In China at least, a little inflation may not be a bad thing

The divergence in the increases in consumer and producer prices is the result of Chinese producers’ preparations for a post-pandemic surge in demand, which has yet to materialise
This lack of price pass-through has kept consumer inflation low, but squeezed the profits of downstream producers, which will ultimately undermine economic growth

Yu Yongding

Published: 1:30am, 19 Jun 2021

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Recent price increases in the world’s two largest economies have unnerved global markets, which have become accustomed to low inflation. But, at least in China, a little inflation would not be a bad thing.

In the United States, massive government spending during the Covid-19 crisis has raised fears of a financial reckoning. The consumer price index (CPI) surged 4.2 per cent year on year in April, the fastest growth since 2008. The producer price index (PPI) has also risen, to 217.5 in April, up from 185.5 a year earlier.

This data has intensified pressure on the US Federal Reserve to tighten its ultra-loose monetary policy, a message that seems to have been picked by the Fed, which this week took a more hawkish line with predictions of two interest rate rises by the end of 2023 and upgraded estimates for inflation for the next three years.

In China, the annual CPI rose 0.9 per cent in April (year on year), compared with a 0.4 per cent rise in March. More striking, the PPI soared 6.8 per cent year on year in April, reaching its highest level since October 2017. In May, the CPI and PPI both rose – and diverged – further, increasing by 1.3 per cent and 9 per cent respectively.

And yet Chinese markets remain mostly calm. With Chinese economists far more worried about waning growth momentum in the second quarter than inflation, there is little pressure on China’s fiscal and monetary policymakers to pursue tightening.

There are good reasons for this. In May, while the CPI rose 1.3 per cent, its sequential rate fell 0.2 per cent. Core CPI added only 0.9 per cent.

The much larger rise in the PPI is being fuelled by Chinese producers’ preparations for the post-pandemic surge in demand. Producers in the upstream portion of supply chains make the first move, rushing to stockpile raw materials and fossil fuels. That is why prices of commodities have shown double-digit increases since March.

But, with the pandemic recovery just beginning, demand for final products remains depressed. This explains the growing gap between the increases in the CPI and PPI. Producers of manufactured products in the middle and downstream portions of supply chains cannot pass the increased costs of inputs to consumers and investors.

Other factors – such as the stockpiling of computer chips and the implementation of the government’s sustainability agenda – may have also contributed to the divergence between the PPI and CPI.

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What are CPI and PPI?

Many Chinese economists believe the surge in the PPI is merely transitional and may have already peaked. Even if it continues to rise, however, there would be no need to panic, as the recent increase did little more than make up for the losses incurred during the 2008 global financial crisis. Moreover, prior to the recent uptick, China had endured multiple years of producer-price deflation.

China inflation: surging factory prices seen nearing peak with no ‘lasting strong demand’ for commodities

In any case, some economists argue that the PPI surge is unlikely to translate into significant CPI growth. This is supposed to be a comforting thought, indicating that China need not fear high inflation. But this scenario should actually be what concerns China, whose economy needs a little more inflation.

The lack of price pass-through – which has kept consumer inflation low – has squeezed the profits of downstream producers, even as upstream industries benefit from a sharp increase in profitability. This undermines consumption, investment and, ultimately, economic growth. And for what? As a developing economy with a per capita income of just over US$10,000, China can tolerate higher inflation.

Shoppers visit a retail district in Beijing on April 15. Per capita income in China is just over US$10,000. Photo: AP

Given this, the Chinese government should be working to boost consumer inflation by embracing much more expansionary fiscal and monetary policies. In May, the growth rate of M2 money supply was 8.3 per cent, higher than in April, but 2.8 percentage points lower than in the same month a year earlier. And while national general public revenues increased by 25.5 per cent in the first four months of 2021, national general public expenditure increased by just 3.8 per cent.

This cautious approach has contributed to the weakening of China’s economic growth momentum. Now, exports have again become a leading driver of growth – an unsustainable pattern the country has been working hard to break.

Eventually – after enterprises recover their profitability and growth is back on track – inflation will stabilise at a positive, safe level.

Yu Yongding, a former president of the China Society of World Economics and director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, served on the Monetary Policy Committee of the People’s Bank of China from 2004 to 2006. Copyright: Project Syndicate

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