From Deflation to Renewed Inflationary Pressures After 2002
Dollar depreciation set in after 2001 and, as discussed in Chapter 1, lowered the renminbi’s value against other world currencies due to the exchange rate peg maintained until July 2005.
The resulting decline in the real exchange rate added to the competitiveness of Chinese exports and gave a boost to China’s economy. China’s growth rate rose above 9% in 2002-2005 and reached 10.7% in 2006 (see Table 3.3). Moreover, with the renminbi now linked to a weakening US dollar, monetary policy could be loosened without putting pressure on the renminbi to fall relative to the pre-July 2005 pegged 8.28:1 exchange rate level. Broad money growth rose from 14.4% in 2001 to 19.6% in 2003, subsequently rebounding to 17.6% in 2005 and 16.9% in 2006 after a retrenchment to 14.4% in 2004. The pronounced acceleration in 2003 occurred as the People’s Bank of China raised its money growth rate target to 18% in the first quarter of that year. Lardy (2005a, p. 44) argues that this 2003 easing was influenced by government fears that thestate-owned enterprises fell by 45 million - or approximately 40% - between 1996 and 2006 (Bergsten et al., 2006, p. 24).
19 Meanwhile, Lin, Cai, and Li (2003, p. 275) stress the importance of excess capacity in making the subsequent deflation so hard for the government to reverse - arguing that even very large increases in the government’s infrastructure investment could not combat excess capacity running at perhaps 30% or more. outbreak of SARS would severely slow the economy- even though the actual effects, although dramatic at first, proved to be short-lived. Credit growth eventually reached an all-time high of RMB 2.99 trillion, or 25% of China’s GDP (Lardy, 2005a, p. 45), and the ballooning lending rates may well have been associated with a renewed upsurge in bank nonperforming loan levels (Chapter 7).
Capital inflows into mainland China began to accelerate in 2001 and the buildup of foreign exchange reserves averaged $US 110 billion during 2001-2004, equivalent to 8% of China’s GDP (He et al., 2005, p.
1). Reserve growth continued to accelerate after 2004, with foreign exchange reserves rising by $US 207 billion in 2005 and then by $US 247 billion in 2006. In response, as detailed in the next chapter, the People’s Bank sought to sterilize the effects of the reserve inflows by selling government bonds and raising reserve requirements. He et al. (2005, p. 5) calculate that 42% of the overall domestic liquidity effects of the reserve growth were offset over the 2001-2004 period. However, continued concerns with overheating prompted new attempts to slow the economy via administrative controls on bank lending rates. Just prior to the May holidays in 2004 the central governmentpromised to choke investment in “overheated” sectors such as property and ordered the dramatic arrest of officials for building an unauthorized steel mill near Shanghai... The measures the government then implemented were straight from the tool kit of the planned economy, with blunt orders going out to state banks to restrain lending to targeted sectors.[54]
China’s economy seemed to largely shrug off such efforts. Although money growth rates did drop back from the near 20% level reached in 2003, export growth ended up more than compensating for some temporary slowing in domestic investment. After lending and fixed asset growth reaccelerated in 2005-2007, notwithstanding the exchange rate appreciation implemented in July 2005, even more tightening attempts were made - with the People’s Bank implementing a series of hikes in its benchmark lending rate from April 2006 on. However, accelerating asset prices were not initially accompanied by any similar explosion in consumer prices. The annualized rate of consumer price increase did see a ten-year high of 6.5% in August 2007, but almost all of the pick up in inflation through the summer appeared to derive from food price hikes exacerbated by flood damage to crops - with nonfood prices up by only 0.9%.[55] Although it remains to be seen whether the latest round of contractionary policy will be any more effective than the administrative measures imposed in 2004, additional perspective is offered in the next chapter in the form of a detailed analysis of the monetary strategy adopted by the People’s Bank of China over the post-1990 period.