China’s inflation turned positive

According to today’s Wall Street Journal:
By Andrew Batson and Shai Oster
11 December 2009

BEIJING — China is moving out of deflation after nearly a year of falling consumer prices, a turnaround driven in part by changes in government policies that kept costs of oil, water and electricity artificially low.

China’s consumer price index climbed 0.6% from a year earlier in November, the National Bureau of Statistics said Friday, after declining every month since February.

The return of inflation — still mild at this point — highlights the recovering economy: Industrial output rose 19.2% in November, the fastest gain since early 2007. But it also shows the result of efforts to raise state-set prices for key resources to better reflect market supply and demand.

Prices are rising for a range of goods, from food to property. The change in resource prices is noteworthy because the government had kept prices insulated from market forces even as it dismantled the planned economy in other sectors.

The effects of controlled energy and resource prices have been broad. Some of China’s trading partners complain that its low prices for raw materials are, in effect, government subsidies to Chinese companies. Many economists say they think these prices send the wrong signals to Chinese corporate managers, encouraging them to overuse scarce resources and invest too much, risking overcapacity. At the same time, resource companies underinvested, leading to periodic electricity and fuel shortages.

"By keeping all these resources underpriced, they encourage overcapacity, which is a drag on overall economic performance," said Yolanda Fernandez Lommen, an economist for the Asian Development Bank in Beijing.

"By assigning market prices to these resources, they will get more efficient use of resources. That’s good not only for the economic structure, but also for the environment," she said

China has dabbled with energy-price overhauls before, but officials met resistance from consumers and businesses to higher prices. This time, they have kept at it. The government has repeatedly raised prices for gasoline and other fuels this year to reflect rising global oil prices.

Local gasoline prices are up 50% since the start of the year, and including taxes are about 25% higher on average than in the U.S., said Gordon Kwan, head of regional energy research at Mirae Asset Securities. Nonresidential electricity prices were raised by about 5% in November, the first move in a year. Several major cities have started increasing charges for water; the capital, Beijing, raised rates for most businesses by 9% last month. Industry analysts say they expect prices for natural gas to increase by 10% to 15% early next year.

The moves don’t yet amount to full liberalization. "Under the new system, pricing decisions are still in the hands of the government. There remains ample room for price interventions, which, however, are likely to be less dramatic than under the previous system," said K. F. Yan, a director at energy consultancy IHS CERA.

With inflationary pressures returning, it could get more difficult to keep liberalizing prices. But Peng Sen, a vice-chairman of the National Development and Reform Commission, the planning agency in charge of prices, said Thursday that while the government is keeping an eye on price stability,

"China will next year continue to reform environmental fees and the prices of water, electricity, natural gas and other resources," the official Xinhua news agency reported. The government argues that such price changes help increase energy efficiency and ease supply bottlenecks caused by the previous system.

China has been resisting pressure from other countries to let its exchange rate appreciate, but these increased costs for companies actually have a similar effect, by making goods more expensive. "The relative price adjustments could help to appreciate the real exchange rate, at least the rate the heavy industries are facing," said Wang Tao, China economist for UBS, in a recent report.

Several problems remain. Bureaucrats have to balance varying interests, such as poor rural households as well as state-owned industries, in adjusting electricity tariffs. The government’s strategy is to switch to pricing mechanisms that better reflect market forces, but at a time when they won’t immediately result in a sharp increase in costs.


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