China’s economic chess game

What would stagflation with Chinese characteristics look like? While the traditional meaning of the word is negative or sluggish growth coupled with rising inflation, China could be experiencing its own version, based on recent data.

Weekend figures for trade and CPI showed that, yes, China is slowing while inflation is picking up.

Inflation in June hit 6.4 per cent, above market consensus, while import figures pointed to softening domestic demand.

So is stagflation looming over the horizon? Not in the traditional sense. Chinese growth rates are still miles off being negative or even sluggish. Wednesday’s upcoming GDP release for the second quarter will surely confirm this, though the risk of some level of disappointment looks to be growing.

But a mild form of stagflation – where growth moderates and inflation remains sticky – doesn’t look too far-fetched. Though many analysts say price rises have peaked, few expect CPI readings to tumble in the coming months. The fact that core inflation rates hit a three-year high in June adds some weight to this view – inflation rates won’t be brought down by one good harvest (though a sudden drop in pork prices would help).

Growth, meanwhile, is clearly moderating. Recent manufacturing data have shown slowing production growth, and government statements that declare inflation to be the top priority suggest policy will remain focused on reining in credit, not giving exporters a boost.

Perhaps a better way of describing the situation has been put forward by Vitaliy Katsenelson of Investment Management Associates, writing for Forbes.com. China, he says, is stuck in zugzwang. The term comes from chess and describes a situation in which any move will put a player in a worse position.

How does that apply to China? Raise rates much further, and a lending shock could force a hard landing (something most analysts insist is still a very remote possibility). But raise rates too slowly, and inflation could speed back to dizzying levels (2008 was bad but the mid-1990s, when CPI hit almost 30 per cent, were frightening).

No wonder the market is split over whether further rate hikes are coming. Traders, meanwhile, are trimming their bets on the renminbi.

Source: www.ft.com