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UPDATED: January 23, 2011 NO. 4 JANUARY 27, 2011
Higher Than Expected
After failing to keep the CPI under 3 percent last year, China looks to new measures to curb inflation
By LAN XINZHEN
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Ma said the central bank should adopt definitive policies to increase the interest rate. Although this may cause slight fluctuations in the Chinese economy, it will facilitate economic development in the long run. "A resolute increase of the interest rate can eliminate investors' inflation expectations," he said.

The central bank may increase the deposit reserve rate three times this year, by 0.5 percentage points each time, Ma said. The interest rate may be raised by 75 basis points, 25 basis points at each interval.

Wang Qing, Chief Economist for Greater China of Morgan Stanley, said one of the major tasks to curb inflation this year is to control the growth of the broad money supply (M2), reducing the rate from last year's 19.7 percent to 16 percent or lower.

Wang says to combat inflation, the central bank will tighten the monetary policy, but as for the tools of the monetary policy, there should be a change: to differentiate the deposit reserve rates among different banks, and even in different months of each bank.

"This shows that the monetary policy will be carried out in a framework of prudent macro-supervision, which can effectively restrain the impulse of granting loans by commercial banks," Wang said.

The pressure of imported inflation could be relieved by appreciating the renminbi, China's currency, Wang said. The exchange rate of renminbi could increase by about 6.5 percentage points, to 6.2 yuan for every $1 in 2011, he predicted.

Xia says to further manage inflation expectations, the government must change the passive situation of money supplies. At present, most of the money issuance is funds outstanding for foreign exchange, which needs to be hedged.

"To thoroughly resolve this problem, the government must transform the economic growth pattern and accelerate economic restructuring. If China just keeps purchasing foreign exchange and continuously hedges, the market will be distorted," Xia said.

Li Heng, an macroeconomic analyst at TX Investment Consulting Co. Ltd. said the counter-inflation policy should focus on more than just curbing inflation, since price hikes of farm produce and growing labor costs were actually conducive to China's economic restructuring.

A big fight

Experts can propose many ways to combat inflation, but no one can answer whether the Chinese Government will be able to effectively curb inflation in 2011.

Cheng Siwei, former Vice Chairman of the Standing Committee of the National People's Congress, says China will face big challenges in combating inflation this year.

Cheng says inflation could not be curbed overnight. Moreover, because common people worry about depreciation of their money, they may spend it buying or speculating on tangible assets such as houses, gold, soybeans, garlic, sugar, edible oil and a long list of other items.

"I once saw a person buy 10 5-kg barrels of edible oil at a supermarket. But there's no way he needs that much oil, which in turn creates a false impression that demand exceeds supply. This makes inflation expectations more dangerous than inflation itself," Cheng said.

He said in 2011 Chinese monetary policy will be transferred from an appropriately accommodative one to a moderate one, but since many projects are already in progress, it's impossible for credit to be tightened too heavily. So M2 growth won't be reduced too much, likely between 17-18 percent, and the growth of bank credit will be 7-7.5 trillion yuan ($1.06-1.14 trillion).

Another problem for China's counter-inflation campaign is that it is impossible for the central bank to raise the interest rate too high, Cheng said. Monetary policy includes three tools: the interest rate, reserve rate and open market operations. The deposit reserve rate was raised to 19 percent, as of January 14, 2011, so there's little room for further increases without repercussions.

Also, open market operations in China are not as developed as in other countries like the United States, where such operations are an everyday practice. When the money supply is not enough, the central bank will buy treasury bonds and release money, and vise versa. In China, open market operations cannot impose much influence on the overall monetary policy; therefore, to combat inflation, the central bank mainly relies on raising the interest rate.

"But we dare not raise it too much, because when interest rates in developed countries are low, more hot money will flow into China if we raise our interest rate. After coming to China, hot money will be converted into the renminbi, and we won't be able to control liquidity," Cheng said. China should be cautious about raising interest rates before developed countries do.

As for measures to curb inflation by tightening money supply, such as raising interest and reserve rates, Zhu Baoliang, Deputy Director of Economic Forecasting Department of the State Information Center, says it'll be hard for these measures to work.

Zhu says since 2010 prices of bulk commodities have been increasing, but this is not because the economy is overheated. The reasons for this round of price hikes are complicated, and inflation expectations are a major factor. Under such circumstances, excessive use of monetary policy may produce a less-than-desirable effect.

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