June CPI suggests inflation is moderating, but PPI tells a different story
As expected, the National Bureau of Statistics of China released a new set of economic numbers today. According to the release, CPI inflation year on year for June was 7.1%, its lowest level since January. It was 7.7% in May, 8.5% in April and 8.3% in March. On a month-on-month basis CPI declined by a little under 0.2% (following a 0.4% decline last month). This is more or less in line with expectations. The information is presented a little differently than it has been in the past, and I cannot back out the food and non-food components. I am hoping some cleverer analyst will be able to do so, but so far I haven’t seen anyone else provide a breakdown.
PPI numbers, also as expected, were much worse. PPI prices rose 8.8% year on year in June, compared to 8.2% in May, 8.1% in April, and 8.0% in March. I have already pointed out many times before that as the CPI numbers become increasingly tainted by price controls, more and more of us are looking at PPI to get a sense of underlying inflationary pressures. I think any sense of relief prompted by the continued decline in CPI inflation will be held in check by the frankly very poor PPI numbers.
On a related topic today’s Financial Times has an interesting article by Jamil Anderlini and Geoff Dyer with the rather worrying title "China on the brink of electricity shortfall."
China faces its worst power shortage in at least four years as soaring coal prices and government-set electricity tariffs force dozens of small power plants to shut down rather than face mounting losses. Nearly half of China’s provinces have started to ration electricity as the country enters the peak summer season, facing what analysts describe as its worst coal shortage.
Analysts warn that this year’s electricity shortfall could be more severe than in 2004, when the country was affected by its worst power shortage in decades because of soaring demand for power as the economy boomed.
This is part of the problem with the inflation numbers. We are exchanging higher prices for shortages, and although one is as much an indication of inflationary pressure as the other, only the former shows up in the CPI and PPI numbers. These kinds of shortages (and there are many more) are masking very real inflationary pressures, but earlier experience, such as those of the US in the 1970s, suggest that shortages are only a temporary way to mask inflation. I expect price increases will have to occur soon.
In general I don’t think the numbers today are going to help the economic policy-makers reach any kind of firm conclusion one way or the other. GDP growth has slowed, according to today’s release, but a slowing to 10.1% growth in the second quarter (from 10.6% in the first), although slightly lower than expectations (and the lowest in three years), shouldn’t be enough to strike terror just yet., especially since, worryingly enough, fixed asset investment surged, by 26.8%, compared to 25.6% in the first five months of the year. This suggests that if the economy is moderating, it is not because of a decline in the overinvestment problem.
None of us really expected this batch of numbers to do much to clarify policy-making, and that is more or less what happened. That won’t stop the lobbying, of course. The Ministry of Commerce and its allies are stepping up the pressure to limit RMB appreciation, even though it is very hard to conclude from the numbers that Chinese exports are suffering because of currency appreciation. In fact export growth is remarkably strong given the slowdown in global demand and the high price of commodities.
I suspect the debate about whether or not to further "tighten" monetary conditions will also rage on. In his article on the data release Dong Zhixi in today's China Daily put it this way:
These concerns may be part of the reasons why the finance committee of the National People’s Congress, China's parliament, pledged on Wednesday to maintain its tight monetary policy for the rest of the year. However, watchers sensed a softening of words in its description of the fight against inflation. The committee said curbing price pressures would be a "prominent task" in the months ahead, instead of "top priority," phrasing that economic leaders repeated in the early months of 2008.
Analysts believe policy makers are trying to find a balance between inflation and economy growth and are gradually shifting towards preventing a major economic slowdown.
China’s banking regulator told policy makers that forcing banks to increase reserves has hurt the industry's ability to repay debt, according to a person with knowledge of the matter. The People's Bank of China raised its reserve ratio requirement to a record 17.5 percent last month to rein in loan growth and inflation. The China Banking Regulatory Commission has warned against ordering further increases, the person said, declining to be identified as he isn't authorized to speak publicly on the matter.
China's push to remove funds from the banking system resulted in the slowest loan growth in more than two years last month. The risk is that more banks will fall below the minimum requirement for short-term financial strength, the person said.
Amid all the economic data, the stock markets continue to be depressed. The SSE Composite drifted more or less steadily downward today, to close at 2685, down 0.78% for the day. So far I haven’t heard too much angry noise coming from investors, perhaps because last week was pretty good (up nearly 8%), but I did read with some dread a report on today’s Bloomberg that says “Pakistan investors stormed out of the Karachi Stock Exchange, smashed windows and cursed regulators after the benchmark index fell for a 15th day, the worst losing streak in at least 18 years.”
Comments (11) for "June CPI suggests inflation ...
Mr Pettis
Agree about the shortages/higher prices exchange but could part of the problem be the very infrastructure- power grids et al which provide the network and services?
Probably a silly question but don't beijing's power stations run on coal? Still remember the ironic thought when I realised the funky burnt smell of Beijing's air was due to the coal burning, the irony being that I was near the "fragrant mountain/hill" at that time. Could the clean air drive be part of the shortage situation?
The difference between the china stockmarket investor situation vs pakistsan is perhaps the expectation that central government has to step in to support the stock market at some time. But not a good sign...
One reason of diversity between PPI and CPI is lag effect. When input cost firsts rised, the producers would absorb the increased cost rather than raise price immediately to stay being competitive. After a while, producers will have to raise prices as well. Thus, the peak in PPI will be behind CPI's peak.
By fatbrick - 7/16/2008 8:36 PM
Michael,
the confusion about the actual state of the economy increases, if you take this Bloomberg report into account: same day, same news agency, same market but totally different message: http://www.bloomberg.com/apps/news?pid=20601089&refer=china&sid=a2UtPRM55FS8
“China's currency declined for the first time in three days after a report today showed China's economic growth cooled in the second quarter, increasing pressure on authorities to switch from fighting inflation to protect exporters. The yuan also dropped after the central bank set a weaker daily reference rate, suggesting it's seeking to boost growth and deter speculators.
``If there's a further slowdown in exports, authorities may slow the pace of yuan gains to prevent widespread bankruptcies,'' said Liu Dongliang, a Shenzhen-based foreign- exchange analyst at China Merchants Bank Co., the country's sixth-largest lender. " Compare that to the Bloomberg report you have quoted: "China's state radio said yesterday that the nation needs a ``tight'' monetary policy, citing the legislature's Financial and Economic Affairs Committee."
Obviously the whole financial market is under high stress and there is no clear path out of the mess. China is facing the same dilemma as the US; a stronger currency hurts, a weaker as well.
What I find worrisome, are the increasing reports about bankruptcies and credit defaults. How many companies are kept above the waterline by loans from the informal banks?
Again from Bloomberg: “So-called special mention loans at Chinese banks, credits that may become non-performing unless amended, increased by 35.8 billion yuan in the first five months of the year to 2.16 trillion yuan, according to the regulator. That may be a precursor to a rebound in bad loans, as shrinking corporate profits in some industries erode companies' ability to repay debts, the person said. Chinese banks' bad-loan ratio dropped to 7.5 percent at the end of May, down 1.74 percentage points from a year earlier, the person said. Total non-performing loans fell 5.3 percent to 2.25 trillion yuan. „
By Gregor Neumann - 7/16/2008 8:41 PM
You may want to check the month-to-month growth for June 2008. I think the reported -0.2% change is bogus.
By Bill - 7/17/2008 12:55 AM
The disparity between moderating current CPI and accelerating lagging PPI has to have a dampening affect on China's financial markets. Is there a chart available of trading volume measured against actual CPI and PPI reports?
Fatbrick, the relationship between PPI and CPI is more complex than that. PPI inflation is as often a leading indicator of CPI inflation in China and elsewhere as it is a lagging indicator. More importantly, because of price controls and the undercounting of food (food is officially around 33% of the CPI basket officially, but the ADB says it should be 40% and one analyst, I think Stephen Green, argued that it is 43%), CPI has become tainted as an indicator of consumer price inflation, so whether it is likely to lag or lead is less clear.
Duoist, I have not seen such a chart, but I know more than one insitutional investor who claims that when PPI exceeds CPI the result tends to be a subsequent fall in corporate profits. Because of the murkiness of CPI, I am not sure if this will hold true in the same way as it has.
By Michael Pettis - 7/17/2008 3:33 PM
Gregor- Bloomberg has a story like that every day. What's really going on is that the PBOC is slowly letting the CNY appreciate (on something of a trade weighted basis, though with a massive overweight to USD). This means that some days the PBOC sets the USD/CNY reference rate stronger and some weaker. Bloomberg columnists are literally required by their editors to state a reason any time they report on a market move. As a result, when CNY strengthens Bloomberg has a piece that day about the PBOC addressing inflation (followed by quotes about tight policy), and when CNY weakens Bloomberg has a piece about China supporting exporters or deterring speculative inflows (yeah, right).
By sharpe_mind - 7/17/2008 5:02 PM
Michael, I don’t think you can consider queues for price-controlled items as suppressed monetary inflation. If the monetary explanation for China’s inflation is correct, then if the price of certain items is restrained, the money that has been created can be expected to bid up the price of other items instead, especially substitutes. In other words, the first order effect of price controls is to redistribute inflation rather than hold it down. Assuming that the Chinese inflation index is sufficiently broad to cover those other items, I would not expect price controls to have much effect on inflation driven by excess money growth. Alternatively, if inflation is driven by supply shortages (that would be accommodated by an increase in money supply), then price controls can suppress inflation by eliminating the cause of extra money demand at source. In that case, it is reasonable to say that price controls represent repressed inflation, because lifting them would allow inflation to proceed.
RE, of course you are absolutely right. In an inflationary environment price controls on one good simply forces the prices of other goods to rise, and I have used a corrolary to that argument often to explain why low but rising non-food inflation is not compatible with soaring food prices if Chinese monetary policy really is consistent with low inflation. I guess I was trying in a very sloppy way to say that long lines indicate a supply/demand imbalance, and that this imbalance indicates the need for rising prices in price-controlled goods.
By Michael Pettis - 7/19/2008 4:34 PM
I'm not quite sure if you're wrong here Michael- since the price controls create shortages, the good itself (say diesel gasoline) is worse than it would be without the controls. In addition, long waits to obtain the good itself are an opportunity cost on wealth creation one could otherwise achieve should the controls not have been in place. So in a sense the real price of obtaining gasoline should include the revenues one could generate with the lost time. One can make a distinction between cases where price controls are fully subsidized and cases where they aren't and lead to shortages; in the former you would expect less of a distortion to the actual CPI print because deflation in the subsidized good would create inflation in the rest of CPI, while in the latter the actual CPI print would go down because the price controlled good is in fact worse.
By sharpe_mind - 7/20/2008 5:05 AM
You raise a couple of interesting points, sharpe_mind. If a cpi is adjusted for quality variations, queues should contribute to a rising cost of living (COL), but that is not the same as monetary inflation. Personally, I do not think that central banks should use a COL index to gauge monetary policy. Subsidies, which I did not mean by price controls, should represent monetary inflation because, other things equal, they have to be paid for by higher taxes (ie an increase in the price of government services), but would be overlooked by most inflation measures since they do not include taxes. The measurement of inflation is an arcane and controversial subject - see, for example, the recent debates on this on econbrowser!
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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Comments (11) for "June CPI suggests inflation ...
December, 2007