China Prices Blamed on Partial Reform

China is struggling with the inflationary effects of its currency policy three years after launching a partial reform. Speculative "hot money" is pouring into the country, while food prices have jumped by over 20 percent so far this year
By Michael Lelyveld
2008-07-25
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BOSTON--Three years after China eased its rigid currency policy under international pressure, the country is still suffering from the inflation effects of an undervalued yuan, experts say.

In July 2005, the People's Bank of China (PBOC) announced a limited exchange rate reform after years of complaints that it was keeping the yuan's value artificially low to make Chinese exports cheaper abroad.

U.S. manufacturers, lawmakers and economists blamed China for undervaluing its currency by up to 40 percent, creating record trade deficits and costing thousands of American jobs.

Since the reform, the PBOC has gradually allowed the yuan to strengthen against the dollar by about 17 percent. The result has been a significant slowdown in the U.S. trade deficit with China. In the first five months of this year, the deficit actually dropped 0.3 percent from year-earlier levels after climbing 17 percent from the comparable period in 2006, according to U.S. Census Bureau reports.

The relative decline in the dollar's value, both against the yuan and other currencies, has helped to restore U.S. exports, analysts told Radio Free Asia. From the beginning of this year through May, U.S. exports were up 18 percent, substantially more than the 12 percent growth in imports, despite higher oil costs, for the same period, Census Bureau figures show.

'A heap of problems'

"U.S. manufacturers are really doing well exporting today," said Patricia Mears, director of international commercial affairs at the Washington-based National Association of Manufacturers. "For many companies that we're talking to, it actually is helping them survive the slowdown domestically."

But China's partial currency reforms have left it with a heap of problems. The worst may be inflation, which has been soaring far above government targets since last November.

While the economy grew by 10.4 percent in the first half of 2008, average consumer prices rose 7.9 percent, compared with the PBOC's "comfort level" of 4.8 percent. The price hikes are far higher for food, which climbed 20.4 percent from a year earlier, according to data from China's National Bureau of Statistics.

Chinese officials are concerned that "hot money" is contributing to the inflationary trends. Economists say that speculative funds have been pouring into China in anticipation of a further appreciation of the yuan from the government's unfinished currency reform.

In the first half of the year, foreign direct investment in China jumped over 45 percent, but regulators fear that much of it is "hot money" in disguise. China Securities Journal reported that $50 billion of speculative currency flowed into China in April alone.

Surging money supply

The surging money supply is seen as a major contributor to inflation, pressuring the government to make faster adjustments to the yuan. But economists say the government is also being pressed by export interests, who complain that the currency's rise has already hurt their business enough.

"There's a general recognition that China will probably appreciate sharply against the dollar before this episode is all out," said Gary Hufbauer, senior fellow at the Peterson Institute for International Economics in Washington. "So, that expectation propels a lot of new hot money to come into China."

"They're really caught on the horns of a dilemma," Hufbauer said. "The Chinese authorities are getting beaten up by the export interests who say 'Don't change the currency value. Don't appreciate, don't appreciate. We can hardly make it as things are now.' But on the other hand, inflation is high and the hot money is coming in."

The squeeze on the government is partly the result of its go-slow approach and of controls, which have not kept pace with international currency markets. Although the yuan has risen by double digits against the dollar in the past two years, both Mears and Hufbauer cited an even greater adjustment of the dollar against the European currency.

According to historical data from the U.S. Federal Reserve System, the dollar has depreciated by over 23 percent against the euro since China started its currency reform.

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