China sets ambitiously low inflation target

The Chinese government has set a target for consumer price increases in 2010 that is aggressive, given that this is only the second year of recovery, credit is still flowing from relatively loose monetary policy, and companies are still sitting on unused loans received last year.

When delivering his annual address to the National People's Congress (NPC) in Beijing -- a 10-day meeting that is the focal point of the country's political and economic calendar -- Premier Wen Jiabao said that China will target 8% economic growth and aim to restrict consumer inflation to no more than 3% this year.

The inflation target was the "key surprise", economists at Citi said after Wen's two-hour speech on Friday.

"Our current expectations are that the CPI (consumer price index) could reach 5% at the turn of the year before settling into a 4% to 5% range next year," they said. The CPI will exceed 3% in the second quarter even though the People's Bank of China (PBoC) has indicated it will adjust monetary policy to achieve the 3% target, Citi said in a report.

China's CPI is likely to grow by 4.9% in 2010 thanks to a general increase in prices, said BNP Paribas' Beijing-based economist Chen Xingdong.

Consumer prices in China have been increasing over the past six months, and we expect the CPI to move up in February and in the coming months to perhaps as high as 4% or 5%, said RBC Capital.

Some economists suggest China's central bank would have to raise interest rates as early as this month in order to meet the low inflation target, but that scenario is made impossible by Beijing's affirmation of a moderately easy monetary policy.

From "difficult" to "complicated"

At this time last year, Wen described 2009 as the most "difficult" year the country had faced in a decade; this year, he said the conditions are "very complicated".

The premier sounded a cautionary note, warning that the nation still confronts structural economic and social problems, that the global financial crisis is still having lingering effects, and that the Chinese economy still faces much uncertainty.

The latent risks include the banking and public finance sectors, where a major concern is that corporates which borrowed a lot of money last year may not be able to meet their repayment obligations.

The PBoC has the challenging task of bringing down the loan growth rate from over 29% in January to around 17% over the course of the whole year. Despite the official statement of keeping a relatively loose monetary policy, the authorities will need to continue introducing liquidity tightening measures, according to HSBC.

The government's investment spending must be focused upon ongoing projects and funding for new projects will need to be strictly controlled, Wen said.

However, the dilemma for the authorities is that even if they start to scale back lending because of inflation worries, the corporate sector will still be able to invest heavily because they are sitting on huge volumes of unused loans received last year. Economists estimate that there is currently about Rmb1.2 trillion ($175 billion) worth of unused loans in the corporate sector. They calculate this by comparing the figures the central bank releases for long-term corporate loans and the figures from the National Bureau of Statistics pertaining to loans for fixed-asset investment in the current year. The bigger the gap between the two, the more unused loans corporates have.

On top of the unused credit, China will exceed its loan target of Rmb7.5 trillion, with total lending reaching as much as Rmb10 trillion, experts forecast.

China's GDP grew 10.7% in the fourth quarter of 2009, the fastest pace since 2007. The premier affirmed a target of 8% economic growth for 2010, the same goal that the government has set and surpassed in each of the past five years.

That would mean a reduction in the number of new investment projects and strong GDP growth combined with strong money supply and a low inflation rate, which is a "complicated" set of conditions indeed.

Photo provided by AFP.