China’s in­fla­tion flir­ta­tion won’t cut debt

The Star Malaysia - StarBiz - - Viewpoint - By CHRISTO­PHER BALD­ING

CHINA is wit­ness­ing some­thing most of the world’s ma­jor economies haven’t seen in quite some time: ris­ing prices.

With growth strong but debt at 300% of gross do­mes­tic prod­uct, that’s a wel­come sign. The dan­ger is that China’s gov­ern­ment now hopes in­fla­tion will solve its other prob­lems.

From 2013 un­til this year, the GDP de­fla­tor, a broad mea­sure of prices, never rose by more than 2.3%. Most of the time, it hov­ered just above zero. This pushed up the real cost of China’s debt and raised the specter of Ja­panstyle debt de­fla­tion. In the first quar­ter of 2017, how­ever, the mea­sure shot up by 4.6%. It’s set to fin­ish the year above 4% for the first time since 2011, when China was ex­it­ing its postcri­sis lend­ing binge.

So what hap­pened

We know that this price in­crease wasn’t driven by con­sumers. Con­sumer price in­fla­tion re­mains below 2%, and the fac­tory prices of con­sumer goods have risen by just 0.7% so far this year. Dur­ing China’s re­cent Golden Week hol­i­day, per-capita spend­ing was up only 2% over the same pe­riod last year.

In­stead, prices are be­ing pushed up en­tirely by ba­sic in­dus­trial and con­struc­tion in­puts. In­dus­trial pro­ducer in­fla­tion has ac­cel­er­ated by 6.9% this year, while coal prices are up 33% and met­al­lurgy prices up 23%. The cost of other ba­sic in­puts, such as petroleum and chem­i­cals, is also ris­ing fast. All this is more or less by de­sign: China’s gov­ern­ment has kept credit loose, en­cour­aged cap­i­tal to flow into fi­nan­cial prod­ucts that trade com­modi­ties, and forced some fac­to­ries to shut down tem­po­rar­ily to re­duce ca­pac­ity.

The re­sult­ing price in­creases have af­fected a broad range of eco­nomic met­rics and in some cases dis­torted them.

Non-per­form­ing loans peaked in 2016, for in­stance, shortly after com­mod­ity prices started ris­ing. Be­cause min­ing and man­u­fac­tur­ing com­pa­nies in­clud­ing steel firms have some of the high­est rates of bad loans, any change to their prof­itabil­ity has an out­sized im­pact on the big­ger pic­ture.

While prof­its at China’s Ashare com­pa­nies were up 20% in the first half of 2017 over the same pe­riod last year, coal com­pany prof­its rose by 319% and steel firm prof­its surged by 508%.

In­fla­tion has also al­tered China’s broader debt out­look. By some mea­sures, debt lev­els rel­a­tive to nom­i­nal GDP may have even started fall­ing. How­ever, this is al­most en­tirely due to rapidly ris­ing com­mod­ity prices push­ing up nom­i­nal GDP. If the GDP de­fla­tor had risen by 2% in­stead of 4.2% through the first three quar­ters, the ra­tio of to­tal so­cial fi­nanc­ing to GDP would’ve risen by another 4%. This doesn’t change the of­fi­cial data. But it does il­lus­trate how one small change can rip­ple through a range of closely fol­lowed vari­ables.

It’s also im­por­tant to recog­nise how nar- row this shift is. The econ­omy as a whole isn’t delever­ag­ing: New to­tal so­cial fi­nanc­ing is up 16% this year, and house­hold bor­row­ing has risen by 23%. That ba­sic com­modi­ties can none­the­less have such an im­pact re­veals just how much China still de­pends on them for growth, whereas these price in­creases have barely reg­is­tered in other ma­jor economies.

China’s gov­ern­ment may hope that in­fla­tion is the path of least re­sis­tance in re­duc­ing debt lev­els. And un­der some con­di­tions, that might be true. But this ap­proach comes with sig­nif­i­cant risks. Al­though in­flat­ing away debt may work for cer­tain in­dus­tries in a con­trolled econ­omy, it is dan­ger­ous for a coun­try run­ning a fixed ex­chang­er­ate regime where as­set prices such as hous­ing and stocks are al­ready el­e­vated. Ris­ing prices will even­tu­ally place se­ri­ous pres­sure on the ex­change rate, and a sig­nif­i­cant ac­cel­er­a­tion in con­sumer in­fla­tion could lead to so­cial in­sta­bil­ity.

More to the point, com­mod­ity prices can’t keep ris­ing by 50% or 100% a year for­ever. An­a­lysts are al­ready pre­dict­ing a de­cline in the Pro­ducer Price In­dex, as the “base ef­fect” that some­times dis­torts in­fla­tion fig­ures starts to kick in. Mean­while, for all the talk of delever­ag­ing, debt is grow­ing faster across a range of mea­sures com­pared to last year, mean­ing that sub­stan­tially faster in­fla­tion would be needed to re­ally make a dent.

Ul­ti­mately, try­ing to in­flate away debt sec­tor by sec­tor is a los­ing bat­tle. Re­bal­anc­ing China’s econ­omy in a sus­tain­able way will re­quire sub­stan­tially re­duc­ing credit and tol­er­at­ing more cor­po­rate bank­rupt­cies, slower growth and higher un­em­ploy­ment. There’s no easy way out.

In­fla­tion surge: Cus­tomers select­ing veg­eta­bles at a su­per­mar­ket in Hangzhou, east China’s Zhe­jiang prov­ince. China’s fac­tory price in­fla­tion rose again in Septem­ber, of­fi­cial data showed on Oct 16, in­di­cat­ing the im­prov­ing do­mes­tic de­mand. — AFP

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