Pettis on Chinese inflation

From Michael Pettis’ exclusive newsletter:

Last week the National Bureau of Statistics released inflation data for the month of January:

In January 2011, consumer price index rose by 4.9 percent over the same period of the previous year. Of which, urban area and rural area was up by 4.8 percent and 5.2 percent respectively; the price of foodstuff, non-foodstuff, consumable and services expanded 10.3, 2.6, 5.0 and 4.6 percent respectively. Compared with December 2010, CPI increased 1.0 percent. The price of foodstuff climbed 2.8 percent.

The market expected a much higher inflation number, but there was a revision of the CPI basket, which brought down what would have been 5.1% inflation year-on-year to 4.9%.  Here is Caixin on the subject:

The January CPI figure was based on a newly-revised CPI basket which lowered the weighting of food prices by 2.21 percentage point and increased the emphasis of the housing sector by 4.22 percent.

I don’t think we should read anything sinister into the revision of the CPI basket (although the timing was perhaps a tad convenient) since rising incomes generally mean a declining food share in the consumption basket. At some point they had to revise the basket.

But even with the revision, the month-on-month increase in prices suggests that inflation is running at just under 13% annually, although month-on-month numbers are always suspect because they don’t correct for seasonality and one or two big numbers can have a disproportionate effect. Still, although the CPI inflation number was below market expectations it is nonetheless well above the PBoC’s comfort level, which is officially 4%. In December the year-on-year rise in prices was 4.6%.

This stubbornly high inflation number, coupled with good growth numbers and a surge in exports will, I suspect, give Beijing the sense that it has room to tighten, so I expect that we will continue to see measures such as interest-rate and minimum-reserve-requirement hikes to slow down economic growth. In keeping with this on Friday the PBoC announced yet another 50-basis-point hike in minimum reserves (making it the fifth hike in five months).

But will these measures bite? My guess is that they will at first, but that when they do they will be quickly reversed. Any real attempt to reduce the sources of overheating will cause economic growth to slow too quickly, and Beijing will change its mind, especially if, as I expect, inflation peaks soon and starts to decline.

Let’s face it – most Chinese growth is the result of overheated investment, and removing the sources of overheating without eliminating growth is going to prove impossible. I have been making the same argument for at least two or three years, and so far we have seen how Beijing veers between stomping on the gas when the economy slows precipitously and stomping on the brakes when it then grows too quickly. I don’t believe anything has changed.

There were other numbers released the same day. Lending for January came in at RMB 1.04 trillion, below the rumored RMB 1.2 trillion but still up 18.5% year on year. M2 growth slowed to 17.2%. Many analysts are referring to these numbers as reflecting a kind of tightening, but as I see it they should be more accurately referred to as a slight diminution of extremely loose credit and monetary policy, especially given the sheer scale of expansion in 2009 and 2010.

On that note my SWS colleague Chen Long sent me a very interesting email. In it he says:

In an article uploaded on the PBoC’s website on Thursday, a PBoC official said that the “society-wide financing” in China is a better proxy than net new RMB loans for monetary policy. According to this measure, total financing came in at RMB 14.3 trillion in 2010, up 1.5% year on year, due to the surge in off-balance sheet lending, which more than doubled to RMB 4 trillion in 2010.

Bank lending accounted for only 56% of overall lending in 2010, the lowest percentage since 2002. “Society-wide financing” grew faster than bank loans. If we track the numbers from the last nine years, we also see that during 2002-2008 total financing grew by 19% annually but exploded in 2009.

The central bank has mentioned non-bank-loan financing many times since the end of last year when it released its “Super & Short-Term Commercial Paper” (SSCP). Even if the new loans number comes in at less than RMB 7.5 trillion this year and trust loans are strictly controlled, we believe that overall financing will continue to grow this year. Monetary policy will not be very tight if we look at the overall number.

David Llewellyn-Smith