Inflation in China - Remain High but Not Hyper

Though we see the current inflation is high, but China is not in hyper inflation, and the public seems to hold confidence on the government being able to regain control. While the government targets at 4% in CPI, we forecast CPI to reach 4.3% on average, characterized high in 1H and trend down in the second half.

• Inflation stays the high level. China NBS estimates Jan CPI up by 4.9% with food price rose 10.3% and non-food price edged by 2.6%. This inflation figure is slightly lower than the market expectation of 5.2%. Food price is the highest since Aug 2008, and non-food price is the highest in our record back to Jan 1999.
• Foods would take a weight of 30.1%. Despite NBS argues the change in CPI weights has minimal impacts on CPI level, we see the CPI weight change could have lowered overall CPI by 0.19 ppt. Although NBS detailed the changes in CPI weights, but refuse to publish CPI weight in detail. If based on 10.3% food price, and 2.6% non-food price, coming out 4.9% in CPI, then food weight should be 29.9% in Jan 2011, and should be 32.1% in 2010. Based on 10.3% increase in food price, and 2.6% up by non-food price, coming out 4.918% in CPI, then food weight should be 30.1% in Jan 2011, and should be 32.3% in 2010 while NBS told food weight is slushed by 2.21 ppts.
• Non-food price should be largely underreported. Though non-food price has reached the highest in our record (back to Jan 1999), we still have doubt onto the statistics such as garment and clothing, transportation and telecommunication, housing and others. For instance, clothing price decreased by 0.2%. Though minimal, it is very contradictory to common feeling. In fact, ex-factory prices of clothes under PPI rose 3.8% y-y or 0.5% m-m in January also in NBS statistics. This should be largely attribute to price samples.
• Food prices would remain at high level. While vegetable and some special fruit price would face a downward adjustment after CNY, grain price, which surged 15.1%, would be hard to set back before the summer grain harvest. China officially reported to have experienced 7 consecutive years bump harvest of grains, but market does not see to have a large amount of surplus supply of grains. High food prices would be hard to go down as 8 provinces in China have been suffering from serious drought in the past more than 3 months.  
• Labor costs undergo a large increase. Media covers widely about short supply in labor force both in coastal areas and hinterland areas after CNY. Labor market in Guangdong and Zhejiang reports labor costs have increased by 10-30% in the past a month. While tens of million of migrant workers return to their rural homes for their family reunion, labor costs for households, retails, restaurants and other service institution in cities cross the country surged. This is partly reflected in CPI under prices of family services, which is up by 11.4% in January.
• Higher-than-expected PPI suggests stronger cost-push inflation going forwards. January PPI rose 6.6%, higher than market expectation, the highest since May 10. Taking domestic and international factors into consideration, it is hard to see PPI to lower anytime soon.

Monetary authorities exercised tight control over fund-raising

• January new renminbi loans ended up Rmb1.04t, some 20% less than market expectation. This outcome confirmed once CBRC once warned that it wanted January new loans no more than Rmb1t, while PBOC tended to allow some RMB1.2tr. Because of this tight control, M1 growth slowed to only 13.6% from 21.2% in last Dec and 39% in January 2010. While household deposits increased by Rmb1.42t, corporate deposit decreased by Rmb1.27t. Apparently, corporate liquidity has been largely tightening up. As a result, short supply in corporate cash-flow have largely boosted interbank lending market. While overnight interbank rate once exceed 7%, the weighted interbank market lending rate reached 3.7% and repo rate surged to 4.29% in January, 218 bps higher than the same period last year.
• Monetary policy implementation seems to have been a bit too tight. Monetary authorities have been made accountable to the high housing prices and the current high inflation. Both PBOC and CBRC have been under pressure to normalize the social fund-raising. From PBOC Quarterly Report (4Q2010), aggregate fund-raising (including loans, stocks, treasury bonds and corporate bonds) was Rmb11.11t in 2010, 14.3% less than 2009. CBRC warned to take another 10% cut into new loans from last year's incremental.
• It is hard to continue such a tough tightening. January new loans operation gives us two information. First of all, the monetary authorities are able to control credit loans if they determine to and if they are allowed to. Second, how much fund-raising through credit loans should be made depends on the political bargain between the central and local governments. We expect the credit financing to local projects would be a hot debate during the incoming NPC (March 5-15). The monetary policy operation may have to repeat "stop and go" cycle after the NPC in March.
• As a result, economic growth would remain strong and inflation would have to tolerate high.