Why was China able to avoid high inflation?

From Project Syndicate, by Zhang Jun – When high capital spending fueled a sustained rise in Chinese inflation from 1991 to 2011, authorities quickly brought the situation under control and over the past decade, the CPI has rarely exceeded 2%, compared to 5, 4% in 2011.

As policymakers in most major economies lose their grip on price stability, can China continue to contain inflation this year and next?

To answer this question, it’s worth reflecting on how China has managed to curb inflation over the past decade. In particular, the government abstained from further rounds of broad fiscal and monetary stimulus and thanks to increased central bank autonomy, money creation and credit growth no longer reacted passively to investment projects.

After 2015, the Bank of China took a cautious stance and adjusted its credit allocation to support sectors with excessive debt-to-GDP ratios. Highly polluting industries and the real estate sector – both of which have fueled rapid GDP growth in the past – faced financial repression. At the same time, the central government has tolerated minimal growth rates that could allow for steady job growth.

Today, that tolerance is being tested. The pandemic shutdowns, especially in Shenzhen and Shanghai, have weighed heavily on the Chinese economy. In the second quarter of 2022, Shanghai’s GDP fell by almost 14% . Meanwhile, the real estate sector – traditionally a major contributor to aggregate demand – is becoming a drag on the economy. In 2020, the Chinese government introduced “ three red lines to limit the sector’s access to credit: The promoters’ liabilities must not exceed 70% of the assets, their net debt must not exceed shareholders’ equity and their liquidity must be equal to short-term loans.

The new debt measures and the COVID-19 pandemic have put the sector under heavy pressure. Once thriving developers are now facing serious debt crises. Due to some housing projects being delayed or halted, homebuyers in several cities have had to stop paying their monthly mortgage payments since the second half of last year.

The good news is that China has effectively brought inflation under control. In the first half of the year, the CPI rose by 1.7% and the government’s inflation forecast for 2022 is around 3%. The bad news is, While the Chinese economy has been spared from overheating, this has clearly come at the cost of a sustained slowdown in GDP growth, or even a recession in some regions.

Under these circumstances, the official forecast of 5.5% economic growth this year will not be met. In the second quarter of this year, Chinese growth was barely positive.

While GDP continued to grow at 2.5% year-on-year in the first half of 2022, thanks to relatively strong exports, real GDP growth would need to be at least 8% in the second half to reach the 5.5% target. 5% before 2022, which course is unlikely. As a result, the central government is most likely to lower the lower bound of its July-December growth forecast to 6% instead of 8%, which represents an annual growth rate of 4 to 4.5% for the whole year.

Considering this, the Chinese government plans to launch another round of stimulus for the rest of the year. With unemployment rising – the rate for 16- to 24-year-olds reached 19.3% in June, an increase of four percentage points year on year – stimulus measures are urgently needed. But Prime Minister Li Keqiang was very wise to emphasize the importance of not overdoing it.

In the past, stimulus measures have taken the form of excessive investment in infrastructure. But China now has limited leeway. One of the main obstacles is the massive over-indebtedness resulting from the massive stimulus measures of 2009-2011, which poses a serious risk to the financial system. Most of the money that could be used to invest in additional infrastructure projects will still have to be financed through local financing instruments and local government bonds.

Since authorities recently asked China’s political and development banks to add a total of 1.1 trillion Chinese yen ($163 billion) in new lines of credit to support infrastructure projects, new fiscal spending — and new debt — may still be needed. .

Another impediment to recovery is the threat of imported inflation. The effects of the pandemic, combined with the effects of the war in Ukraine, are pushing inflation expectations in most western countries, which are already experiencing rapid increases in consumer prices: the CPI in the United States and the UK was over 9% in June, while the Eurozone CPI was over 8%.

Similarly, in Asia, South Korea’s CPI rose 6% year-on-year in June, the largest increase since November 1998. Japan’s CPI increase – 2.4% – surpassed the central’s target for the third straight month. Bank.

As a major importer of energy and food, China will find it difficult to isolate itself from the global trend. Two factors explain why the CPI in China has not risen yet.

First of all, China’s energy and food importers are all giant, state-owned and state-controlled companies, whose pricing decisions are strictly regulated. As long as inflation expectations are not formed, the increase in import costs will not be passed on to consumers. This is reflected in the China Producer Price Index, which has been less stable than the CPI over the years.

Second, although China imports many essential goods, the goods included in the CPI are largely delivered domestically. And, as with importers, prices charged by state producers in the upper echelons of China’s economy do not fully reflect their changing costs, due to government controls.

Think pork – the main commodity influencing the CPI in China, accounting for 2.5% of the index. Countercyclical regulation of pig farming and government subsidies to pig producers have been a major contributor to keeping pork prices – and therefore the CPI – relatively stable.

But while such regulation can help cushion external supply shocks, cutting revenues or increasing subsidies will increase the government’s fiscal burden, especially in a context of global inflation. Add to this the already strained local finances and the enormous costs of maintaining a zero-COVID policy, and the government’s ability to expand and fund public capital expenditure will be severely curtailed.

In this regard, it is understandable that the Chinese government has chosen to adopt a modest stimulus package. Excessive stimulus, experience shows, would almost inevitably lead to excessive monetary expansion, leading to a rise in inflation that would pose new challenges to the Chinese economy in the coming years.

Zhang Jun, dean of the economics faculty at Fudan University, is director of the China Center for Economic Studies, a think tank in Shanghai.

Copyright: Project Syndicate, 2022.

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