China: CPI Surprisingly Low, Trade Surplus High

The stock markets have had a mixed week so far.  On Monday the SSE Composite declined by 2.7%, before regaining a fraction of that on Tuesday to close up 0.1% and another 0.2% Wednesday.  Banks and real estate developers again led the decline.  Things weren’t helped by August car sales which, as I wrote Friday, Lehman Brothers had correctly predicted would decline, although by 6.2% rather than the 10% they predicted.  Some people are saying this decline is temporary, but on the back of several months of rising car inventories it is nonetheless ominous. 

The most interesting news this week has been the slew of numbers released Wednesday by the National Bureau of Statistics.  Of these the most eagerly anticipated, CPI inflation for August, was surprisingly good, coming in at 4.9% year on year, which is well below July’s 6.3% and also well below market expectations of around 5.5%.   The decline in CPI inflation was driven mostly by declining prices in pork and vegetable oil. 

Quite honestly I am puzzled by this unexpectedly low CPI inflation number.  Part of me would like to conclude that I have been overly alarmed about the threat of inflation all year, and that inflation is no longer the risk that I always assumed it was.  That would certainly be good news, and would give the government greater room for maneuver on the money and credit side, although Mark Williams at Capital Economics says in his research piece today that he actually thinks there is a risk of deflation next year. 

But I am still puzzled.  Money growth has been so rapid in the past couple of years, and probably credit growth too if you count all loans in the formal and informal banking sector, that it seems very strange that inflation could come down so quickly.  Is it possible that the huge decline in stock market prices and the smaller decline in real estate prices have had a correspondingly large impact in reducing money in the system?  Or did food prices shoot up so quickly early this year for what were extraordinary reasons, and now as they revert to some more reasonable level of implied inflation they are causing a sharp but temporary decline in inflation.  Or could it even be that price controls and other administrative measures (e.g. selling of food stocks) have seriously tainted the CPI numbers?  I am not really sure.

And there are still other things that are hard to reconcile with the CPI numbers.  All the decline in CPI occurred in the food sector – non food inflation was steady at 2.1%.  More worryingly PPI inflation remains high and actually accelerated slightly year on year, from 10.0% in July to 10.1% in August.  Yesterday I was at the office of a friend of mine, Columbia professor Dan Rosen, and he showed me a graph he had prepared setting out CPI and PPI inflation over the past several years.  What was striking about the graph was that the two numbers were extremely closely correlated until the past few months, when they diverged sharply.  This month’s data causes the divergence to widen even further. 

One can easily make the case for a strong correlation between the two, but it is very hard to explain why they might diverge so sharply without, at some point, one feeding into the other.   Of course if oil and other commodity prices continue to drop, their decline will help ease PPI inflation in the future, but it seems to me that it will need a lot more than this to bring the two into line again. 

Tuesday’s Bureau of Statistics release also included trade data.  Imports grew last month at a 23.1% in August, down sharply from 33.7% in July.  It would be easy to credit the slowdown in growth to a decline in world commodity prices, but Mark Williams claims that the decline in commodity prices only accounts for half of the slowdown in growth.   The Olympics may have distorted the numbers, so it would be risky to draw conclusions with too much confidence, but the reduction in import growth may reflect a decline in domestic demand growth, something that I have been expecting.  

Export  growth also slowed, to 21.1% year on year in August from 26.9% in July.  That left the trade surplus for August at a record $28.7 billion – a number which will help ensure that China’s money supply will continue expanding sharply in August.  Growth in nominal fixed asset investment moderated slightly from 29.2% in July to 28.1% in August.  I think this is still a little high given the slowdown in foreign and domestic demand growth, and suggests that export growth will remain relatively high in the coming year (relative, that is, to slowing international demand) and that the threat of rising inventories remains strong. 

What are the policy implications of the most recent batch of numbers?  I would hope that no one draws too much confidence from the first set of post-Olympic data, since there may be all sorts of temporary distortions in the numbers, but it seems pretty clear that the pro-growth camp will have been strengthened.  Anyone who has been arguing that the risk of inflation is no longer a real constraint on policy will have been heartened by the most recent CPI numbers, and if he has also been arguing (as is likely to be the case) that the real threat is that of a sharp slowdown in growth, the numbers are more or less aligned in his favor.  One consequence is likely to be a further relaxation of price controls.  My guess is that there will also be increased pressure for fiscal expansion to counteract a perceived slowdown in domestic and foreign demand, and that concerns about a too-loose monetary policy will subside further. 

The record high trade surplus will put international pressure on China to let the RMB appreciate, but the southern exporting lobby will still argue – incorrectly, in my opinion – that slower export growth is a consequence of the rising RMB.  I am not sure how this pans out, but I suspect that the recent slowdown in RMB appreciation is more of a “head fake”, one aimed at slowing hot money inflows, than a real policy consensus.  Although the monetary camp continues to be weakened in the policy debate, I think there nonetheless continues to be real worry among policymakers about the pace of money growth in China.  

On a separate note I have met a few investors so far in my trip to New York but Wednesday and Thursday I have a lot of meetings that will, I hope, give me a better sense of what they think about global conditions and about China.  I will try to write something about this later in the week.  For now I am still struggling with m jet lag, although I have to say the weather here has been really nice.

Comments

[Thunderlight:]

Nice article, thanks for sharing

2008 Sep 10 12:06 PM

[Urbane Gori...:]

Michael... I don't suppose the Chinese play with their numbers any more than we do, but I recall that you have been saying that there is pressure on to ramp up the engine again. This sounds like the numbers they needed to do just that.

Interesting as well that the commodity flop has been largely attributed to the slowdown in China's consumption and 'et voila' imports are down.

I wonder if the drop in food prices are a reflection of the extra consumption during the Olympics?

Always interesting to read you comments. Kind of a reporter 'embedded' in the front lines.

jegan

2008 Sep 10 08:23 PM

[Qingdao:]

Bloomberg reports: (9/11) Zhou Xiaochuan said: "But we can't relax as the rate may rebound."

2008 Sep 10 08:47 PM

[James Lewis:]

The Chinese numbers differ in that they are manipulated at a lot of different levels.

Firstly at ground level, incorrect numbers are given for the obvious reason that there are price controls, so sellers have to under estimate the figures somewhat.

Then they are manipulated using the basket weight, as well as a final 'audit' on the numbers by the statistics bureau. If the pro-growth camp currently holds influence over the stats bureau then they will be played with to represent their aims. However at the moment I believe the manipulation is coming from a lot lot higher in an attempt to:

a) give positive messages to market.
b) give positive message to foreign investors to control capital outflows.
c) stem inflation expectations so there are no 3rd round effects. (we have already had second round effects)

I must say that vegetable oil has come down a rediculous amount recently. And so fast. Of course oil has fallen, but it usually takes a lot longer to see the prices come into the actual market place (ie supermarket). Also the price has fallen a lot more than it should. It as if they have passed on the savings (plus some) instantly. Looks pretty obvious to me that the prices have been driven down (with implicit instruction from the government ) . This would effect the CPI to create positive number, But far far more importantly it is an attempt to communicate to the public prices are coming down to displace price fears/expectations (the Chinese are very sensitive to issues like this, more than the westerners). By displacing price fears they are hoping to give consumer spending a boost and improve the gloomy sentiment that a lot of people are feeling. Reducing the price of cooking oil (and of course pork) is a very effective to communicate price reductions. The Chinese watch very closely the price of cooking oil, it is a product that everyone buys and the Chinese attach a huge huge amount of significance to cooking oil. In old times, cooking with oil was a symbol of wealth. Having oil on your clothes signified that you ate good food.
So going into Mid Autumn festival, the appearance of reduced cooking oil and pork is quite a good way to show inflation is under control. It has been very effective, people are already talking about it.

The price controls have contributed to the widening cpi/ppi differential. But to a large extent the differential is due to the factories not feeling they are able to pass on the increase in costs to consumers. On a great deal of products they have planned many many times over the last 4-5 months to increase their prices, at the last stage deciding not to on the basis that everyone is reining in their spending. Things are now quite tight here. If bargins is not to be had, people as a whole just won't buy. My personal experience is that it is far easier to negotiate a far lower price than it has been for at least a year and a half. Of course they are also handcuffed because of the huge overcapacity that is present in China. There are so many factories supplying similar products that there is no scope to raise prices because of the choice consumers have (non-food,non-energy). There will always be a factory that doesn't increase their prices and as a result they will gain amrket share. Businesses are in survival mode, revenue and cashflow is trumping margins. Theoretically if international markets slow then there will also be an inventory build up that the factories will then try and channel to the domestic market. Making price increases impossible regardless of PPI inflation.

In fact I think it is fair to say that China runs the risk on certain components of the economy of deflation. We have seen huge stock market deflation already, the first hand property market is under stress in most cities and has fallen in some cities. Now it could be funneling into consumer goods. I question whether we have reached such an extreme of investment that any tail off in monetary growth (however small) may lead us into a temporary cycle of deflation.

2008 Sep 12 12:42 AM

[kelaido:]

Micheal,
Try Melatonin on your way back. Take one onboard according to your intended sleeping time in Beijing, say 11am EST (11pm Beijing time). Take another one around bedtime in Beijing and that should do it. For many years, I suffered very bad jetlag travelling between the US and Asia, until a colleague introduced me to melatonin. Hope it works for you too.

2008 Sep 12 07:12 AM