By TOM ORLIK
Higher oil prices and a stronger-than-expected recovery in the U.S. have raised fears that China's inflation may be higher and more persistent than expected. But given that China's government has already tightened more than the markets recognize, the real question is how long before Beijing swings policy back to neutral mode.
There is no doubt the Chinese government has tightened policy quickly: Three increases by the People's Bank of China in the lending rate have raised the benchmark 1-year rate by 0.75 percentage points since October. Banks are free to charge lending rates as far above the benchmark as customers will pay, so the figure understates the true increase in the cost of capital.
PBOC figures show that at the end of 2010, 43% of borrowers were paying above the benchmark, compared to 33% at the beginning of the year. Data from a Market News International business survey shows that the actual rate borrowers face has continued to rise in the opening months of the year. A Market News index of borrowing costs rose to 92.11 in February from 57.14 in December, indicating that the cost of capital for nearly all respondents has continued to rise.
Anecdotal evidence also suggests China's corporate sector is facing a credit crunch. Reports from the black market for credit in Wenzhou, a source of informal finance to entrepreneurs, suggest that interest rates are higher today than they were in summer 2008, before the government started cutting rates to fight the global recession.
With the credit taps tightened, growth has started to slow. Purchasing managers' index data for January and February show some of the momentum coming out of China's economy.
But there also are forces pulling in the other direction. The recovery in the U.S. is stronger than expected. If resurgent demand overseas contributes to buoyant exports, that will cut into space capacity in China's economy and push prices higher. Higher commodity prices will also push up producer prices. International Monetary Fund research suggests 45% of the movement in China's producer price index is explained by changes in foreign demand and world commodity prices.
China hasn't solved the problem of higher inflation. Most analysts expect the CPI to push past 5% in the first half of this year and stay around 4% in the second half, as tighter labor markets continue pushing up wages and prices.
But with the policy brakes already slammed on hard, the real question for the months ahead is not how fast prices will rise, but when China's government will put its foot back on the growth accelerator.