China's inflation threat - detailed data show price rises still primarily bunched in food and housing and parallels with India

Considerable international media coverage was given to China's 2.7% consumer price index (CPI) rise in February. This was justified. The trend in China's inflation rate has moved upwards from 1.5% in January and is being met by monetary tightening. As China is at present the world's most rapidly growing economy, with its increasing imports being a key driver of Asia's economic recovery, tightening in China will have international consequences. The inflationary pressures, as this blog has analysed earlier, are real.

Before any hint of exaggeration sets in however it is necessary to look at the detail of February's CPI figures. This shows that inflation is primarily being driven by increases in the price of food and, in second place, by housing costs. Most other elements of inflation in China remain subdued. This parallels a process taking place in India where higher inflation is also primarily being driven by higher food prices.

Looking at the detail of China's February CPI data the price of foodstuffs rose by 6.2% - undoubtedly a severe effect in a country where a far higher proportion of household expenditure goes on food than in a developed economy. Housing costs also rose by 3.0%. Both the need to avoid social discontent and those of economic rationality clearly require urgent government attention to be addressed to food and housing costs - which is undoubtedly a primary reason why the current meeting of the National People's Congress, China's highest legislative body, is chiefly focused on domestic issues.

However China's non-food prices rose by only 1.0% in February - clothing prices actually fell by -1.3% and transport and communication costs rose by only 0.1%.

Inflation also clearly did not cut into retail sales - which increased by 17.9% in January and February 2010 compared to same period in 2009. Purchases of consumer durables in particular soared - sales of building and decorating materials were up 30.5% year on year, household appliances up 31.7%, furniture up 36.3% and automobiles up 41.7%.

What conclusions follow from this situation?

First, evidently, that the fight against inflation requires serious action in the spheres of food and housing. It is necessary to take measures to squeeze inflation in these sectors and prevent inflationary trends spreading to others.The Chinese government is clearly well aware of this. It is arguable that its overall 3% inflation target for 2010 is too tight, the IMF recently released a paper suggesting an international norm of 4% and rates of 3-5% have historically not been unusual in rapidly developing economies, but clearly food inflation is too high and housing has significant upward momentum.

Second, it confirms again how correct China was to increase domestic demand in 2009 by expanding both investment and consumption. If China had followed the advice of some analysts and only raised  domestic consumption, without the greater capacity and efficiency produced by increased investment, it would face more widespread capacity constraints and therefore greater inflationary pressures.

Third, this pattern of inflation gives a further reason why both China and India are stepping up the priority given to investment in rural areas. In China the economic stimulus package gave preferential treatment to household purchases in rural areas and government officials from President Hu Jintao and Prime Minister Wen Jiabao downwards have been stressing the need for increasing investment in rural areas. On a recent trip to India the crucial priority to investment in rural areas was stressed to me by Amir Ullah Khan, dean of the Bangalore Management Academy, and other Indian experts. This is undoubtedly required by wider considerations but is reinforced by the inflation pattern in both countries.

The pattern of inflation in China and India, the abandonment of reliance on 'trickle down' as an approach in both, and the emphasis being given to rural investment shows important parallels in both economies.

Comments

[Kieran Latty]

The problem of rising food prices in China is real enough. However, rising food prices also opens the possibility of profitably employing greater factor inputs in agriculture and related infrastructure. There are a two areas where greater inputs of labor and capital are likely to lead to significant increases in agricultural output. These include;

1. Transport and Irrigation/Water management infrastructure, such as the already under construction South-North water transfer project, and increased and improved rail connections to rural areas. These serve to reduce either input or transport costs and therefore lower the cost at the point of consumption.

2. A shift to more labour and and capital intensive agricultural methods, as opposed to land intensive methods, for example a shift from land extensive grain cultivation to more labour intensive vegetable production - with a corresponding increase in monetary yields per hectare.

Furthermore, given the open nature of the Chinese economy and existing large trade surplus, there is a significant capacity to cover any food shortages which cannot be met through an increase in domestic production via employing greater factor inputs through an increase in imports.

A higher valuation of the RMB or some form of selective preferences on food imports would help facilitate an increase in food imports, however increased food subsidies at the point of consumption or domestic production may be a better option- subsidies at the point of consumption would serve to increase both imports and stimulate domestic production, whilst production subsidies (bounties) would stimulate the latter.

As food consumption forms a large portion of the income of poorer Chinese, production or consumption subsidies would be redistributive in an egalitarian fashion, and would help address the high and growing level of inequality in China.