World over inflation fears have dominated headlines in the last few months. China has seen the commodity price index (CPI) rise to highest level seen in decades. India is witnessing inflation rate upwards of 7% that is the highest seen in three years.
Unaffordable food prices and consumer inflation have resulted in severe civil unrest and even governments being toppled in the past. In April, Haitian PM Jacques Edouard Alexis was ousted amid protests over soaring food prices. The UN estimates food prices by this march have surged by 57% globally from a year earlier. Inflation in Zimbabwe soared to 164,900% in February this year as shortage of wheat and other goods pushed the price of bread loaf to $650. Three women in China were trampled to death last November in their endeavour to grab the discounted cooking oil in a supermarket, price for which has increased by 50% in last one year. Meanwhile, Chinese surpassed France and UK as the world?s fourth largest economy with GDP growth rates averaging 10% in the past five years.
The Indian government puts fighting inflation as its highest priority even at the cost of economic growth. The Bank of England recently announced a freeze on further interest rate cuts until 2010 to combat inflation in spite of the dire need to inject liquidity in the face of severe credit crunch and falling house prices.
Resurgent inflation, everyone agrees, seems a global problem while a slowdown, may be largely limited to US with some spillover effect to Europe. A closer look might reveal stark differences in the nature and composition of inflationary risks faced by developed and emerging markets. China, which is an undisputed manufacturing factory of the world, is being closely scrutinised.
China exported deflation for the last 15 years by stocking the shelves of retailers in the West with products made in their factories employing cheap labour and easy capital. Chinese imports constitute 7.5% of spending by Americans on consumer goods, but they make a higher share of categories such as toys, foot ware and clothing.
The import price index of the US shows falling prices of Chinese imports by 1.5% year-on-year in dollar terms? that was until 2005. Since then, there has been a sharp uptick in the index. Falling dollar had a role to play but nominal prices of Chinese exports had a bigger role to play. Inflation in the US was 4.1% in 2007, up from 2.5% in 2006. Alan Greenspan, in his new book, has emphasised that prices for Chinese exports has started to rise, which will contribute to a revival of global inflation. Where China was a deflationary inflation over the last decade, will it take the honours as inflationary influence in the next decade? Probably not.
A closer look at drivers of Chinese inflation is in order to anticipate what to expect from the world?s factory in the coming years. The cost of manufacturing in China has been rising not only due to rising fuel and commodity prices, but also due to upward pressure on wages partly as a ripple effect of the new labour law and increasing cost of capital as a result of increase in interest rate by the Chinese central bank.
Unofficial estimates put rise in factory wages to be close to 80% in many coastal regions in the past few years with the lowest wage about $130 per month. Beijing has been encouraging local governments to raise minimum wages, which cities like Beijing, Shanghai, Guangzhou, Shenzhen and Nanjing have already done. The recent spate of massive recalls of Chinese made toys and canned food raising serious quality concerns for `Made in China? products have been taken seriously by Chinese government. Quality checks and audits have been forced onto manufacturing and export process adding to exporter?s cost, which has since been passed on to importers.
In April, the CPI figures rose to 8.5%, the second highest figure for 12 months inviting more monetary tightening measures by the Chinese government. China is no stranger to inflation and the current situation may be similar to 1992 when the inflation went from 3.4% at the beginning of the year to 11.4% at the end and the GDP growth rate accelerated from 10% to 15% in the same period.
By 1993-1994, with the economy going wild, the inflation had shot up to 25% at its peak that led to a forced hard landing of economy by 1997. For almost seven years from 1997, China has witnessed a deflationary economy as a result of excess capacity and deflated corporate earnings. Prices started to rise by 2004 again at an annual healthy rate of 2% for the next three years. By 2007, the Chinese economy was growing at a clip of 10% and even touched crossed 11%. CPI inflation correspondingly went from 2.2% in January 2007 to 6.5% a year later and climbed further to 8.5% last month.
However, there is clear distinction between the 1990s and the current scenarios. Unlike the structural correction in economy post 1990?s bubble scenario, the factors causing increase in inflation this time are driven solely by food and seem temporary in nature. Food, which constitutes around 30% of urban household expenditure in China, is the main cause of dramatic increase in CPI inflation. While the CPI food basket rose to 20% in 2007, the inflation in non-food goods and services has been crawling at a meagre 1.5%.
Even within food category, the distortion is attributable to an abnormal increase in only pork, vegetables and cooking oil prices due to temporary supply shocks that are expected to be overcome in the next couple of quarters. For instance, April?s 22.1% rise in food prices was primarily fuelled by 68% jump in pork, 46% for cooking oil and 15% for vegetables. This is not to say, inflation fears are exaggerated in China. Rising energy cost–China imports bulk of its oil, which the Chinese government will have to eventually pass on to the consumers, upward pressure on wages in rural areas, coal shortage and rising global commodity prices all point to more inflation in future.
?The author was the former head of the Beijing branch for Infosys in China and is a fellow of India, China Institute. He is currently business development manager for Infosys, Europe Region. These are his personal views. He can be reachedat hirend@yahoo.com
