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Brian Coulton, Global Emerging Markets Strategist, LGIM

Comment: China failing to get to grips with inflationary pressures

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Legal & General Investment Management’s (LGIM) Global Emerging Markets Strategist, Brian Coulton (pictured), explains that mounting inflationary pressures in China could potentially force more substantial monetary tightening than currently signalled by the authorities or the market…

As inflationary pressures continue to build in China, the situation is increasing the risk of a slowdown in the country’s growth, which would have major implications for the global economy. China’s role is more important than ever having officially become the world’s second-largest economy last year, accounting for a quarter of global growth. With other countries importing cheap Chinese goods, China has played a key disinflationary role over the last decade. However, this is likely to reverse in the coming years, with China to become an exporter of inflation to the rest of the world. Many commentators suggest Chinese inflation is peaking but we feel the authorities are yet to get on top of the situation. Higher food prices are seen as a temporary driver of elevated inflation, with the assumption both will drop away. For us, food prices reflect imbalances in the Chinese economy, with credit expansion, wage pressure, property speculation and monetary policy also contributing to overall inflation.

Recent credit expansion in China has been on par with that seen in several Eastern European countries prior to the 2008 credit crunch and all of those have since suffered serious slowdowns. Wage inflation is also on the rise, with hefty increases in minimum wages in the provinces and urban firms struggling to import cheap labour from rural regions. A further factor in the inflation picture is the lack of spare capacity in the Chinese economy, which in the past has exerted downward pressure on rising prices.

This combination of drivers is creating inflationary pressure and Brian is doubtful of the effectiveness of the Chinese authorities’ measures taken so far. Against this background, Brian cited a growing risk of more substantial tightening than expected, perhaps not in 2011 or the first half of 2012 but at some point in the next two to three years.“This means rising risk to the country’s macroeconomic stability and of growth falling from the current 10% a year to 4 or 5%. That is not our central case but if it does happen, it would have serious implications for global growth.

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