In the China Business News, Xiong Jianfeng casts an eye over a gathering of academics at Tsinghua University last week to discuss inflationary pressure in China. Despite general concerns, some academics called for calm over inflation figures, claiming high inflation will be short-lived and could help stabilize structural imbalances in China's economy

On November 3, the Center for China and the World Economy (CCWE) at Tsinghua University’s school of economics and management hosted the 3rd annual conference on China’s macro economy. To accompany the conference, the center issued a report analysing the current macroeconomic environment and forecasting future trends.

While academics at the conference tended to agree with the report’s analysis and forecast for economic growth, there were large differences in their opinions regarding inflation.

The CCWE report, which was drafted by Li Daokui and Yuan Gangming at CCWE and two researchers from the economic development research center at the Hong Kong University of Science and Technology, said China’s GDP growth would slow after reaching 11.79% in the fourth quarter, but that the consumer price index (CPI) would continue to grow rapidly.

Driven by food prices or currency policy?

The CCWE report said that CPI would only start to fall after reaching a peak of 7.52% in the third quarter of 2008. This would put CPI growth for the whole of 2007 at 4.72%, ballooning out to 7.34% for full year 2008.

The chairman of the center for quantitative economics at the China Academy of Social Sciences, Wang Tongsan, agreed that rising oil prices and incomes, as well as controls over energy and emissions and excessive liquidity in the system would continue to drive CPI forward in 2008.

However, the chief of the forecast department at the State Information Center, Fan Jianping, disagreed. Fan said that the 6.5% gain in the CPI in August was the peak for consumer price inflation, and that prices for consumer goods would gradually fall in 2008.

The Deputy chief of the Center for China Public Sector Economic Research at the National Economic Research Institute (NERI), Wang Xiaolu, said that CPI was likely to be lower in 2008 than this year as the main driver for recent price inflation had been the hikes in the price of food, especially pork. Food supply will improve, he said, which would help calm prices.

However, other factors, such as rising incomes, could be a moderate driver for further inflation, he added. Therefore, it was reasonable to conclude that there would be moderate inflation next year, but at a slower speed than this year.

Francis Lui, the director of the center for development at the University of Minnesota, considered the rise of consumer goods prices to be a currency phenomenon. Lui is considered to be a member of the so-called Chicago School of Economics and, hence, a supporter of free markets and monetarism.

Lui attributed growth in the currency supply and GDP growth as the two key determining factors for inflation. If growth in currency supply is faster than GDP, inflation will be boosted, he said. If slower, price deflation could occur. Judging from China’s long-term statistics, the rate of growth of the currency supply is catching up with the growth of GDP.

“The rise of food prices only pushes up the prices of food-related goods, which does not mean overall inflation,” said Lui. “Assuming currency supply and GDP remain unchanged, the rise of food prices would lead to price deflation for other goods. Thus, inflation is determined by GDP and currency supply, while yuan appreciation is also an inflationary pressure. Appreciation creates a large increase in the currency supply [through hot money inflows], which puts pressure on asset prices and then consumer goods prices. I believe the pressure for inflation will persist next year since there will be considerable growth in the currency supply.”

In the CCWE report, which Lui was also involved in, currency supply is forecast to grow rapidly from now through 2008, with the full-year currency supply growth estimated at 17.5% this year and 18.4% in 2008.

Aizawa Securities chief economist Zuo Xiaolui also agreed with Lui: “Food price hikes are only a trigger and stimulant. Generally speaking, excessive liquidity will impact consumer goods prices with a two-year lag,” he said. “Judging from this perspective, the international circumstances around 2004 are impacting China’s current CPI.”

Is inflation excessive or acceptable?

With inflation currently running at more than 6%, a number of academics considered that China’s economy was overheating, especially when GDP growth was factored in. However, both Zuo and Lui believed current inflation was acceptable considering overall economic trends.

Zuo said that although there was an obvious hike in consumer goods prices, there was still a balance in overall supply and demand. Moderate inflation was beneficial to the Chinese economy, he argued, coming as it does from a rise in consumption and national income. However, there was a need to prevent the current inflation rate from becoming an ongoing feature of the Chinese economy.

According to National Bureau of Statistics (NBS) figures, growth in urban income was faster than GDP growth for the first time in the first half of 2007. Urban incomes averaged RMB7052, up 17.62% year-on-year, and up 14.2% year-on-year in real terms after price factors were removed. Rural incomes averaged RMB2111 in the first half, up 13.3% year-on-year in real terms, which was also higher than the 11.5% GDP growth recorded in the first half.

Wang believes the change has been constructive. “In the past, consumption’s contribution to GDP has been falling, dropping below 50% last year. Reduced consumption meant an increase in savings deposits, which boosted investment and production. Excessive production resulted from the failure of consumption to absorb liquidity.

“Also, the rise in the income of high-earning individuals has been even faster than the wage rises in the low-income group. An improved consumption structure would help remove excessive production and boost efficiency.”

From this perspective, Wang added that future economic growth may not be lower than for this year, predicting GDP to be above 10% next year.

Zuo added that rural product prices had been increasing gradually, which had directly increased rural incomes, which was a desirable result which government subsidies alone would have been incapable of producing. To change the current economic development model and raise the contribution of consumption to GDP, the most important task is to stimulate rural consumption, which would both remove excess production [due to lower savings] and strengthen the overall economic growth structure.

Addressing concerns over whether China’s economy was overheated, Wang insisted it was not. “Even if the economy grows faster next year than this year and reaches 12% or even 13%, this doesn’t necessarily mean China’s economy is overheated,” Wang said. “Determining if it is overheated depends on the balance of the internal economic structure. I believe economic growth will still be rapid in the future but the economy won’t overheat.”

Several factors were driving stable and rapid economic growth, he added, “First, China’s technological advancement was speeding up, which is likely to result in a continuous increase in productivity. Second, vast investment in infrastructure since the 90s has, to a large extent, shaped a more optimized infrastructure landscape in China which has greatly improved economic efficiency. A certain portion of future economic growth is the fruit of this improvement in national infrastructure. Third, a consumption rebound would bring a series of constructive improvements to the economic structure. If consumption continues to rise, this would contribute to a positive productivity rate.”

This article was first published in Chinese in China Business News on November 5, 2007. The China Perspective accepts no responsibility for the accuracy of the original article.