Inflation is universally viewed as a scourge. But it appears to be seen as a worse scourge in China than in other countries. At the moment, Beijing is obsessed with keeping the annual inflation rate below 4 percent, its declared target. Yet based on the latest figures, the government is losing the inflation fight.
First, some data and a little background. To be sure, rising inflation isn’t a recent economic challenge for China—prices were spiking as early as last autumn. What makes China’s recent round of inflation fighting interesting is the apparent ineffectiveness of the measures adopted by the government, including raising interest rates, hiking the bank reserve ratio (so that less money is lent out), and imposing price controls on some goods. According to official data, China’s consumer price index (CPI) rose 5.3 percent in April, following a slightly higher increase of 5.4 percent in March. The inflation numbers for the last six months kept hovering around 5 percent per annum, considered high by China’s historical standards (the average inflation rate per year was 4.3 percent from 1994 to 2010).
For a rapidly growing economy such as China’s, some inflation is inevitable. But in the Chinese case, there are additional causes fuelling price increases. The massive credit boom unleashed by the Chinese government to revive growth in 2009 obviously succeeded—perhaps too well. Tighter labour supply, due to changing demographics, has pressured wages upwards. Global food price hikes have also hit China—food price inflation for April was 11 percent, which was double the CPI.
The problem could be being compounded by Beijing’s policies. For a start, interest rates are too low. Despite recent increases, the one-year lending rate today is 6.31 percent a year, barely one percentage point above the inflation rate. The deposit rate, at 3 percent a year, remains negative, making putting money in Chinese banks a losing bet. Quantitative tightening through raising the bank reserve ratio, meanwhile, has been ineffective—since last October, Beijing has increased the bank reserve ratio eight times, to a record of 21 percent (meaning that one-fifth of bank deposits can’t be loaned out). However, China’s shadow banking system, consisting of various non-bank finance companies and clever regulation-evading schemes, is hard to subdue.
So it appears that rising inflation will be with China for quite some time, raising an interesting political issue: will rising inflation create social instability in China, and if so, how?
Chinese leaders have good reason to fear rising inflation. The Kuomintang government lost the Chinese civil war to the Communists in the late 1940s, as the legend goes, mainly because it allowed hyperinflation to destroy the wealth of the urban middle class. Another anecdote frequently cited by observers of China was the Tiananmen pro-democracy movement in 1989. In 1988, China’s failed price reform led to price spirals and panic buying in cities. So some observers attributed the massive nationwide protest that occurred in the spring of 1989 to high inflation at that time.