China Risks `Rush' to Tighten in 2011 After Inflation Surges

China risks a more abrupt tightening in monetary policy next year after refraining from raising interest rates since October even as inflation accelerated to the fastest pace in more than two years.

Consumer prices jumped 5.1 percent in November, a statistics bureau report showed Dec. 11. A measure of wholesale costs climbed 6.1 percent, exceeding all 28 estimates in a Bloomberg News survey of economists. Even so, the central bank held off over the weekend on the rate move predicted by firms including UBS AG and Mizuho Securities Asia Ltd.

Policy makers’ hesitation may be in part a product of China’s policy of holding down the yuan, as higher returns on deposits and loans would boost prospects for inflows of speculative capital that put pressure on the exchange rate. The danger is that a quicker move to raise borrowing costs next year unsettles the expansion in the fastest-growing major economy.

“The only reason to hold back is the hot money issue,” said Shen Jianguang, a Hong Kong-based economist for Mizuho who formerly worked for the International Monetary Fund and the European Central Bank. “If they are overwhelmed by this concern and refrain from a rate hike, inflation will be a big risk next year, and then eventually they will need to rush in tightening.”

Leaders’ Pledge

China’s leaders pledged yesterday to give a greater priority to stabilizing prices in 2011 and also better manage liquidity, Xinhua News Agency reported after an annual conference in Beijing to set economic policy guidelines.

Policy makers will also seek to prevent officials “blindly” starting investment projects as the nation’s next five-year plan takes effect, Xinhua said.

The central bank has raised rates once since December 2007, pushing the benchmark one-year deposit rate to 2.5 percent and the lending rate to 5.56 percent. Across Asia, India has moved six times this year, Malaysia three times and South Korea twice.

Premier Wen Jiabao’s government has also restrained gains in the yuan that could help restrain import costs, with the currency appreciating less than 3 percent against the dollar since mid-June. The yuan has fallen about 0.4 percent in the past month, closing at 6.6556 in Shanghai last week.

Inflation’s Cost

Higher prices erode households’ spending power and make it tougher for the poorest to afford basic goods. Food prices rose 11.7 percent in November from a year before, and residence- related costs such as charges for water, electricity and rent jumped 5.8 percent. More than 81 million people in disaster- affected parts of China may need food assistance this winter, the Ministry of Civil Affairs said on its website on Nov. 18.

Meantime, officials have warned that an influx of foreign capital may contribute to asset-price pressures. Funds are flowing into China because of monetary easing in developed economies, the strength of the nation’s recovery, along with forecasts for higher rates and a stronger yuan.

Trade surpluses are also bringing in cash from overseas, with figures last week showing a $22.9 billion total for November. Liquidity in China is also buttressed by continued growth in credit, with banks lending 564 billion yuan （$85 billion） last month.

“The global low interest-rate environment prevents China’s central bank from raising interest rates,” Wu Xiaoling, a former deputy governor of the central bank, said Dec. 11 in a speech at a hedge-fund conference in Shanghai. She cited the risk of attracting more capital inflows, adding that “excessive money supply is one of the important reasons for China’s inflation.”

Lending Growth

The nation’s outstanding local-currency loans were 47.4 trillion yuan in November, 60 percent more than two years earlier, a central bank report showed last week. The M2 measure of money supply rose 19.5 percent in November from a year before.

China’s economic data for November indicated that the economy is withstanding government campaigns to limit energy consumption in industry and speculation in the real-estate market. Industrial-output growth accelerated to a 13.3 percent annual pace. Retail sales advanced almost 19 percent.

Inflation may be “relatively high” in the first half of 2011 after likely easing to below 5 percent this month, the National Development and Reform Commission, the top state planning agency, said two days ago. In the first 11 months of 2010, consumer prices rose 3.2 percent, exceeding the government’s full-year target of 3 percent.

Weekend Watch

Analysts focused on the possibility of a rate increase over the weekend because of the timing of the release of the inflation data on Saturday, Dec. 11, eight days after the Communist Party’s Politburo said the nation would shift to a tighter, “prudent” monetary policy next year.

Instead of raising rates, policy makers have drained money from the financial system over the past two months by setting higher reserve requirements for banks.

On Dec. 10, the central bank said the ratios will climb by half a percentage point, indicating that the biggest banks must set aside 18.5 percent of deposits, excluding any extra curbs on individual lenders not publicly announced. Barclays Capital Asia Ltd. estimated the move would lock up 350 billion yuan.

The government is also focusing on administrative measures to combat inflation and its effects, including subsidies for the poor, sales from state food reserves and, where necessary, price controls on “daily necessities.”

Wage Gains

Rising wages are fueling inflation pressures. Yum! Brands Inc., the owner of the KFC restaurant chain, said last week that its labor costs in China may climb 10 percent or more in 2011.

China should “move quickly and aggressively to deal with inflation” before tackling longer-term tasks such as boosting private consumption, Stephen Roach, non-executive chairman at Morgan Stanley Asia Ltd. said Dec. 9 in Hong Kong.

Delaying the use of the interest-rates and the exchange- rate tools may lead to “a painful correction at a later stage,” said Chang Jian, a Hong Kong-based chief China economist at Barclays Capital. She saw risks including asset bubbles.

The Shanghai Composite Index of stocks has fallen 10 percent from a Nov. 8 high, extending this year’s loss to 13 percent, on concern tighter monetary policy will damp economic growth and profits. Investor reaction to the latest inflation number may be attenuated by the figure matching a report ahead of the release in the Economic Information Daily last week.

Economists anticipate a 1 percentage point rise in the key lending and deposit rates by the end of next year, according to the median forecasts in a Bloomberg survey on Dec. 2. Gross domestic product will rise 9.2 percent in 2011, the median projection shows.