Chinese manufacturers have recently seen a rise in the costs of raw materials pushing the PPI inflation rate with the price of raw materials and goods leaving factories rising by 6.8% in April 2021.
This brings the Chinese PPI inflation rate to its fastest ever growth in more than three years as demand for raw materials has resulted in demand-pull inflation.
The recent economic recovery associated with global vaccine rollout has caused Chinese firms and firms around the world to be much more confident compared to the start of the pandemic, consequently, because firms are much more certain that they will make a profit on their reinvestments, businesses have begun to trade much more.
Increased business trading and activity as firms try to organically expand has resulted in a rising demand for raw materials, both domestically and internationally.
This rising demand makes the supply of these raw materials much more scarce, consequently, producers prices increase in an effort to ration the market.
This price increase from rationing the market as a direct response to demand-pull inflation has consequently caused the PPI inflation rate to rise.
However, FT reports that economists are currently observing the rising PPI inflation rate closely as policymakers need to decide if this rising inflation will be passed onto the CPI inflation rate.
A rising CPI inflation rate will not only affect the people of China but may also affect foreign buyers such as American and European consumers who typically buy products manufactured from China.
This means that a rising CPI inflation rate within China may actually lead to the decreased buying power of consumers in foreign nations, a downside of rising inflation.
However, the main reason why policymakers are looking at the Chinese CPI inflation is in relation to monetary policy.
Nations such as the U.S. have recently seen a CPI inflation rate of 2.6% with forecasts predicting for it to go way over target.
This rising CPI inflation within the U.S. has been a likely cause of both expansionary Fiscal and Monetary policy measures ‘overheating’ the American economy as demand-pull inflation is going out of control.
If the same demand-pull inflation spirals out of control in China, the nation may be forced to adopt a contractionary monetary policy to prevent the economy from getting carried away and potentially rebounding back into another recession as the growth will be incredibly unsustainable and unstable.
Additionally, a rising CPI inflation rate will pose a threat to the Chinese economy which is incredibly export-focused.
A rising CPI inflation rate means that the Chinese economy will be less internationally competitive. This is a problem for China as it is an export-led economy due to it being the manufacturer of the world. This means the rising CPI inflation rate within China makes Chinese goods more expensive for foreign buyers as previously stated. This means that the number of individuals buying Chinese products will decrease as the market rations, leading to a fall in the value of exports of the Chinese economy.
This combined with rising PPI inflation increases the cost of raw materials which China is importing, thus increasing the value of imports.
So, because exports and imports make up the current account, a fall in the value of exports and a rise in the value of imports lead to a worsening current account as more cash is leaving the economy and less is being injected
And, because the current account is a component of aggregate demand, a worsening current account will decrease the levels of aggregate demand of the Chinese economy, leading to slower economic growth levels.
Thus, it is essential for the Chinese economy to keep inflation under control as it is essential for their export-led economy.
Hence, if CPI inflation does go over target, the Peoples Bank of China will have to impose contractionary monetary policy measures such as decreasing quantitative easing and increasing the base interest rate so that borrowing and servicing debt is made more expensive.
This is done to ensure that aggregate demand is stifled so that China’s CPI inflation rate does not go over target, meaning international competitiveness does not decrease due to rising inflation, thus showing why it is important for China’s policymakers to monitor the situation closely.
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Written by Hubert Kucharski