Zhang Jun,

SHANGHAI — When high levels of capital spending fueled a sustained rise in Chinese inflation from 1991 to 2011, authorities quickly brought the situation under control, and over the past decade the CPI rarely exceeded 2% , compared to 5.4% in 2011.

With policymakers in most major economies now losing their grip on price stability, can China continue to contain inflation this year and next?

To answer this question, it is worth looking at how China has managed to rein in inflation over the past decade.

Notably, the government refrained from further rounds of broad fiscal and monetary stimulus, and thanks to increased central bank autonomy, money creation and credit growth ceased to respond passively to investment projects. from below.

After 2015, China’s central bank adopted a cautious tone and adjusted credit allocation to support sectors with excessive debt ratios.

Highly polluting industries and the real estate sector – both of which had driven rapid GDP growth in the past – faced financial repression.

At the same time, the central government has tolerated minimum growth rates that could allow for steady employment growth.

Today, that tolerance is being tested. The pandemic shutdowns, especially in Shenzhen and Shanghai, have weighed heavily on the Chinese economy. In the second quarter of 2022, Shanghai’s GDP fell by almost 14%.

Meanwhile, the real estate sector – traditionally a major contributor to aggregate demand – is becoming a drag on the economy.

In 2020, the Chinese government introduced “three red lines” to limit the industry’s access to credit: developers’ liabilities must not exceed 70% of assets, their net debt must not exceed equity and their liquidity must be equal to short-term borrowings. .

The new debt measures, as well as the COVID-19 pandemic, have put intense pressure on the sector. Once-thriving developers are now facing severe debt crises.

With some residential projects delayed or halted, homebuyers in several cities have had to stop making monthly mortgage payments since the second half of last year.

The good news is that China has effectively brought inflation under control. In the first half of the year, the CPI rose by 1.7% and the government’s inflation forecast for 2022 is around 3%.

The bad news is that while the Chinese economy has been spared the overheating, it has clearly come at the cost of a sustained slowdown in GDP growth, and even recession in some regions.

Under these conditions, the official forecasts of 5.5% economic growth this year will not be achieved. In the second quarter of this year, Chinese growth was barely positive.

Although GDP still grew by 2.5% year-on-year in the first half of 2022, thanks to relatively strong exports, real GDP growth should reach at least 8% in the second half to reach the target of 5.5 % for 2022, which of course is unlikely.

Therefore, the central government is most likely to revise down the lower bound of its growth forecast for July-December to 6%, rather than 8%, implying an annual growth rate of 4 to 4.5 % for the whole year.

In view of this, the Chinese government plans to launch a new round of stimulus measures for the rest of the year.

With unemployment rising – the rate for 16-24 year olds reached 19.3% in June, up four percentage points year on year – stimulus measures are urgently needed. But Premier Li Keqiang was very wise in emphasizing the importance of not overdoing it.

In the past, stimulus measures have taken the form of excessive investments in infrastructure. But China now has limited room for manoeuvre.

One of the main constraints is the huge over-indebtedness resulting from the massive round of stimulus measures of 2009-2011, which poses a serious risk to the financial system.

Most of the cash that could be used to invest in additional infrastructure projects will still need to be funded through local financing vehicles and local government bonds.

As authorities recently asked China’s political and development banks to add a total of 1.1 trillion Chinese yen ($163 billion) in new credit lines to support infrastructure projects, new fiscal spending – and new debt – may still be needed.

Another constraint to recovery is the threat of imported inflation. The effects of the pandemic, combined with the fallout from the war in Ukraine, are driving up inflation expectations in most Western countries, which are already experiencing rapid increases in consumer prices: the CPI in the United States and in the UK exceeded 9% in June, while the CPI in the euro zone exceeded 8%.

Similarly, in Asia, South Korea’s CPI rose 6% year-on-year in June, the biggest such rise since November 1998.

Japan’s CPI rise – 2.4% – exceeded the central bank’s target for a third consecutive month.

As a major energy and food importer, China will find it difficult to insulate itself from the global trend. Two factors explain why the CPI in China has not yet jumped.

First, China’s energy and food importers are all giant, state-owned and state-controlled corporations whose pricing decisions are tightly regulated.

As long as inflation expectations are not formed, the increase in import costs is not passed on to consumers.

This is reflected in China’s producer price index, which has been less stable than the CPI over the years.

Second, although China imports many essential goods, those included in the CPI are largely supplied domestically.

And, as with importers, the prices charged by state-owned producers in the upper reaches of the Chinese economy do not fully reflect their changing costs, due to government controls.

Consider pork – the largest item affecting the CPI in China, accounting for 2.5% of the index.

Counter-cyclical regulation of pig farming and government subsidies to pork producers have largely contributed to keeping pork prices – and, therefore, the CPI – relatively stable.

But, while such regulation can help cushion external supply shocks, reducing revenues or increasing subsidies will increase the government’s fiscal burden, especially in a context of global inflation.

Add to that already strained local finances and the huge costs of maintaining a zero COVID policy, and the government’s ability to expand and finance public capital spending will be severely limited.

In this context, it is understandable that the Chinese government has chosen to adopt a modest stimulus package.

Too strong a stimulus, experience has shown, would almost inevitably lead to excessive monetary expansion, leading to a surge in inflation that would create new challenges for the Chinese economy in years to come.

Zhang Jun, dean of the faculty of economics at Fudan University, is director of the China Center for Economic Studies, a Shanghai-based think tank.

Copyright: Project Syndicate, 2022.