Fisher Investments Editorial Staff
Inflation, GDP, Emerging Markets, Monetary Policy

Chinese Inflation Conundrum

By, 01/21/2011

Story Highlights

  • In the fourth quarter, Chinese GDP expanded by an impressive 9.8% y/y.
  • 2010 GDP growth should put to rest (at least for now) conjecture China imperiled growth by tightening too much, too fast in 2010.
  • China serves as a reminder that while geographically far-flung Emerging Markets are frequently lumped together for expediency's sake, individual nations have wildly diverse political, economic, and sentiment drivers.

 

Chinese president Hu Jintao's busy agenda in the US includes trade talks with President Obama, a black-tie state dinner (menu here), a visit to Capitol Hill that promises to be slightly chillier than the state dinner, and a trip to Chicago. And if that wasn't enough, on Thursday, China reported stronger-than-expected Q4 GDP growth.

 

In the fourth quarter, Chinese GDP expanded by an impressive 9.8%. For the full year 2010, Chinese GDP grew 10.3% to $5.88 trillion—likely ending Japan's 42-year run as the world's second largest economy behind the US (though this will not be confirmed until Japan reports official figures in February). That should put to rest (at least for now) conjecture China imperiled growth by tightening too much, too fast in 2010. Naturally, this has led to renewed fears China is "overheating"—which morphs into fears of future tightening stifling growth. (This "can't-win" territory has become familiar to China in the past few years.)

 

Some tightening is in fact likely but shouldn't be a major hurdle (provided it's not too onerous), and is something we saw from China in the last bull market. Going forward, China for now appears content to primarily contain inflation through bank loan quotas and reserve requirement adjustments instead of raising interest rates, which Chinese officials worry could impact consumption.

 

For 2011, China has set a lower new loan quota of 7.2 trillion yuan, which equates to roughly 15% y/y loan growth—down from 19% y/y in 2010. That should help moderate money supply and inflation growth rates, which is China's aim. They've also taken steps to ensure that loan quotas are more closely adhered to after banks exceeded last year's target (7.95 trillion yuan versus a target of 7.5 trillion) and pushed some loans off of balance sheets to avoid being included in official numbers. (Banks were estimated to hold 1.66 trillion yuan in off-balance sheet assets at the end of 2010.) Off-balance sheet assets held in trust companies must be brought back on balance sheets this year at a rate of at least 25% per quarter.

None of this is alarming or unprecedented; it's just a way to make sure the established quota is adhered to—a quota that allows for loan growth! The danger is it could morph into a way for the government to control what types of loans are made—potentially creating inefficiencies in capital allocation. That can indeed be a drag on growth. Our guess is inefficiencies will occur—normal in a command economy—but nothing too deleterious to ongoing Chinese growth.

 

China's battle with inflation serves as a reminder that while geographically far-flung Emerging Markets are frequently lumped together for expediency's sake, individual nations have wildly diverse political, economic, and sentiment drivers—and domestic monetary and fiscal policies in any individual nation can have a major impact at home, but less impact on the outside world. When examining Emerging Markets, any proper analysis requires a deeper look into individual constituents.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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