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China’s inflationary worries have broadly eased in recent months

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Despite inflationary worries in recent months, it seems unlikely that the Chinese government’s inflation target of three per cent will be significantly breached in the near future, says Ewan Markson-Brown, a member of the team managing the Newton Asian Income Fund. 

Markson-Brown says the government is keen to promote itself as a purveyor of stable economic and political policy, and has a number of dampening tricks up it sleeve, while the underlying inflationary pressures seem to be easing in the short-term at least. 
 
“At present, the Chinese economy seems to be cooling, with falling growth in construction and industrial output, property prices stalling and export growth slowing, while the government has also implemented a crackdown on energy intensive industries,” he says. “Growth and inflation seem fairly balanced for the time being but, needless to say, there are some possible pitfalls ahead over the longer term.”
 
“Despite the broader slowdown in recent months, wage and food price rises have continued, although authorities and businesses alike are taking steps to ease these problems.

In June, it was announced that the minimum wage in a number of Chinese regions was to rise by around 20 per cent. However, companies are seeking ways of avoiding these increased costs. For example, Hon Hai Precision Industry, a company recently in the headlines due a number of suicides among its employees, has relocated some of its factories from the wealthy East to the relatively poorer West of China in a move to cut costs. Its wage bill is now around 40 per cent lower in those relocated factories. 
 
Markson-Brown says another long-term issue is that of demographics. Chinese demographics turn less positive post 2012 – the dependency ratio (the ratio of those under 16 and over 65 versus the rest of the population) starts to increase, meaning the labour force will begin to grow more slowly. This is likely to increase upward pressure on wages.

“While this is a concern, it should be offset by productivity gains through greater capital intensity and an improvement in labour quality over time,” says Markson-Brown.
 
Rising food prices have not been helped by widespread flooding across much of the North of China, while domestic grain prices remain much higher than they are abroad – although any increase in imports would help dampen prices should the government wish to intervene.

“Elsewhere, having increased sharply, hog prices are now more stable after recently rising above the hog/corn ratio breakeven point – the cost of corn required to fatten a hog to sale weight versus the sale price of the hog – meaning that it is now profitable to farm pigs, increasing supply. 
 
“As such, we think that a sharp spike in hog prices is unlikely considering the government’s dedication to stabilise pork prices, although longer term concerns remain over the stability of prices given the cost of land, severe erosion problems and water prices,” says Markson-Brown. “Furthermore, the government is much more aware of the food industry and its inflationary impact than previously; it has already started going about consolidating pork processing plants in order to ease price pressures and make the industry more scaleable.”
 
Over the short-term, Markson-Brown expects a gradual slowdown in both the property market and broader economy and would not expect to see further monetary tightening, although a proactive approach to fiscal policy is likely to remain in place. Higher food and wage costs are likely to create upward inflationary pressure over the longer-term, but the Chinese economy is in good shape to deal with this pressure. 
 
“We maintain that, as long as the West remains in a slow growth environment, then inflation shouldn’t be a serious problem in China. However, if Western economies strengthen significantly, then inflationary pressure could return, although we see this as being fairly unlikely,” says Markson-Brown. “Furthermore, should soaring inflation return, then the government still has numerous tricks up its sleeve to deal with it. Meanwhile, any further quantitative easing in the West could now see the renminbi gradually appreciate against the major Western currencies and thus offset inflationary pressures, and this would also be of benefit to those US dollar and sterling investors invested in China.”

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