High prices for food, fuel and other goods are troubling

Despite a slight dip in China's year-on-year consumer price inflation rate to 8.3% in March, from 8.7% in February, inflation remains at the top of the government's short-term policy concerns. According to a regular survey by the People's Bank of China (PBC, the central bank), a new high of 49% of respondents complained that prices were too high in the first quarter of 2008. These sentiments were echoed in a study by a market research firm, ACNielsen, which showed that consumers were cutting back on discretionary spending.

Worrying trends in underlying inflation have emerged, with price rises triggering increases in minimum monthly wage rates and welfare benefits. In Shanghai, for example, the minimum monthly wage rose on April 1st to Rmb960 (US$137) from Rmb840, and unemployment insurance rose to Rmb550 (from Rmb410). Allowances for poor rural households within Shanghai's jurisdiction have risen to Rmb3,200 a year.

 In an effort to address concerns that grain shortages might push up food prices in China as they have done elsewhere in Asia, the premier, Wen Jiabao, in April reassured consumers that the country's grain reserves are ample, comprising over 150m tonnes. However, in late 2007 China had nonetheless imposed restrictions on grain exports, and the State Administration of Grain is conducting inspections in Anhui province, following claims by a renowned agricultural scientist, Yuan Longping, that grain reserves in some parts of China are empty. Press speculation about province-wide shortfalls, notably in Guangdong, has been repeatedly denied by the government.

Spiralling inflation prompted the imposition of stricter official controls on the prices of staple goods in late January. These remained in place throughout the first quarter of 2008, but some producers (notably of dairy goods) have been allowed to raise prices. Oil companies have not been successful in similar efforts, and it may be no coincidence that reports of oil product shortages, notably for diesel, re-emerged in March, first in southern provinces, but spreading to Shanghai and Beijing by the end of the month. The government recently announced a large package of compensation to China's top state-owned oil firms, meant to cover their losses on selling refined oil products at state-capped prices. These funds covered the period up to the end of the first quarter of 2008, suggesting that pressure for another rise in retail fuel prices will build in the weeks ahead.

Despite year-on-year growth in broad money (M2) trending down from 18.9% in January 2008 to 16.2% in March, according to central bank data, the PBC's governor, Zhou Xiaochuan, has emphasised the need to maintain the current regime of monetary policy tightening to fend off inflationary pressures. The reserve requirement ratio (the proportion of funds banks must keep as deposits at the PBC) was raised by 0.5 percentage points to 16% with effect from April 25th, following an earlier 50-basis-point increase on March 25th. On March 20th the PBC had also drained Rmb130bn (US$19bn) from the interbank market through repurchases and bill issues.

The government has also supported a continued strengthening of the renminbi against the US dollar, as part of a strategy to curb liquidity inflows through the trade surplus. In early April the renminbi reached a landmark by appreciating above Rmb7:US$1; on April 16th it was trading at Rmb6.99:US$1.

Outlook
Despite the headlines Chinese inflation is currently attracting, the Economist Intelligence Unit expects the year-on-year rate of inflation to fall rapidly in the second half of 2008. The key factor will be a cyclical fall in pork prices from the high base in 2007, helped by a restocking of China's pig herds. However, surging global food prices are likely to mean that the deceleration in inflation will not be as swift or deep as we previously expected. We have consequently increased our inflation forecast for 2008 to 5.9% (from 5% previously).

Short-term grain price inflation remains to a large extent dependent on the weather, and there is a risk that a major drought in China could cause price growth to accelerate rapidly. In the longer term, a falling supply of agricultural land, water shortages, and rising fuel and fertiliser costs will put upward pressure on food prices. However, inflation in the cost of manufactures will remain low, owing to intense competition and massive investment. Inflation should slow further in 2009, averaging 3.6%, owing to improving agricultural supply.