Beijing’s light touch policies under strain

By Geoff Dyer in Beijing

Published: March 11 2010 17:40 | Last updated: March 11 2010 17:40

For the past two months, the Chinese government has been trying to finesse an economy that has rebounded quicker and more strongly than anywhere else in the world.

Amid fears about bubbles and overheating, the Chinese authorities have opted for a subtle approach, lifting the reserves that banks have to deposit a couple of times and privately pressing them not to lend too much.

Wen Jiabao, premier, outlined this light-touch strategy in his speech last week to the National People’s Congress when he said the government would maintain expansionary fiscal and monetary policies but restrict new infrastructure projects – setting a path for a gradual slowing of investment over the next year to 18 months.

Yet a slew of data this week could increase the pressure on the government to consider more decisive steps, including raising interest rates or letting the currency appreciate.

There is a “rising risk of economic overheating”, said Qu Hongbin, economist at HSBC. The new figures are anything but conclusive – data in China during January and February are always difficult to interpret because of the lunar new year holiday; also these two months last year were the bottom of China’s post-crisis slowdown, so results for this year could be flattered by a low base of comparison.

The figures released this week have added to concerns that the economy is expanding too quickly. Consumer and factory-gate inflation, which have been on an upward trend since November, both rose again sharply, with the consumer price index at 2.7 per cent already getting close to the 3 per cent target set by Mr Wen last week. The inflation rate for January and February combined was 2.1 per cent, only slightly up on December’s 1.9 per cent.

However, Peng Wensheng at Barclays Capital pointed out that non-food prices are picking up, which could reflect underlying demand pressures, while last year’s large expansion in the money supply could start to feed into inflation this year. “It is important to control inflation expectations by raising rates in a timely fashion,” he said, predicting the first rise in the second quarter of the year.

Industrial output increased by 20.7 per cent in January and February year-on-year, which partly reflects comparisons with a slow period last year but was also the highest level since the data series began in 1995.

At the same time, exports increased more than expected after taking into account the weak figures in 2009. According to Goldman Sachs, exports rose 61.8 per cent in February on a month-on-month, seasonally adjusted basis.

The combination of “renewed monetary loosening since the start of the year” and stronger external demand mean that “we are likely to see higher inflationary pressures” if the government does not take more decisive measures, said Helen Qiao and Yu Song at Goldman Sachs in a note.

Yet some of the other data released by the government tells a more mixed picture. Fixed asset investment in January-February increased 26.6 per cent, a big rise on December but down from the 30 per cent rate seen during the peak of last year’s infrastructure boom. Many economists believe increases in FAI of around 25 per cent in the coming months will be manageable.

The figures released for sales of houses in recent weeks by the government and by private researchers suggest that the market is slowing down. Indeed, some economists said the headline increases in inflation and production were unlikely to prompt a change in the government’s approach.

“With senior figures lining up over the last week to express their caution about the outlook and the need for policy continuity, the chances of any imminent move on the exchange rate or interest rates have diminished,” said Mark Williams at Capital Economics.