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New tools needed to curb inflation

By Ma Hongman (China Daily)
Updated: 2008-05-26 15:03

On May 12, the National Bureau of Statistics announced the Consumer Price Index (CPI) growth in April reached 8.5 percent year-on-year, 0.2 percentage point higher than in March. On the same day, the People's Bank of China raised the reserve requirement ratio by half a percentage point.

Effective from May 20, the reserve requirement ratio, the proportion of money banks must set aside in reserves, is pushed to 16.5 percent. The fourth increase of the year, it is a quick response to the high CPI growth, an indicator of the inflation level.

The April CPI of 8.5 percent is only slightly lower than February's 12-year record high of 8.7 percent and the deposit reserve ratio is already at a historic peak.

Since the inflation pressure became intensive in 2007, it is a common expectation of the market that the monetary policy would be further tightened once the price keeps going up. And the most frequently used policy tools for reducing the money supply are to raise the interest rate or the deposit reserve ratio.

Since it has been used in several rounds, it is necessary for us to examine whether such a response from the policymakers has worked the way it was meant to do. Different from the high inflation level in the past, the latest round of price hike has an obvious characteristic: it is structural.

Since the later half of 2007, the continuous high growth of CPI was mainly driven by the price rise in agricultural produce, especially meat, eggs and poultry products. This driving force has not faded away till now although its growth momentum has been checked after the policies for curbing inflation are carried out.

Another important element lifting the CPI level is the ever-climbing price of crude oil and other raw materials on the international market, which is spreading into the Chinese market through China's huge volumes of import.

Although the national economy watchdog did not approve raising the prices of refined oil or electricity, the price pressure on the global market has been felt by the oil companies. The shortage of oil supply is one of the direct consequences of such State price control. Given the huge pressure, it is only a matter of time that the prices are pushed upward by the inadequate supply.

Therefore, it is wise to take a closer look at CPI, the textbook indicator of inflation pressure. After all, it may not mirror the real situation of the economy as a figure of the comprehensive calculation.

As a matter of fact, the traditional monetary policy tool, the interest rate or the deposit reserve requirement, could hardly work exactly upon the price-driving elements mentioned above.

Both measures could reduce the money supply in the economy, but they could do nothing in the short term to boost the supply of meat, eggs, poultry products or any other plants grown in the farm. The supply of agricultural produce cannot get free from the time span of their unique production cycle.

In this cycle, raising the interest rate would only make the agricultural production more expensive, which, in turn, would push up the price of these produces, worsening the inflation pressure.

As to the price of crude oil and other energy products on the international market, they are practically out of the reach for domestic monetary policies. The continuous depreciation of the US dollar, the speculation of the hot money and the ever-growing demand from emerging markets have worked together to push up the oil price.

The tight monetary policy within China is unable to prevent this process and has a risk of attracting more international speculators to put their money in China, further boosting the money supply here.

It is not realistic to rely on tightening the monetary policy as the single solution to China's inflation. At best, the traditional monetary policy tools could change people's expectations on inflation. It remains a moot question whether the interest rate hikes and the rises in the deposit reserve requirement could really bring down the inflation growth.

At a recent financial forum in Shanghai, Zhou Xiaochuan, governor of the People's Bank of China, described the dilemma of the decision-makers: to boost the economic growth, consumption should be nurtured or stimulated, while consumption needs to be curbed to ease the inflation.

He has really got the crux of the problem. The contradictory targets to maintain the economic soundness are really challenging the wisdom of the policymakers.

Therefore, they should drop the customary practice of tightening the monetary policy once the inflation indicator is lifted, but fix more flexible countermeasures according to real-time changes.

To boost the supply of agricultural produce, the State should offer more favorable policies to boost the development of agriculture and more practical arrangements should be made to ensure the State subsidies reach the farmers instead of being gripped by others.

As to the inflation pressure on the overseas market, the State should try to reform the price-forming scheme of the energy products, especially the refined oil products, in the domestic market. When the price of these products is subject to the changes in the supply-demand balance in a free market, it would work as a sensible pivot to recover the balance.

The inflation we are seeing now is not formidable, China has seen worse. As long as the policies are tailored to treat the real problems, we could expect a soft landing after the high-flying inflation.