Beijing's policy settings may not be such a big boob after all

PUBLISHED : Tuesday, 12 August, 2008, 12:00am
UPDATED : Tuesday, 12 August, 2008, 12:00am

At first sight it looks like Beijing's economic chieftains may have made a major blunder last month when they switched their policy priority away from fighting inflation and towards supporting export growth.

A quick look at data for July released yesterday suggests that while the country's export sector remains in rude health, rising prices pose a greater economic threat than at any time during the past dozen years.

Trade figures for last month published by China's customs bureau confounded analysts' expectations, showing that exports increased a robust 26.9 per cent compared with July last year.

Most forecasters, mindful of stories about shuttered factories in southern China and warnings of softening demand in the United States and Europe - China's biggest export markets - had predicted a further deterioration following June's anaemic 17.2 per cent growth.

Instead exports rebounded vigorously, with the country's monthly trade surplus widening to levels not seen since the end of last year. On last month's data at least, China's exporters appear not nearly as sickly as many observers had believed.

No one was celebrating, however, because another batch of figures released yesterday showed that China's wholesale inflation rate climbed to double digits last month, the highest level seen since the National Bureau of Statistics began compiling the data in 1996.

The uptick looks scary. Although consumer price inflation has fallen from February's high of 8.7 per cent and is expected to fall further to about 6.5 per cent when figures for last month are published today, the decrease is explained almost entirely by a seasonal fall in fresh food prices with the coming of summer.

Meanwhile, producer price inflation, which measures raw material prices and the wholesale prices businesses pay for goods as they leave the factory gates, has continued to climb. Last month it reached 10 per cent, raising fears that higher consumer inflation is on the way as companies pass their increased costs on to retail customers.

Viewed in these terms, it looks as if Beijing's recent moves to slow the appreciation of the yuan and lift loan quotas for smaller companies not only offer exporters help they do not need, but risk exacerbating inflationary pressure just when price rises look like getting out of control.

Happily, a closer look at the data suggests that Beijing's policy-makers may not have made such a big boob after all.

For one thing, exporters face a tougher environment than the headline trade data indicate. That is because the figures are released in US dollar terms.

As the chart below shows, China's export growth looks a lot less impressive in yuan terms. And while shipments did rebound last month compared with June, the overall trend is still towards weaker growth.

Secondly, the inflation outlook may not be as bad as July's producer price numbers imply. Closer examination reveals that much of the rise can be explained by last month's increase in government-controlled energy prices. With international commodity prices now falling, further increases in official price ceilings look less urgent, suggesting wholesale inflation could be nearing a peak.

And even if producer prices do continue to climb, it is far from clear companies will pass the rises on to their customers. With competition fierce, it is likely many businesses will absorb the increase in their costs rather than aggressively raise retail prices.

That would be a relief both for consumers and for Beijing's inflation-fighters, raising hopes that consumer price inflation may indeed have topped out for this cycle.

The picture is not entirely rosy of course. If companies are absorbing higher costs without passing them on, their earnings will suffer. Yesterday the prospect weighed heavily on A-share prices, with the Shanghai Composite Index falling a painful 5.2 per cent.

And it remains far too early to declare victory in the fight against inflation. A premature relaxation of policy could still send prices soaring again.

But while the implications of yesterday's numbers cannot exactly be called good news, they do at least suggest that Beijing's new policy settings are not as misguided as they might at first appear.