Tightening may ease as demand weakens
Despite inflation hovering at high levels, the spectre of stagflation is threatening the mainland, and expectations are high that the central government will abandon its credit squeeze policy in the mid-term amid falling domestic and external demand.
Expectations of an economic slowdown are being further fuelled by a flatter yield curve in the mainland's bond market this year. The benchmark seven-year bond yield fell to 3.9 per cent on Thursday, compared with 4.2 per cent at the end of last year, even with soaring inflation.
'China's economy will probably drop as early as the second half of this year due to the rising cost of labour, the appreciation of the yuan and the subprime debt crisis,' an economist said.
Data released by the National Bureau of Statistics last Wednesday backed up expectations of a slowdown.
The bureau said exports in the first quarter rose 21.4 per cent but the overall growth rate fell 6.4 per cent. Growth in exports to the European Union, China's biggest trading partner, dropped 10.3 per cent during the period while growth in exports to the United States, the mainland's No2 trade partner, declined 15 per cent.
'Exports will continue to worsen because of the US subprime debt crisis and a sharp appreciation of the yuan,' said Guotai Junan Securities analyst Lin Zhaochui.
The yuan continued to strengthen against the dollar, with the central bank issuing central parity on Friday at just over 7, not far off Tuesday's 6.9838, a record high since 1994.
Analysts also suggest that domestic demand is being eroded by slower growth in disposable income and a slump on the stock market.
Disposable income grew 11.5 per cent in the first quarter, 8 percentage points lower than a year earlier, the first slide in three years and the biggest slowdown since December 1997.
Mainland bourses are now only at half the highs hit in October last year.
In addition, the total inflation-adjusted value of retail sales of consumer goods in the first quarter - which covers the peak Lunar New Year consumption period - was up 12.6 per cent, compared with 12.2 per cent for all of last year.
The producer price index, a measure of wholesale price changes, grew 6.9 per cent in the first quarter from a year earlier, a high level that would usually push up the consumer price index, a key measure of inflation.
However, Huaan Property Insurance trader Gu Chunyue said producers would not be able to pass on the higher factory-gate prices to consumers because of various domestic and international conditions, including overcapacity.
Shenyin Wanguo Securities bond analyst Qu Qing said it was obvious that inflation would slow in the second half, with the base inflation rate rising 'to July at the latest'.
The consumer price index consolidated near the 3 per cent level in the first half of last year, but it has soared more than 6 per cent since July last year.
In addition, core inflation, excluding food, contributed 6.8 per cent to overall inflation in the first quarter, which lingered at 1.2 per cent, a figure close to slight deflation.
'I suspect the central bank will not increase the interest rate this year but the reserve rate will continue to rise and the yuan will continue to appreciate,' Mr Qu said.
