China's Inflation Surges
James T. Areddy
A surge in food prices pushed Chinese inflation in July to its fastest growth in a decade, prompting fresh predictions of a further interest-rate increase at a time when credit woes are forcing the U.S. and other major economies to consider looser credit.

China's National Bureau of Statistics said its consumer-price index jumped by 5.6% in July from the same month last year, the highest rate of increase since 1997. Food prices were the main culprit, led by a 45.2% rise in some meat prices.

The inflation report underscored that China, once described as exporting deflation to the rest of the world, is now more likely to be exporting inflation. In the U.S., prices of Chinese imports have been climbing faster than at any time since the U.S. began tracking them separately in 2003. They are up 1% over the past three months, equal to a 4.1% annual rate.

The rise in inflation in the world's fourth-largest economy is just one reason analysts expect the People's Bank of China to raise interest rates for a fourth time in 2007. Last month, the central bank made an explicit reference to its concern about inflation when it lifted the one-year lending rate by 0.27 percentage point to 6.84%.

But the need for even tighter credit appears to go beyond inflation. China's benchmark stock index has jumped 80% this year to just short of the psychologically important 5000 mark. Yesterday, the Shanghai Composite Index added 1.5% to end at 4820.06, a record. Meanwhile, a brisk revival of mortgage lending in Shanghai, and sustained growth in foreign direct investment -- which for the first seven months of 2007 was up 13% to .93 billion -- are also adding fuel to an economy that grew nearly 12% in the second quarter of this year.

Chinese consumer prices had been largely stable since the country's last major bout of inflation in the mid-1990s. Many economists had said the impact of price increases this year seemed limited because the trend was isolated to food. But accelerating inflation could take on growing political weight, making it harder for lower-income Chinese to get by at a time when the government is battling an already widening wealth gap.

The inflationary trend comes at a particularly sensitive time, ahead of this autumn's Communist Party Congress, a once-every-five-years event. Since June, Premier Wen Jiabao has been photographed visiting meat markets and essentially calling for more moderate prices.

The CPI's growth rate has increased by a full percentage point or more in each of the past three months, driven by the cost of food, which represents one-third of the index. Besides the 45.2% surge in poultry and meat prices, egg prices rose 30.6% and grain prices 6%.

The higher prices are causing growing frustration even among China's better-off urban residents. 'When I'm shopping in the supermarket, I have started to compare prices in a way I never did in the past,' says Cindy Wang, an advertising-company employee in Beijing. To make her approximately 0 in monthly food spending go further, she and her family eat less or substitute less-costly items like noodles for meat or fish, she says.

While rising prices are a growing concern globally, China's central bank is one of the few now with some leeway to take a hawkish line. For the U.S. Federal Reserve and its European counterpart, a more immediate task is to mitigate the risk that cash could dry up in credit markets as investors wind down their exposure to U.S. mortgage loans.

China isn't fully immune to the global credit-market woes -- some of its banks are thought to have small exposures to debt backed by U.S. mortgages. But China's continued controls over capital flows in and out of its economy are binding enough that it can largely go alone on monetary policy, according to a report last week by two researchers at the Bank for International Settlements, a Swiss organization of central bankers. That means Chinese authorities retain significant leverage to adjust short-term rates without regard to U.S. policy, the researchers say.

Ultimately, some analysts say a stronger Chinese currency -- in addition to higher interest rates -- might be needed to slow food-price increases. A more valuable yuan would increase the purchasing power of Chinese consumers and could slow the flow of cash into the economy from China's booming trade surplus.

'China instead needs to allow [the yuan] to appreciate faster, in order to cure its food-inflation problem and solve the excess-liquidity problem rooted in external imbalances,' Qian Wang, an economist at J.P. Morgan Chase in Hong Kong, said in a report.

China has allowed the yuan to appreciate by about 9% against the U.S. dollar since July 2005. But Beijing has largely preferred administrative measures to reduce demand for the yuan. Yesterday, for example, it issued a notice that allowed local companies to hold more of the dollars they earn overseas, dropping a requirement that the money be exchanged into yuan.