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March (NO. 9-NO. 13)
Cover Stories Series 2012> Q1 Economic Growth Stable> Market Watch> March (NO. 9-NO. 13)
UPDATED: March 5, 2012 NO. 10 MARCH 8, 2012
MARKET WATCH NO. 10, 2012
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OPINION

Behind Slumping PPI

China's consumer price index (CPI), a barometer of inflation, grew 4.5 percent year on year in January, up from 4.1 percent in December 2011, according to data from the National Bureau of Statistics. The rebound was attributable to the impact of the Spring Festival holiday, which fell on January 22-28 this year. Expectations abounded that the CPI growth would drop.

In striking contrast, growth of the producer price index (PPI), an effective gauge of inflation at the wholesale level, drastically fell to 0.7 percent in January, after peaking at 7.5 percent in July 2011. The plunging PPI growth sends out a strong signal that the Chinese economy may be braced for a deeper slowdown.

In economics, CPI is closely connected with PPI, and both indexes can indicate a short-term economic outlook. While the PPI reflects price changes in production, the CPI is a sensitive indicator of consumer prices. Price fluctuation should firstly occur at the stage of production, and then filter through industrial chains to impact prices of consumer products. That is why the PPI is usually considered a pre-indicator of CPI. But sometimes the CPI may not necessarily move in line with the PPI as they have a different basket of surveyed components.

Many researchers believe the economy will face simmering risk if the CPI growth drops while the PPI growth remains high. That is because cost inflation in raw materials, energy and labor can force up production cost and squeeze profit margins. Worse still, the slipping CPI growth means enterprises would face shrinking revenues. That situation may deal a heavier blow to the economy than inflation.

In my opinion, the economic health may be worse if the PPI growth falls while the CPI growth remains stable, because that situation means the consumer price increase may be caused by insufficient production. The problem defies regular measures to curb inflation, such as tightening monetary policies, since liquidity shortages would further affect product supplies. As demand remains buoyant, squeezed supplies could drive up continued growth in consumer prices and lead to a serious consequence of stagflation, an economic phenomenon characterized by slower growth and rampant inflation.

China's past experiences also show that faster declines in the PPI growth than in the CPI growth do not bode well for the economy. For example, China's PPI growth slipped to -5.68 percent in November 1998 from 0.47 percent in March 1997 while the CPI growth went down from 4 percent to minus -1.2 percent. Meanwhile, the country's GDP growth slowed from 10.4 percent in the first quarter of 1997 to 7.2 percent in the second quarter of 1998.

As similar situation happened 10 years later. The CPI growth decreased from 4.9 percent in August 2008 to -1.8 percent in July 2009 while the PPI growth nosedived from 10.6 percent to -8.2 percent. Unsurprisingly, the GDP growth slowed from 11 percent in the second quarter of 2008 to 6.6 percent in the first quarter of 2009.

So we have a reason to believe that the Chinese economy may be heading for a deeper downturn. Worse still, other data have already show weakness of the economy, including newly extended loans, inflows of foreign direct investment and exports. As a result, it is necessary for the country to stay alert against growing downside risks. n

This is an edited excerpt of views of Wang Tianlong, an associate researcher with the China Center for International Economic Exchanges published in the Securities Times

Email us at: yushujun@bjreview.com

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