China fears imported inflationary pressures as raw material prices climb

China’s latest Producer Price Index (PPI) for May increased by a whopping 9 percent from a year ago, a record high in nearly 13 years, representing the escalation of international raw material prices that has put tremendous cost pressures on China’s manufacturing sector. If this wave of factory cost pressure is further passed on to the selling price of commodities, it could lead to an inflationary crisis in China and endanger the Chinese Communist Party’s regime.

Therefore, the Chinese government is actively taking strong measures, including cracking down on price inflation, providing corporate subsidies, and even planning to release state reserves of metals, to curb the inflationary pressure on factories that are running at high levels.

However, some international investment banks believe that the probability of China declaring war on international raw material prices is low, and the measures may be futile, while some experts interviewed by the Voice of America believe that the central bank may let go of the yuan will further appreciate to ease the pressure of import costs on enterprises, but should not tighten monetary policy so much as to avoid damaging the force of economic recovery.

According to the latest data from China’s National Bureau of Statistics, China’s producer price index (PPI) expanded to an annual rate of 9% in May due to the impact of a 20% to 90% increase in international raw material prices for iron ore, coal, crude oil and non-ferrous metals, which was not only higher than the market estimate of 8.5%, but also the largest annual increase in the past 13 years since September 2008.

The PPI is an important indicator of inflation on the factory side, i.e., in the goods manufacturing sector.

Last May, China’s PPI index was affected by the epidemic and decreased by 3.7% annually, but then rebounded from its low point and continued to climb all the way up. Since the beginning of this year, the rising prices of imported raw materials have been on the minds of officials and companies, reflecting cost pressures on manufacturers. Now, with the PPI index jumping month by month, representing the cost pressure of enterprises also soared again and again, but due to government policies and market competition pressure, many manufacturers still do not dare to reflect the cost, raise the selling price of goods, only in the profits continue to be eroded under the hard to hold up.

Thin margins, struggling to hold up to change

Located in Shanghai, surnamed Zheng semiconductor equipment traders through WeChat to the Voice of America said: “the United States and China trade war (since 2018) after the start, coupled with this year (2021) to the big rise in raw materials, many semiconductor equipment parts have been quite difficult to buy. Last year (2020) to expand the impact of the epidemic, the supply chain tightening situation is more obvious. Chemicals and other prices rose significantly, to pre-empt the order difficulty is also high, and the local large semiconductor industry and the government audit business qualifications more rigorous, business is increasingly difficult.”

Shanghai-based Zhong surnamed e-commerce business also cried out that the economy is bad, business is difficult. He said to the Voice of America through WeChat: “The price of all kinds of goods is basically gradually becoming higher, the official data is not much feeling, we are simply afraid to raise prices, e-commerce competition is too fierce.”

CNBC previously quoted CKGSB finance professor Gan Jie pointed out that her team had surveyed more than 2,000 Chinese industrial manufacturers in early June, and found that the industry’s view of the economy was more pessimistic than in previous months, mainly because of the sharp rise in costs, and the expected increase may continue until the end of the year. Professor Gan said, “Because of the compression of corporate gross profit, several companies even refused to take orders because the more they produce, the bigger the loss, and the net profit has turned negative.”

Although the current raw material prices and production prices remain high, manufacturers have not yet passed on the costs to consumers, which allows the prices of China’s livelihood goods to remain at a reasonable level. The latest data released by the National Bureau of Statistics shows that China’s consumer price index (CPI) only increased by 1.3% annually in May, which is lower than market expectations.

CPI is the most important indicator of a country’s inflationary situation. Although China’s annual CPI increase in May was slightly higher than the 0.9 percent annual increase in April, it still fell within the central bank’s target of about 3 percent increase.

CPI watered down?

However, China’s official price index has always been questioned with water, with the actual feelings of private consumers often have a small gap.

Liu, a housewife living in Zhangzhou, Fujian province, told the Voice of America via WeChat that she has long been under pressure from rising prices as she shops for groceries every day. She said, “(2018’s) African swine fever drove up the price of pork (last year), and a lot of things have followed the price increase. Although there has been a slight drop recently, it’s still not cheap compared to the previous price. In the past, pork ribs were about RMB 25 or 26 per catty, but now they are usually RMB 30 or 40 per catty, and the prices in boutique supermarkets are even more expensive, about RMB 70 or 80, or even more. The price of vegetables and fruits has also increased, bread, cakes, drinks are much more expensive than before, before a piece of small cake is about 20 to 30 yuan, but now it is basically 30 to 40 yuan between, chain beverage store drinks are basically a cup of more than 20 yuan, there are 30 or 40 yuan, small stores may be cheaper.”

China’s current prices are still stable, but the future will not be subject to the negative impact of the PPI continues to climb, further response to the cost pressures in the manufacturing sector and triggered by runaway inflationary crisis in prices of people’s livelihood?

In this regard, Wang Hao, who has worked in investment banks in London and Hong Kong for many years, said in an interview with the Voice of America that the relatively low CPI increase in May was due to government price interventions in addition to the stabilization of pork prices.

He said: “The Chinese government has taken many administrative measures to keep downstream producers from raising prices, so the upstream PPI increase is not fully reflected in the downstream CPI, as companies absorb costs on their own. In this case, the downstream consumption of the people in the short term is relatively unaffected, but the long-term is no way, because enterprises basically do not make money, because the price of raw materials rose a lot, this way after the production, but can not increase the price to sell, the end result of enterprises do not make money.”

Authorities worried about PPI pressure to CPI transmission

However, for the PPI may bring the pressure of imported inflation, Chinese officials have long been actively warning and launched various measures to curb inflation, because they know very well that China’s current consumption and economic recovery is still slow, can not make consumer prices more obvious upward, so as not to hurt the willingness of consumption and economic recovery force.

Chinese Premier Li Keqiang asked officials as early as mid-May to “resolutely crack down on monopolies and hoarding in accordance with the law and strengthen market supervision. Guo Shu, chairman of the China Banking Regulatory Commission, recently warned at the Lujiazui Financial Forum in Shanghai that “countries have developed super stimulus packages to deal with the new pneumonia epidemic, and that inflation is on schedule and expected to be high, and may not last as long as many experts predict.”

In terms of actual measures to curb inflation, China’s State Council announced in May subsidies for small businesses to ease the cost pressure on their imports of commodities. New restrictions were also offered on commodity futures trading to curb speculation.

China’s State Bureau of Material Reserves announced last Thursday (June 16) that it would put up national reserves of copper, aluminum and zinc in batches in the near future to do a better job of keeping the supply of commodities at stable prices. The media, including China Securities Journal, quoted market participants as predicting that China’s National Materials Reserve Bureau is expected to release 800,000 to 900,000 tons of primary aluminum in July to slow down the rise of the metal, while the next few months will also release some of the copper, aluminum and zinc stocks to the end of this year, which will be the first time in more than 10 years China released the national metal reserves.

As for China’s Development and Reform Commission, it will start compiling price indices for important goods and services from August based on market supply and demand, to further monitor prices and to sternly show off non-compliant price hikes or price-boosting practices.

According to Bloomberg tracking, the Chinese authorities to take measures to curb inflation, local iron ore, corn, copper and other raw materials futures prices from the peak in mid-May to the end of May did appear about 20% drop, but its ability to control apparently can not be extended to international raw materials commodity prices, Bloomberg raw materials commodity spot index fell only about 1% in the same period.

Control measures are afraid of futility

As a result, Goldman Sachs, a leading U.S. investment firm, believes that the Chinese authorities’ measures to control rising commodity prices will be futile because of the limited supply of existing raw materials, coupled with the fact that the United States and other developed countries have gradually emerged from the gloom of the epidemic and accelerated economic recovery, leading to a strong rebound in demand for raw materials. Although China is a major importer of manufacturing and raw materials, it is no longer the only buyer that can dominate market pricing under these market conditions.

In the face of the threat of a new epidemic, most countries around the world have adopted monetary easing policies to stimulate the boom, but this has also had the side effect of rising inflation. To further combat the economic threat posed by inflation, central banks in Russia, Brazil and Turkey have long taken measures to raise interest rates to curb economic overheating or price spikes.

The market now expects that the U.S. Federal Reserve may also start raising interest rates by the end of 2022 and is expected to raise rates up to twice in 2023.

In order to curb prices, will the People’s Bank of China probably join the ranks of interest rate hikes?

I don’t think China’s central bank will tighten monetary policy significantly anytime soon, as that would further increase cost pressures on businesses and slow demand in the market,” said Sai-Lan Xu, a visiting scholar at the Center for Financial Technology Studies at Fudan University’s Panhellenic Institute of International Studies in Shanghai, via email to Voice of America. The Chinese authorities are very focused on raising demand this year. I believe that PPI inflation will slow down next year as supply chain and production bottlenecks are broken and the global economy will further normalize.”

High chance of long-term depreciation of the yuan

Wang Hao agrees that China’s macro monetary policy is inherently much tighter than that of Europe and the US, so the pace of interest rate hikes is not too fast. However, he believes China’s central bank may let the yuan appreciate further to moderate import prices.

He said, “the yuan rose nearly 10% in the past 1 year, the overall export surplus is still expanding, according to the first 4 or 5 months of this year, China’s import and export surplus, it is possible that this year’s annual surplus reached 700 billion U.S. dollars, a record high record, such a high surplus on the appreciation of the yuan has further pressure.”

However, monetary policy is a two-sided blade, the appreciation of the yuan is too fast is not conducive to China’s export-oriented economy, especially the dollar has begun to appear stronger momentum, analysts believe that the chances of long-term depreciation of the yuan is relatively high.

The RMB has limited room for further appreciation,” said Huang Liyang, senior economist for Asia Pacific at French credit insurer Yuliyongyi, to Voice of America. The U.S. dollar has already appreciated after the U.S. Federal Reserve’s tightening message. If there are other tightening actions or hints in the next few months, the chances that the yuan will depreciate against the dollar in the future are rather high.”

Xu Sai Lan also believes that the yuan may depreciate in the future. She said, “Now there are several forces that will press the yuan downward, including the U.S. economic recovery, the U.S. Federal Reserve will begin to tighten funds, and this will lead to the depreciation of the yuan against the dollar or other currencies.”