick and broad macroeconomic policy actions are no panacea for the problems of rising inflation and market imbalances that China is currently facing, just as rounds of aggressive fiscal stimulus and quantitative easing have so far failed to reverse the deflationary trend or revive the economy in the US.

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