Much has been written about the severe winter weather that made the Lunar New Year a holiday in hell for hundreds of millions of people across more than a dozen provinces in China. Looking beyond the sheer misery endured by travellers, and bungling by officials, the key question now is: what will the impact be on the economy? If all the supply disruptions put the brakes on gross domestic product growth and speed up inflation, how should Chinese policymakers respond?
As a matter of fact, the Chinese government would not mind seeing the economy slow after another year of double-digit growth in 2007. GDP expanded 11.4 per cent, according to official statistics, but many observers suspect the true rate may have been higher, as in previous years. So, even if the supply shock from the storms and knock-on effects from a US recession shave mainland China's GDP growth rate in 2008 by, say, 2 percentage points to under 10 per cent, this would hardly be the end of the world for Chinese policymakers.
But what about a spike in inflation from food and electricity shortages? Should the government adopt a more hawkish stance even as economic growth decelerates? Until the storms, conventional wisdom called for further tightening through higher interest rates and faster appreciation of the yuan. The concern was that an undervalued currency was the chief culprit behind a flood of liquidity propelling overinvestment and rampant speculation in asset markets. In fact, the Chinese government's tightening campaign to date has been quite harsh. Besides repeated interest rate rises, banks are subjected to quarterly lending quotas. And, last month, the yuan's pace of appreciation against the US dollar amounted to an annualised 18 per cent to 19 per cent.
China's tightening, however, contrasts with rapid easing in the US, its most important trade partner. Such a policy divergence would not be a problem if the two countries' economies had 'decoupled'. But the sharp correction of the A-share market, in tandem with Wall Street, belies this assumption. Chinese investors are clearly taking the view that the government needs to soften its tightening stance soon. Witness the stock market rally following the China Securities Regulatory Commission's decision to lift the moratorium on new mutual funds just before the Lunar New Year. Indeed, in the absence of the snowstorms, mainland China's inflation was on course to peak in the first half of the year. For one, reduced demand from the US is squeezing export earnings. For another, it is almost impossible for food and energy prices to experience similar increases in 2008 as in 2007, because the initial base of measurement is much higher.
The inflationary impact of the storms will only be temporary. While this month's consumer price index is certain to jump, the average for the year could be only about 5 per cent (before the storms, the Economist Intelligence Unit had forecast 4 per cent). So again, there is no need to panic about inflation. Why, then, did the government suddenly embrace energy-price controls? In short, it is good politics. They are consistent with the broader objective of building a 'harmonious society' with greater emphasis on the welfare of the poor.
The problem, of course, is that price controls often result in unintended consequences. It is well known that the weather-related power shortages were exacerbated by price restrictions on both electricity and coal. The ceiling imposed on the utilities' rate of return has also been a huge disincentive for private and foreign investment in the power sector. Elsewhere, the government's repeated efforts to cool the property market by restricting land supply has perversely fuelled both speculative buying and developers' hoarding of land.