Should Investors Be Worried by China's Growing Inflation?

Henry Truc  |

If there were any winners from the financial crisis, China's economy and stocks would arguably be considered right at the top. The world's largest country by population accelerated to become the second-biggest economy trailing only behind the United States last year. While China's export-heavy economy took the hardest hit at the height of the recession, it's also been growing the fastest since of the established global markets. With GDP expanding at an annual rate of nearly 10 percent, the Chinese government as well as the investment community is now starting to worry that it may be growing too fast. As the U.S. and Europe continue to try and jump-start their economies, China is in the enviable position of having to rein in their growth.

But how serious is the China inflation threat? And how could that affect the rest of the global financial markets and economies? Since major global corporations depend on the country for growth, the Chinese government now has to strike the right balance between controlling domestic growth and inflation without hurting relationships from outside investors and international companies that rely on China's cheap production. But inflation in China has already caused consumer goods like food to spike 5.4 percent over the last month.

Combating Inflation in China

The Chinese government has initiated several strategies in hopes to curtail runaway inflation, but while these strategies may help to reduce the scorching 5 percent annual rate of growth in the country's Consumer Price Index, it could also stymie demand from exporters that have counted on China's low-cost goods for their businesses. China's central bank has taken a few steps to strike a balance for its consumers and tighten up its financial system:

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  • The People's Bank of China increased capital reserve ratio for banks to a record-high 20.5 percent of their cash. It is the fourth time they've increased the ratio this year.
  • The central bank has increased interest rates four times this year as well, currently set at 6.31 percent.
  • The Chinese government has increased agricultural subsidies to help reduce growing food prices, and has tried to forbid some Chinese companies from raising consumer prices.
  • China has raised its minimum wage, and some municipal governments have also required businesses to increase employee wages.

But the country's real estate bubble and possibly over-stimulated infrastructure sectors seem to be the primary area of concern. Real estate speculation has been running rampant in China over the last few years, and the 37 percent growth in investments shows that it hasn't slowed much this year either. Infrastructure spending was the primary target of the government's $586 billion stimulus plan during the peak of the economic downturn, but the growth may have been too fast too soon.

Global Impact of China's Inflation

For most of the last century, China has been widely considered a poor and emerging economy. Now, as the second largest market in the world, the nation has emerged. While its size qualifies it as a developed market, China's growth is still that of an up-and-comer. The adjustments its economy and consumers are undergoing should form what the new China will look like going forward. More importantly, the impact of this new China will reverberate throughout the global economy.

While manufacturers in China have always been a dependable source for cheap goods, the demand and new status have caused them to become quite picky. Chinese exporters have been reportedly turning down orders from major retailers because bids have been considered too low. As the cost of doing business in China--government mandated higher employee wages, lower prices of goods--becomes more of a strain, these exporters and manufacturers are forced to charge a higher margin. These higher costs will be passed on to international buyers that could eventually be forced to look for cheap suppliers elsewhere.

The question now really depends on whether or not China's government can curb the growing inflationary pressures on its consumers, and at the same time, maintain balance in the economy's growth. The unstable recovery of the Western financial system could very well depend what China does next.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:


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