Analysis: China's inflation overhaul clouded by data doubts

Chinese 100 yuan banknotes are seen in this picture illustration taken in Shanghai January 17 , 2011.

BEIJING (Reuters) - Like a home renovation that reveals old cracks, China's overhaul of its main inflation gauge has exposed long-standing problems in the reliability of official data.

While some suspect that Beijing is intentionally seeking to mislead, the main worry is that the government has been far too slow to keep up with changes sweeping over the economy and so is not painting an accurate picture of the reality on the ground.

With China vaulting past Japan as the world's second-largest economy last year, questions about the quality of its data and whether the government is manipulating it are far from academic.

In the confusion about whether Chinese inflation is taking off or, on the contrary, nicely under control, prices of commodities from oil to iron ore and monetary policy decisions in developed and emerging markets alike hang in the balance.

China on Tuesday announced a 4.2 percentage point increase in the share of housing costs in the basket of consumer goods used to measure inflation. It reduced the weightings of a series of other items, notably food, which it cut by 2.2 percentage points.

That hardly solved the problem.

"Non-food price inflation is underestimated, not because of the weighting, but because actual prices are not being reflected in the CPI (consumer price index) itself," said Jinny Yan, an economist with Standard Chartered Bank in Shanghai.

According to the official data, annual consumer prices rose 4.9 percent in January. Economists polled by Reuters had expected 5.3 percent. For ordinary Chinese, something smelled fishy.

"Why did the government make the adjustment this particular month?" asked Vera Yuan, 29, an advertising designer in Shanghai. "Are they trying to shift public attention from high inflation?"

THE PRICE IS WRONG

In truth, the timing was not suspicious. Every five years, the National Bureau of Statistics conducts a major revision of the way it measures inflation.

What was concerning were its methods. Analysts worried that the agency had fallen behind the curve in the fast-growing Chinese economy and was resistant to subjecting its techniques to the sort of scrutiny that would bring about improvements.

"It is how they sample the data and do the statistics," said Wei Yao, an economist with Societe Generale in Hong Kong.

The new CPI weightings were emblematic of this. On the one hand, the changes were consistent with the evolution of consumption patterns in the Chinese economy.

But by placing extra emphasis on housing, the CPI basket now gives prominence to a deeply flawed set of price data that economists say will make reported inflation too low.

The statistics agency uses mortgage rates to extrapolate changes in residential rents. Since housing prices have soared in recent years while borrowing costs have stayed largely flat, that grossly under-estimates housing costs.

A similar problem is seen in official data on housing price inflation, which is markedly lower than private sector estimates.

Analysts say the government is not fabricating the housing numbers, but rather taking a non-representative sample of prices. Curiously, the statistics agency acknowledges this shortcoming and has declared an intention to fix it. But caught in the thicket of Chinese bureaucracy, it has been slow to implement changes.

And the flaws run deeper than under-counted housing costs.

Clothing prices, as measured by China's CPI, have fallen for the past decade. In fact, rising material and labor costs as well as better brands have made clothing more expensive for many consumers, Gao Shanwen, an economist at Essence Securities in Beijing, noted.

"One guess is that the statistics agency's sample of clothing no longer reflects the mainstream of consumers, and so its prices have gradually declined," he said.

In other words, China's statisticians are out of fashion.

STRUGGLING TO CATCH UP

The government has also had difficulty in tracking the country's burgeoning services sector, from grey-market lending firms to ubiquitous massage parlors.

That has been reflected in regular revisions to growth data. For several years running, the statistics agency has raised its estimates of the size of the Chinese economy, always because its initial measurements missed activity in the services sector.

"If they do improve those methods, not just the weighting, we should see more inflation coming from the non-food sector," said Yao.

China's core inflation rate, stripped of volatile food prices, hit 2.6 percent in the year to January.

Although that was the highest since the late 1990s, it was remarkably low for an economy that has enjoyed real growth of about 10 percent a year for a decade.

With its re-weightings, Beijing is at least trying to move in the right direction by increasing the focus on non-food prices.

"A small adjustment is better than no adjustment," said Yi Xianrong, a researcher at the Chinese Academy of Social Sciences and a vocal critic of the country's CPI calculations.

But the revisions also exposed another problem in Chinese economic data: opacity.

Although the statistics agency announced percentage changes of the CPI components, it did not disclose their absolute weightings in the index. Nor did it say how the composition of the individual components had changed, leaving analysts to hazard guesses to fill in the official blanks.

"The CPI problems and the lack of transparency in China's statistical system have harmed the reliability and the credibility of the data," Gao said. (Additional reporting by Zhou Xin; Editing by Ken Wills, Vidya Ranganathan and Alex Richardson)