Just a few days ago, economists were fretting about signs of deflation in the Chinese economy, given falling prices for everything from clothing to telecommunications to food.
Now, a surge in global grain prices is raising concerns of higher prices, particularly for pork, a national favourite. If prices do start to rise, that could constrain policymakers' ability in the near term to spur the mainland's flagging economy with further interest rate cuts. And it could point to a bigger problem next year if inflation gathers momentum.
The worst drought in the United States in 56 years sent prices of actively traded soya bean and corn futures on the Chicago Board of Trade to new highs on Friday, marking the fifth straight week of gains. Prices fell a bit early this week after rain in the US Midwest.
Concerned by expected crop output shortfalls and runaway prices, the United Nations Food and Agriculture Organisation says the situation is serious.
Adding to worries that global supplies will tighten further in the coming months are bad weather in Black Sea grain-exporting regions, a poor start to the Indian monsoons and an incipient El Nino, a situation when unusually warm ocean conditions along South America's west coast adversely affect fishing and agriculture, according to Barclays Capital.
'Speculation exacerbates price rises,' Beijing Orient Agribusiness Consultant analyst Chang Guixian said, adding that recent easing by central banks around the world had made more credit available for bets on soft commodities such as grain.
Drought-ravaged cornfields in the US Midwestern states of Indiana and Ohio were aided by recent rain, but yields were likely to be sharply lower than a year ago, US crop experts said early this week at the start of a five-day evaluation tour.
Although Beijing has forecast a bumper grain harvest this year, the country will still be affected because of rising reliance on such imports.
Foodstuffs account for 32 per cent of the basket of goods in China's consumer price index. Rising global grain prices are expected to push the CPI higher next year. Last month, the index rose 2.2 per cent from a year earlier, the slowest pace in nearly 21/2 years, and down from a 3 per cent increase in May. The producer price index, which measures price pressures among producers, has been contracting since March, adding to the overall deflation worries.
Beijing policymakers have loosened monetary policy to counter a slowing economy, anticipating that inflation will stay in check in the near term. But economists said the changed outlook for prices was expected to constrain any further monetary easing down the road.
'The sharp rise of global agricultural prices will likely push up pork prices in China,' Nomura Securities economist Zhang Zhiwei said. 'Consumer inflation will rebound to 3.1 per cent in the fourth quarter and 4.2 per cent next year ... We believe the central bank will not cut rates further in the second half.'
But other economists expect the People's Bank of China (PBOC), the central bank, will cut rates one or two more times this year after economic growth slowed to 7.6 per cent in the second quarter, the lowest in three years. The PBOC recently cut interest rates twice in a month - the first cuts since 2008 - to lower borrowing costs and spur the economy.
Under the food category in the mainland's CPI calculation, grain has an 8 per cent weighting, while oil and fat are 4 per cent and eggs 2.7 per cent. Pork accounts for 12 per cent and other meats hold a 23 per cent share, while seafood and freshwater products are 8 per cent. A shortage of pork was the main driver for the bout of serious inflation in 2007-08.
Pork prices have fallen, and are now about 12 per cent lower than a year ago. But the main feed for pigs is corn and soya bean meal. With the surge in corn prices, the ratio of the price of pork to the price of corn has dropped to six, which is generally considered the break-even level for pig farms on the mainland.
'Historical data suggests once the ratio drops below six, farmers will reduce pork output and pork prices will begin to rise,' Zhang said.
'I expect this to happen' during the current quarter.
China has been a net corn importer since 2008, with import volumes surging to 1.75 million tonnes last year from 51,000 tonnes in 2008. However, imports still account for less than 5 per cent of total domestic use, according to the National Development and Reform Commission.
Barclays economists said the immediate impact of higher global corn prices was small, but in the longer term domestic corn prices would move in tandem with the global price.
For China, the biggest effect is likely to come from soya bean prices because the country is the world's largest soya bean importer and imports account for 80 per cent of their consumption on the mainland, according to Barclays.
Even a further 20 to 40 per cent pick-up in global grain prices would not spark a surge in food inflation in China in the second half, but it would become a bigger concern next year, the Barclays economists said.
'We expect it to rise to 4.5 per cent by the middle of next year,' they said, adding that Chinese policymakers were likely to adopt a 'prudent stance' to do 'measured easing' in the second half of this year.
China is the world's largest soya bean importer, its imports accounting for this percentage of soya bean consumption on the mainland