China to keep lid on inflation despite pork spike

Two investors have lunch in front of an electronic board at a stock exchange in Shanghai May 28, 2007.

BEIJING (Reuters) - A surge in pork prices is fanning popular and political concern in China, but researchers are confident broader inflation will remain in check.

Even so, they said interest rates are likely to keep moving higher as the central bank is under increasing pressure to rein in runaway economic growth and deflate what many see as a bubble in equities and in some parts of the property market.

"For an economy growing at a rate of 11 percent, why should we worry about inflation of 3 or 4 percent?" asked Wang Xiaoguang, a researcher with the Academy of Macroeconomic Research, a think tank under the National Development and Reform Commission," China's planning agency.

Nevertheless, Premier Wen Jiabao visited a market in Xian, China's ancient capital, at the weekend to highlight government concern over the rise in pork prices. China is the world's largest consumer of pork.

The price has soared due to more expensive feed, a widespread disease outbreak and a previous surplus, which discouraged farmers from raising more pigs.

Ji Min, a researcher with the People's Bank of China (PBOC), the central bank, said he expected supply to increase quickly in response to the signal of higher prices.

"There's no concrete evidence as to whether the current rise is a trend or a temporary phenomenon, but given the supply potential the momentum behind food prices is unlikely to be sustained," said Ji.

But, taking a longer term view, Ji said interest rates in China were headed higher. "Compared with investment returns in China, the current rate level is obviously low," he said.

The consumer price index in March rose 3.3 percent from a year earlier before subsiding in April to 3.0 percent -- bang on the central bank's target for 2007.

Wholesale pork prices in 36 major cities jumped 43.1 percent in the first three weeks of May compared with a year earlier, according to figures from the Ministry of Commerce.

PRESSURE ON PBOC

Economists are not panicking over pork because non-food inflation has held steady around 1.0 percent in recent months.

With capital spending growing at 25 percent a year, supplies of manufactured goods are likely to remain plentiful, spurring competition and holding down prices.

Still, as higher pork prices spill over to other meat and food products, CPI inflation is likely to rise above 4 percent in coming months, said Hong Liang, an economist with Goldman Sachs in Hong Kong. Food accounts for a third of the CPI basket.

Although temporary shortages are a factor, she said fundamental factors are at work as upstream cost pressures -- in this case dearer feed stock such as corn -- pass through to retail prices because of buoyant demand driven by rising wages.

As a result, Goldman has raised its forecast for CPI inflation this year to 3.6 percent from 2.6 percent.

"The pick-up in CPI inflation will likely intensify pressures on the central bank to raise interest rates more decisively," Liang said in a note to clients.

The central bank has increased its benchmark lending and borrowing rates twice this year. But, at 3.06 percent, the one-year deposit rate remains negative after inflation and taxes.

"If left unaddressed, such negative real rates would add more fuel to asset inflation in the domestic equity market, and will also dent the central bank's credibility," Liang said.

Yi Xianrong, an economist with the Chinese Academy of Social Sciences, agreed that the central bank would have to hoist interest rates further if inflation exceeded its comfort zone.

"What can the central bank do apart from raising interest rates further?" Yi asked.

For its part, the Commerce Ministry attributed the jump in prices mainly to seasonal factors and said the price of pork and eggs would stabilize as supplies increased and demand weakened over the hot summer months.

In a wet market in eastern Beijing, prices resumed climbing on Sunday, to 20 yuan ($2.60) a kg, after stabilizing around 18 yuan late last week, a pork retailer said. In early May the price had been 14-15 yuan.

Wang, the planning agency researcher, said higher food inflation should be welcomed, not feared, as long as it did not spill over to other categories.

"It's a good thing for the cost of agricultural products to rise because it increases farmers' incomes," he said.

($1 = 7.647 yuan)