beyondbrics

By Victor Shih of Northwestern University

Policymakers in Beijing were likely congratulating themselves when the latest inflation numbers came out at over 50bps below those in September.

Even better, the autumn harvest is reported to be at a historically high level, forcing some speculators to unload their stocks. Thus, early November food prices are falling across the board.

The sell side community is already priming for macroeconomic loosening in the form of reserve requirement ratio reduction or even a drop in interest rates.

To be sure, some liquidity would alleviate pressure in many quarters.

The entire Rmb1,000bn railroad construction industry faced mass bankruptcy until the central government ordered banks to lend Rmb200bn to bail-out the Ministry of Railroad and its contractors.

Wen Jiabao had to fly to Wenzhou to order banks to keep lending to small and medium enterprises. Some are hoping that the government will do the same for infrastructure and real estate through more general easing.

Yet, policymakers should think twice before easing too much. Inflation remains high, and food inflation for the year remains at over 12 per cent, which especially high pressure on low income households.

Aggressive general easing, such as a rapid lowering of RRR, would once again build up inflationary expectation in China and international expectation for high commodities prices. China could be back in a high inflation situation in a year’s time. Moreover, any aggressive easing now would render macroeconomic tightening incredible in the future.

Even in the current cycle, firms bet heavily that the central bank would ease in the second half by borrowing as much as Rmb10,000bn from the shadow banking sector, according to Fitch. As a result, until recent weeks, there really was not much of a slowdown in China for much of this year. Investment still rose by nearly 25 per cent in the first 10 months.

If the PBOC were to ease less than one year before the beginning of tightening, when inflation spikes the next time, firms, especially connected SOEs, will continue to leverage and invest without pause, thus rendering PBOC tightening powerless.

Sure, some firms are hurting, but without the hurt, central bank tightening would not be credible.

Victor Shih is associate professor of political science at Northwestern University. You can follow him on Twitter at @vshih2

More from Victor Shih on beyondbrics:
Guest post: China’s disappearing Rmb1,100bn bank deposits
Guest post: Corruption may undo China’s economic miracle
Guest post: China’s local debt problem is bigger than it looks
Guest post: China’s non-bank credit bubble