China inflation: 2-edged sword

Seoul bracing for Beijing's slower growth amid steep inflation

By Jung Sung-ki

South Korea and China are in the same boat of slowing economic growth and high inflation, as the two economies are considered being in the same group of the looming “four-speed” world, one divided not just between countries with fast and slow growth, but also those with high and low inflation.

Even with apparent supply-chain disruptions in Japan after the deadly earthquake in March, on the bright side, trade between the two countries is expected to expand further in the short-term with an increase in China’s imports of Korean-made materials and equipment.

On the other hand, economists warn, both nations are facing the growing risks of soaring consumer prices and a housing market bubble, which could mutually affect each other and lead to an economic downturn.

Inflationary pressure is a key threat to both governments. Some experts believe rising food and commodity prices in China will spread to Korea fast and the contraction of the world’s second biggest economy could hurt Korea’s exports for years to come.

“The Korean economy is actually influenced more by the export growth in China than domestic growth in the Asian giant,” Park Young-joon, chief researcher at the Korea Institute for International Economic Policy (KIEP), told Business Focus on May 12. “Chinese exports in the first quarter of the year were good, giving a good signal to the Korean economy. But as Beijing may appreciate its currency later this year to hold inflation n check, its exports could contract, affecting the Korean economy.”

Korea is heavily dependent on trade with China, which is the largest trading partner of the country. The former’s exports to the latter accounted for 25.1 percent of its total overseas shipments in 2010 with an estimated value of more than $200 billion, according to the Korea International Trade Association.

The figure is even larger than all of the country's exports to the United States and the European Union combined with 22.2 percent that year. On the other hand, nearly 17 percent of South Korean imports come from China. Korea posted a $45.3 billion trade surplus with China last year.

China’s trade surplus grew to $11.4 billion in April after the country recorded a rare trade deficit the first three months of the year.

Runaway inflation

Despite the increase in the trade numbers, policymakers in Beijing are seeking measures to control high inflation and cool down its overheated economy. Such measures will have an impact on other economies, particularly South Korea, says Mauro F. Guillen, director of the Lauder Institute at the Wharton School.

“For South Korea, the most important aspect is that China’s growth continues to be high. I would also point out that it is important that the Chinese domestic consumption market continues to develop,” Guillen noted. “China will continue to have a problem with inflation. Unless addressed, this could slow down economic growth.”

China reported inflation hit 5.3 percent in April, with food prices galloping at 11.5 percent, the sixth straight month in which food prices have risen at double-digit rates.

The inflation figures were slightly lower than in March with 5.4 percent, the highest rate in 32 months, but they still represented a significant risk that the Chinese authorities haven’t put a lid on inflationary pressure. Thus the Chinese government is unlikely to halt its tightening campaign aimed at tamping down price increases.

Hoping to lock up cash and tame inflation, Beijing raised its banks’ reserve requirement ratio by half a percentage point last Thursday, the third increase this year.

“Even ten years ago, China’s inflation was nothing to do with our economy, but the situation has changed remarkably,” Park from KIEP said. “High inflation endangers China’s long-time status as the low-cost workshop for the world, and we cannot ignore the ‘Chinaflation’ effect anymore.”

China’s export prices have skyrocketed thanks to the rise of raw material prices worldwide and higher labor costs, he said, adding higher wages subsequently pushed up the costs of production, leading to higher consumer prices.

As wages and production costs rise, coastal factories are demanding higher prices for the goods they ship overseas. That means Chinese goods buyers have to pay more for those goods or seek lower-cost suppliers elsewhere.

Citing a KIEP survey released in March, Park said Korea’s inflation has been trailing the Chinese trend for seven months. In addition, a one-percent increase in China’s inflation would push up the Korean consumer price index by 0.12 to 0.15 percent, according to the researcher.

“China’s inflation is fueled both by the supply and demand aspects, such as higher wages and rapid economic recovery, so inflationary pressure is likely to remain for a long period,” Park said.

Since 2000, a one-percent increase in China’s consumer price index has made Korea feel a 10-percent equivalent rise of Dubai crude oil, he said.

Fearing the bubble

Rising home costs in China are also referred to as a risk factor, but many analysts say there is little chance of bubble-bursting because the Chinese government’s campaign to tighten interest rates and reserve requirements will help ease the problem.

“I believe chances for the Chinese property market to burst remains very slim,” Eom Jung-myung, a researcher at the Samsung Economic Research Institute, said. “A property bubble-bursting is normally tied to bad loans. Given the relatively stable financial system in the communist state, however, there is little chance for bad loans and a sharp decline in the property market.”

Housing prices in China have been on a steady rise even though Beijing promised to curb the property market and to spend billions of dollars over the next few years on affordable housing.

The average apartment in central Shanghai is said to cost more than $500,000, and even in second-tier cities like Cheongdu, in central China, the price of a typical home costs about 25 times the average annual income of residents.

The rise of home prices was attributable to the country’s growth being tied to inflationary spending on real estate development and government investment in roads, railways and other multibillion-dollar infrastructure projects, according to analysts.

Experts anticipate a stronger Chinese currency will help keep inflation under control.

“China will eventually have a currency that appreciates relative to most others, given that they have such a large trade surplus,” Guillen said. “This will be good for Chinese consumers, though it may put pressure on exporters to innovate. Even that is good in the long run.”

He added it is important for China to start thinking about a plan to make the currency convertible, with some specific timeline.

The Chinese currency, known as the yuan or renmenbi, was de-pegged from the U.S. dollar last June and has risen against the greenback by more than 5 percent since then. The currency traded at 6.5013 per dollar in Shanghai Friday.

Despite a tight-money policy, China’s GDP growth is expected to continue to remain high at around an annualized rate of 9 percent over the rest of the year, according to analysts.

The Chinese economy grew at an annualized rate of 9.7 percent over the first quarter of 2011, compared to 9.8 percent during the same period in 2010.

Morgan Stanley economist Sharon Lam said, “Tightening measures are likely to be frontloaded in first half only, and growth will pick up again in terms of both consumption and investment in second half.”

Goldman Sach’s Jim O’Neil told Reuters Friday that China’s economic growth could slow to 8 percent because economic data and a drop in commodity prices point to Beijing ending its monetary tightening policy sometime this year.

“It is my judgment that the Chinese economy is probably slowing down more than people realize,” he was quoted as saying.