The calm before the storm for China inflation
Acceleration of supply side reforms may push up consumer prices faster than expected, with medical inflation already at its highest since 1997
China economists have been nodding off at the wheel on inflation figure predictions, underestimating how quickly prices are rising across factory gates and potentially overlooking the trickle down effect on consumers.
The biggest surprise in this week’s inflation data out of China was clearly the unexpectedly large acceleration of the Producer Price Index to 5.5% in the final month of 2016. Economists were looking for a 4.5% rise. A month earlier, the median estimate for November PPI was 2.2%, only to see the actual growth to be a whopping 3.3% uptick.
And the 2.1% rise in the Consumer Price Index came in below expectations of 2.3%, which appears to reinforce the view that consumers are too removed from sharing the higher input costs at the factory level.
However, the sanguine inflation expectation for the world’s most populated economy is at odds with Beijing’s aims to deepen cuts in excess capacity in other industries this year, with the possible targets being glass, cement, aluminum and shipbuilding. Chinese authorities are keen to keep the ball rolling since last year following the initial successes achieved in cutting overcapacity in the highly fragmented coal and steel sectors.
Supply-side reforms in these two basic material industries last year helped to stir up a year-end perfect storm that resulted in surging coal and steel prices, and hence, substantially better profitability.
Improved earnings, better operating cash flows, and rosier business outlook could very well pave the way to put the industrial economy’s reeling debt situation back on track.
In the China Banking Regulatory Commission report for 2015, the bad debt ratio for the manufacturing sector stood at 3.35%, twice the overall total ratio of non-performing loans in commercial banks.
Manufacturing bad debt reached 430 billion yuan (US$62 billion), official 2015 data shows.
Industrial overcapacity has been a key obstacle between higher upstream producer prices and broad inflation pressure across the economy. But as China accelerates the fight to streamline its manufacturing sector, consumer prices will be affected much more and there are early signs of prices creeping up.
Stripping away the dramatic swings in food-related prices in the past year, China’s non-food Consumer Price Index ended 2016 on a high note of 2%, twice that at the turn of the year. Prices of services also expanded at the fastest level in two and half years in December, at 2.5%.
To be fair, the upward trajectory of such core inflation measures should be welcomed by investors as a sign of economic acceleration for the time being, but if non-food prices edge higher toward 3%, it may tip the scales on China’s monetary policy decisions.
Chinese consumers are already dealing with the highest medical inflation in almost two decades. The healthcare component of the CPI basket, comprising Western drugs, Chinese medicines, and medical services, has risen to just under 5% – a figure last seen in 1997 – after climbing steadily during the past three years.
The rise in medical inflation coincides with the surge in the number of high-net-worth individuals and more city dwellers with dependants, which has boosted demand for health care. The surging health care costs has driven the push to buy more private insurance.
A PricewaterhouseCoopers (PwC) study has indicated that
insurance for young and elderly dependents has become
more important for middle-aged consumers who have
shown a greater willingness to pay for varied and better
health services, including health insurance as their disposable
incomes have increased.
Higher prices for energy and other items are also pushing up China’s non-food CPI. Vehicle fuels are now up more than 10% from a year ago as seen in the report, a direct result of higher crude oil prices.
Furthermore, the deflationary trend in durable consumer goods is looking to bottom out, and a reduction in this negative component of the CPI will certainly add to the core inflation rise.
In fact, the latest producer price report is telling the same story about budding price pressures in the consumer basket. The PPI for daily personal articles is on a steep climb, while ex-factory prices for durable consumer goods has already bottomed out since June 2016.
These upward factors underscore the fact that PPI for consumer goods is beginning to breakout of a multi-year doldrum. At 0.8%, it may appear muted, but it is nonetheless the highest since 2012 and this is only the beginning. Compounding the month-on-month gain of 0.3% would put the annualized inflation rate for consumer products at 3.6%, above the government’s 3% target for consumer inflation.
The consensus view for China’s PPI has remained rather conservative, anticipating it may not rise much higher. Furthermore, analysts are generally putting forward a mild CPI picture for the year ahead. However, data are showing core inflation pressure rising and the transmission mechanism from PPI to CPI may be more active than originally anticipated.