China's government may be running out of options as it struggles to keep inflation in check.
Since April 6, the People's Bank of China (PBOC) has raised interest rates for the second time and ordered banks to boost reserve ratios for the fourth time this year.
So far, consumer price inflation (CPI) has refused to respond, hitting a 32-month high of 5.4 percent in March, while first-quarter GDP growth of 9.7 percent showed few signs of slowing down.
On April 16, PBOC Governor Zhou Xiaochuan voiced reluctance to keep raising interest rates out of concern that more hikes might only attract more speculative inflows of "hot money," Reuters reported.
The government may now have to examine alternatives it has previously resisted, said Harvard University economist Dwight Perkins.
"Obviously, one of them is to appreciate the (yuan) renminbi exchange rate vis-a-vis the U.S. dollar," said Perkins. A stronger yuan would drive down the cost of China's imports and slow the hot money that has sought to profit on exchange rates when appreciation comes.
On April 15, Zhou said the PBOC would be "more flexible" on letting the yuan's value rise, but only with a gradual "step-by-step" approach, the official Xinhua news agency reported.
China has faced frequent criticism for undervaluing its currency to give its exports a price advantage abroad.
The yuan has risen by 27 percent against the dollar since a 2005 reform, according to Bloomberg News, but some U.S. business groups and economists have argued that the yuan remains up to 40 percent too low.
China fears faster revaluation will cost it exports and jobs, but none of its choices will be easy, Perkins said.
Cooling the economy
The other anti-inflation alternative is to get serious about cooling the economy.
In March, Premier Wen Jiabao set a 7-percent annual target for GDP growth under the 12th Five-Year Plan through 2015 with a slightly more bullish goal of 8 percent for 2011.
But the 9.7-percent rate in the first quarter suggests China is still being propelled by the stimulus-driven policies that pushed GDP growth to 10.3 percent last year. Rapid expansion and rising inflation have gone hand in hand.
"They may be getting to a point where they need to slow the growth rate," said Perkins. "I think the growth rate is now really too high and unsustainable."
Perkins noted that spending on public works like high-speed rail projects is still stirring inflationary pressures, although the government has tried to slow sectors like the runaway real estate market down.
The official CPI target for this year is 4 percent, but inflation in March jumped well over the limit, thanks in part to an 11.7-percent surge in food costs.
Premier Wen has promised the public that price stability will be the "top priority" of the government's economic policy.
Pressures on pricing
Carmen Reinhart, senior fellow at the Peterson Institute for International Economics in Washington, said that both domestic and external pressures in China have been driving prices higher.
On the domestic side, big wage gains last year and the remaining effects of China's 4-trillion-yuan (U.S. $612-billion) stimulus program have pumped liquidity into the economy. On the external side, capital inflows have done much the same thing, as banks convert foreign currency into yuan.
Reinhart said Zhou's concern about further interest rate hikes is understandable.
"They are facing a tug of war between trying to keep the inflationary pressures at bay and not really choking off the economy," she said.
But China's actions so far have not eased the pressure of huge capital inflows.
The State Administration of Foreign Exchange (SAFE) estimates that annual inflows of hot money rose 7.6 percent last year to $35.5 billion, the official English-language China Daily reported.
But that figure may be conservative, since such speculation is technically illegal in China. In the first quarter of this year alone, hot money inflows may have reached $130 billion, the Wall Street Journal said.
Exchange rate pressures are also helping to push PBOC reserves of foreign currency to new highs, climbing by over $197 billion to $3.04 trillion in the first quarter of the year.
Paradoxically, China may have moved more gradually on boosting the yuan's nominal value than expected in recent months due to its rising prices, since higher CPI rates than in the United States mean the yuan has appreciated faster in "real" or inflated-adjusted terms.
"That is the route they have taken," said Reinhart. "But because the growth differentials are large and they are persistent, this dilemma is not going to go away anytime soon."