month in review • quESTIoN oF THE MoNTH Slippery slope
Is it time to get worried about producer price inflation? Producers are already worried
H
eadlines about inflation threat- ening China’s future economic stability are getting tiresome,
and yet Beijing seems incapable of chang- ing the channel. In March, news outlets broadcast the same familiar story – the consumer and producer price indexes (CPI and PPI, respectively) surged com- pared with one year ago, and both beat market expectations. March CPI was up 5.4% (its sharpest
increase in nearly three years), while PPI grew by 7.3% after increasing 7.2% in February. In addition, purchasers’ prices for industrial products rose 10.2% annu- ally in the first quarter. Increased concern about inflation’s effect on profitability led Fitch Ratings to downgrade renminbi debt in April. Rising consumer prices in China are
a recognized political risk, and therefore CPI announcements tend to hog the an- alytical limelight. But while PPI growth doesn’t always trickle into consumer price inflation, the continued rise of producer prices – which are now at their highest level since 2008 – is nevertheless causing concern.
Divergent growth
“Since March 2010, we have clearly seen the gap between PPI and CPI growing larger and larger,” said Wei Yao, China economist at Société Générale. “Large international companies such as Procter & Gamble and Unilever, as well as [do- mestic competitor] Liby have all had to increase their sales prices. Tis is a signal: Tose companies can’t absorb the increase in costs anymore. Although the govern- ment is using administrative methods to suppress the pressure, the increase is starting to spread into CPI.” Huang Lin, vice director of research
at Soochow Securities, concurred. “PPI’s unstopping increase could be risky, put- ting increased pressure on CPI, corroding company profitability and causing an ac- celerating economic slide,” he said. Where companies cannot vent higher
PPI into the market by raising prices – either because of government policy or
12 China Economic Review • May 2011
highly elastic demand – producer price inflation runs its course on companies’ balance sheets. Unfortunately, in many industries overcapacity has led to this precise situation. Rising costs are squeez- ing profit margins and increasing the risk of loan defaults for leveraged firms making textiles, fast-moving consumer goods, steel and aluminum products, and chemicals.
Quantity and quality
It’s not just that PPI is rising, but the way in which it is rising that has people worried. In addition to being exposed to higher prices for raw materials – recently aggravated by acts of god, war, and the US Treasury (a weaker dollar means more ex- pensive commodities) – PPI is also being pushed up by domestic structural factors. First, Beijing’s drive to increase the
minimum wage and otherwise improve labor’s share of growth is in turn inflat- ing the price of intermediate and finished goods, both of which include more cap- tured labor value. In comparison, raw ma- terials’ prices have grown more slowly in the last three months. Ideally, shifting income toward labor
also shifts demand out of investment and into consumption, and higher wag- es then offset the effects of factor price growth by making consumers willing to pay more. Tis has in fact happened to an extent: Inflation-adjusted urban income rose 7.1% in the first quarter and rural incomes rose a whopping 14.3%. Tese rising wages help explain the lack of riots in the streets over 11% increases in food prices in the first quarter.
Cost of doing business
Producer price index growth rate 8
7 6 5 4 3
Mar 10 Apr 10 May 10 Jun 10 Jul 10 Aug 10 Source: National Bureau of Statistics Sep 10 Oct 10 Nov 10 Dec 10 Jan 11 Feb 11 Mar 11
OVERSTOCKED: Companies with overcapacity have to eat high costs
Second, the numbers also show that
old-school infrastructure investment continues to play an outsized role in cre- ating demand. Fixed-asset investment in- creased 25% in the first quarter of 2011, and new loans hit US$106.7 billion, sur- passing market expectations of US$91.8 billion. Te central bank says it will make
two more interest rate hikes in the sec- ond quarter to get inflation under control, but Wei of Société Générale is skeptical: “Tere’s little hope that the rise in PPI can be mitigated in the second quarter.” Labor costs, she pointed out, are increas- ing by 20-30% in company reports, and not all companies can endure mandates to hold prices down indefinitely. “Tese administrative strategies [like
price controls] cannot last,” she said, but noted that structural approaches like in- creasing interest rates require time to take effect. In fact, higher interest rates and
tighter money supply have done more to aggravate PPI inflation than allevi- ate it in the short term. “Tight monetary policy increases the cost and difficulty of corporate financing,” said Liu Xiahui, a researcher in the Institute of Economics at the Chinese Academy of Social Sci-
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