- There are fears China's growth is unsustainable—that inflation will either outpace its economy or a too-strict monetary reversal to stem inflation will choke it.
- Recent data show no evidence of slowing growth yet, but inflation is slowly heating up.
- China's central bank has implemented measured monetary tightening measures, but inflation typically lags monetary policy.
- Tightening today may not be evident until at least later this year.
- As long as monetary policy remains moderate, there's no reason China's economy can't grow as it did during the last bull market.
China's growth in the past decade has been remarkable—it's now the third-largest economy in the world, up from 7th ten years ago. But along with its economic prowess come fears its explosive growth is unsustainable—that massive growth will either lead to much higher prices or a too-strict monetary reversal to stem inflation will choke growth. Recent data show no evidence of slowing growth yet—fixed asset investments, exports, and retail sales remain strong—but inflation is slowly heating up.
China's Consumer Price Index (CPI) rose 2.8% year over year (y/y) in April—higher than previous months (though still below 2008 highs). Food and housing led the upswing. Food prices rose 5.9% year over year, partly due to colder-than-usual weather that negatively affected the spring harvest. Housing prices have risen fast too, but were the target of late-April tightening measures. These included restrictions on third mortgages in high inflation areas, higher down payments on first and second homes, minimum mortgage rates, and trial property taxes in a number of cities. The restrictions aren't fully reflected in April numbers. But early reports from property developers and regulators indicate prices have come down since the restrictions' implementation.
Nevertheless, with wholesale prices ticking higher too—6.8% year over year (also below 2008 highs)—it's thought consumer prices might soon follow as producers pass on costs.
Inflation may continue, but we should use a different yardstick for emerging markets when measuring inflation's harm. Inflation is typically higher in developing economies than developed, but the negative impact of elevated inflation can be offset by faster economic growth. Double-digit economic growth is common in developing nations (China's Q1 GDP was a heady 11.9% y/y), making higher inflation more manageable than in the developed world. And China benefits from huge productivity gains as citizens move from the agrarian West to Eastern coastal cities, which boosts the middle class and is helping drive domestic consumption.
Also, the Chinese government isn't blind to the threat of rampant inflation outpacing the economy and has taken steps to rein in stimulus. Monetary tightening so far includes increased bank reserve requirements (three times this year), lower 2010 loan quotas, and all those restrictions on the housing market. Monetary policy impacts the economy, but with a time lag, so the effects of these actions probably won't be evident until later this year. Another reason we shouldn't place too much stock in a month (or even a couple months) of higher prices.
In all, Chinese monetary policy has taken the middle road—inflation-limiting but not growth-choking. The Chinese government has been hesitant to move interest rates meaningfully higher and indicated they are aware of the need to continue supporting the economic recovery. There may be further tightening down the road, including higher interest rates (a "rough tool," according to the government)—and perhaps eventually yuan appreciation. But if recent policy is any indication, the moves likely won't be draconian.
As long as monetary policy remains measured (as it's been so far), there's no reason China's economy can't grow as it did during the last bull market. After all, reserve requirements, interest rates, and currency all rose then too.