With exports continuing to grow strongly in January, mainland China is yet to feel the impact of slower US economic growth and a stronger renminbi on its economy.

Mounting inflationary pressure and foreign trade surplus have forced the government to cap the growth of money supply (M2) at 16% for 2008, and a similar growth target for bank loans. The same factors may also force the government to appreciate the renminbi further, not just against the US dollar, but also against other major currencies.

Though international food and commodity prices are still rising, the government's administrative measures to control prices together with a tight monetary policy and a stronger renminbi will help keep inflation from rising out of control.

Inflation rate reached an 11 year high

Mainland China's inflation rate, as measured by the consumer price index (CPI), reached 7.1% (year-on-year) in January 2008, the highest since September 1996 (Exhibit 1). The latest inflation hike is disturbing given that the Mainland has frozen the prices of daily necessities since 10 January. The snowstorm that hit most parts of the country heavily between mid-January and mid-February was one reason for the surge of inflation in January. Heavy snowstorm disrupted the supply of staple goods such as coal, which is vital for power generation in China. It also damaged power supply networks and resulted in heavy losses of agricultural produce in some regions.

There was also the seasonal factor, the Lunar New Year that fell in early February this year as against late February in 2007. Prices usually rose more in periods prior to and during the Lunar New Year holidays. Disruptive supply and strong demand kept food prices high. In January, food prices rose 18.2% year-on-year following an increase of 16.7% in December, and were responsible for 86% of the increase in the CPI.

…mainly because of surging food prices

Mainland China's consumer prices have been rising steadily since early 2007, but the pace of increase started to accelerate in the second half of 2007 as food prices surged, notably the price of pork. Food prices rose by just 5% year-on-year in January 2007. But they jumped to 11% by June and further to 18% by October, and have stayed at around 17-18% since. With a weighting of 1/3 in the CPI and relatively stable non-food prices, the sustained surge of food prices since 2007 was responsible for over 80% of the increase in CPI in the last 6 months.

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China Economic Monitor (March 7, 2008). Hang Seng Bank Limited. All rights reserved. Reproduction of article(s) in whole or in part is permitted provided the source is quoted. Please direct any inquiry to Treasury, Planning and Research Department, G.P.O. Box 2985, Hong Kong.