China’s recovering economy needs to cool down to manage overheating risks

Name: China reports first Covid-19 death in eight months; quarantine site construction underway in Hebei
Uploaded: 2021-01-18T08:30:13.000Z
Duration: 2 min 11 s
Description: China reports first Covid-19 death in eight months; quarantine site construction underway in Hebei

It might be time for Beijing to consider reining back the excess slack and for markets to be prepared for the prospect of higher interest rates ahead. Easy money can’t last forever and Beijing needs to think about normalising policy

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An employee works on a production line manufacturing steel structures in a factory in Huzhou, Zhejiang province, in May last year. China’s economy grew by 2.3 per cent in 2020, in a dramatic turnaround since the coronavirus pandemic ravaged the country in the early part of the year. Photo: Reuters

David Brown

Published: 4:30pm, 18 Jan 2021Updated: 4:30pm, 18 Jan 2021

Sometimes you can get too much of a good thing. In China’s case, it might be time to step off the policy gas. Beijing has done a great job fighting off the Covid-19 crisis and steering the economy towards what is turning out to be a pretty impressive recovery.

Growth is revving back, exports are booming and economic confidence is building good forward momentum. Sustainability is the key but there will come a time when Beijing must consider whether all of the extra monetary and fiscal stimulus pumped into the mainland economy over the last 12 months might be inflaming domestic overheating pressures and boosting inflation risks further down the line.

It might be time for Beijing to consider reining back the excess slack and for markets to be prepared for the prospect of higher interest rates ahead. Super easy money can’t last forever and Beijing needs to think about normalising policy as soon as the pandemic eases.

Domestic inflation risks seem very benign with China’s consumer price inflation running at only 0.2 per cent in December, after a brief foray into deflation in November when headline inflation turned negative to the tune of 0.5 per cent. There is no room for complacency though, as base effects could easily see the inflation rate picking up fairly sharply in the next few months, reflecting the dramatic drops in consumer prices when the coronavirus crisis first gripped the economy early last year with devastating consequences.

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China reports first Covid-19 death in eight months; quarantine site construction underway in Hebei

As growth began to stall, consumer prices dropped very sharply in March 2020 by 1.2 per cent month-on month, followed by falls of 0.9 per cent in April and 0.8 per cent in May. It’s a statistical quirk but without similar price falls in the next few months, even on modest assumptions, inflation could hit the government’s 3.5 per cent CPI target very quickly this year.

Domestic inflation risks are far from down and out and last November’s deflation dip should prove to be nothing more than a short-lived fluke. Before the coronavirus crisis struck, Beijing was already grappling with a high inflation rate of 5.4 per cent in January 2020, and underlying price pressures should resume once the economy starts to normalise.

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