CHINA: MODERATE INFLATION HERE TO STAY, EXPERTS SAY

UNCLAS SECTION 01 OF 02 BEIJING 007554

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E.O. 12958: N/A
TAGS: ECON EFIN PGOV ETRD EINV CH
SUBJECT: CHINA: MODERATE INFLATION HERE TO STAY, EXPERTS SAY
(C-AL7-02027)

REF: (A) BEIJING 7233
(B) BEIJING 6859
(C) SHANGHAI 553
(D) BEIJING 6936
(E) BEIJING 5578
(F) SECSTATE 166908

SUMMARY
--------------


1. (SBU) Beijing-based economists said this week that moderate
inflation likely will continue in 2008, and they expect further
administrative tightening measures by the Central Government in
order to control prices. Their comments followed the government's
announcement earlier this month that China's Consumer Price Index
(CPI) inflation increased to a new 11-year high at 6.9 percent
year-on-year in November -- a surprise to most observers who had
expected inflationary pressures to be easing by now (Refs A and B).
A Shanghai-based western economist said he is concerned that high
food inflation is now becoming structurally inflationary (see Ref
C). The economists agreed that inflation will remain in the 5 - 7
percent range next year and is not likely to go higher, but they
acknowledged the danger of global price increases affecting China
and they noted the possible impact of higher prices on social
stability. END SUMMARY.

CPI STILL SURGING
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2. (U) China's CPI rose 6.9 percent year-on-year in November, a new
11-year high. Food prices increased 18.2 percent y-on-y with pork
up 56 percent and cooking oil up 35 percent. Core CPI (excluding
food prices) increased 1.4 percent in November, the highest growth
this year. Government announcements and press reports indicated
that an oil price increase in November (Ref D) was the major
contributor to the non-food price increase during the month.


3. (U) Prior to the release of the November inflation figures, the
Central Economic Work Conference (an annual economic policy meeting
held December 3-5 in Beijing) announced that preventing structural
inflation would be the primary task for China's macroeconomic policy
in 2008. The Work Conference, and the National Development and
Reform Commission (NDRC) Work Conference that followed on December
7, both emphasized the importance of stabilizing prices. NDRC
Chairman Ma Kai and Vice Chairman Bi Jingquan focused on stabilizing
prices in their public comments.

ECONOMISTS: INFLATION HERE TO STAY
--------------


4. (SBU) Beijing-based economists expressed surprise that the CPI
increased nearly 7 percent in November and said that the new figure
casts doubts on claims previously made by the Central Government and
economic analysts that China's inflation problem is likely to be a
short-term trend driven by a food supply shock. Rather, the current
situation indicates that moderate inflation (5 - 7 percent) likely
will continue in 2008. Wang Tongsan, Director of the Institute of
Quantitative and Technical Economics at the China Academy of Social
Sciences (CASS),who is one of the few analysts who has consistently
pointed to underlying structural factors in the economy that could
lead to more inflationary pressure (Ref E),said again this week
that China is facing a serious inflation problem that will last into
2008, particularly because price surges -- both in China and
internationally -- in the latter half of 2007 will have a lagging
impact on next year's CPI. Sun Bulei, an economist at the Stock
Exchange Executive Council (SEEC),said he would have expected the
CPI to be decreasing by now rather than increasing from 6.5 percent
y-on-y in October to 6.9 percent in November.


5. (SBU) Our contacts agreed that the Central Government will need
to implement additional administrative tightening measures in order
to control prices. Those measures are late in coming, said Wang
Boming, President of the SEEC. He stated that the Central
Government should have introduced tightening measures in the summer
but government officials failed to agree on the best course of
action because of disagreement on the root cause of the inflation.
Even if they were to agree, Wang said, policymakers have few tools
to counter inflation and are virtually powerless to rein in local
governments, which are not interested in slowing investment.


6. (SBU) Wang Tongsan at CASS agreed, stating that on both fiscal
policy and monetary policy, the government's hands are tied. The
government should pursue a more prudent fiscal policy with slower
growth in fixed asset investment, he said, but there is a conflict

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because the government also wants to promote development in western
China and rural areas by providing budgetary support. In addition,
provincial officials in other parts of the country (ex. Central
China) want to continue to attract investment and boost GDP growth.
The government could tighten its monetary policy by speeding up the
pace of exchange rate appreciation and/or raising interest rates but
is reluctant to do either because China benefits from the
undervalued exchange rate and does not want the interest rate gap
with the United States to grow.

NOT JUST ABOUT FOOD PRICES ANYMORE
--------------


7. (SBU) Stephen Green, the Senior Economist at Standard Chartered
in Shanghai, maintained his position that higher food prices are
hurting average consumers (Ref C) and added that the cumulative
effect of high food prices over the past six months is now creating
a structurally inflationary situation. The oft-heard government
argument that inflation is not a significant problem because core
inflation remains low is no longer a valid position, Green said, as
a high-inflation environment that persists for 6 - 12 months is one
that is structurally inflationary and will affect non-food sectors.
Wang Boming agreed that the focus on food prices to date has been
misleading because it has ignored other causes of higher prices
(fast GDP growth, higher international prices, excess liquidity in
the money supply, etc.),and the government will have to address
those problems in 2008.

THE IMPACT OF GLOBAL PRICES
--------------


8. (SBU) Contacts uniformly agreed that higher global prices for
energy (oil) and food (grains) will affect prices in China in 2008.
Some also said they are concerned about the possible impact on China
of higher inflation in the United States. (Note: Econoff delivered
Ref F talking points to those interested in the financial situation
in the United States. End Note.) Wang Tongsan at CASS said that he
believes higher international prices will lead directly to higher
domestic inflation in China in the coming year.

SOCIAL STABILITY CONCERNS STILL PARAMOUNT
--------------


9. (SBU) Economists also stated that the government's efforts to
address inflation are primarily due to continued concerns about the
impact of rising prices on social stability. Wang Boming said that
the government is in a difficult position because it wants to
encourage fast GDP growth (9.5 to 10.5 percent) to maintain social
stability, but GDP growth in 2007 (which is likely to exceed 11.5
percent) has been too fast, thereby fueling inflation. Indicating
the level of concern about inflation at the local government level,
a December 12 Reuters report stated that a recent survey of 154
officials studying at the Communist Party's Central Party School
showed that 30.5 percent of officials believe inflation is China's
most pressing social problem followed by income inequality at 23.4
percent.

COMMENT: A TURNING POINT?
--------------


10. (SBU) It appears that moderate inflation will continue in early
2008, but there are no indications yet that inflation will reach
dangerous levels of 10 percent or higher. Nevertheless, the
government is concerned about on-going 5 - 7 percent inflation and
wants to control prices in an effort to ensure social stability. We
are likely to see more subsidies for food and energy for low-income
groups. Our discussion with local economists suggest that this may
be a turning point for policymakers in their perception of
inflation, as there now are few who believe short-term food
inflation is the only factor leading to price increases. Inflation
will continue in 2008, and government officials and economic
analysts now appear to recognize that the Central Government needs
to address price increases not only as a short-term food supply
shock but as a long-term structural issue. The government's ability
to address inflation through market mechanisms or administrative
controls, however, remains limited.

RANDT