China to stem high inflation, low growth

China’s economy is expected to shed its high inflation and low growth, seen since last August, when governmental policies take effect in the third quarter, analysts said on Tuesday.

China’s inflation hit a near three-year high of 5.5% month on month in May, according to official data published on Tuesday. At the same time, industrial growth contracted to 13.3% in the month from 13.4% in April.

“The current situation is a very bad combination – accelerating inflation plus slowing growth. The economy is at high risk of a hard landing if such a situation continues,” said Li Huiyong, an analyst at Shanghai-based SWS Research.

Following the announcement of May's inflation figures, China’s central bank, the People’s Bank of China, said that it will raise the reserve requirement ratio for banks by 50 points starting from 20 June. This is the sixth time the central bank has raised the ratio this year in a bid to curb accelerating inflation.

The government has been taking a series of efforts to curb inflation, including tightening lending and raising interest rates.

More policies are under consideration, including the cutting of logistic costs by lowering the tolls at expressways and providing subsidies to transportation companies. There are also measures to increase the supply of key necessities such as electricity and rice to keep prices stable, analysts said.

The petrochemical sector has seen little impact from the high inflation because of the China government’s monetary measures to rein in inflation, a market researcher from the China Petroleum and Chemical Industry Federation said.

"However, the lending cuts may weigh on small medium enterprises (SMEs) in the petrochemical market as most SMEs face issues of tight capital. Some SMEs may cut production or shut down plants as a result, and we may see a price increase in these petrochemical markets,” said the researcher who declined to be named.

He added that the shutdowns will mostly be in downstream sectors, as upstream or raw material producers have flexible supply of capital.

Analysts said that inflation would likely slow in the third quarter as the government measures take effect.

“We believe that inflation will be contained in the middle, or late, of the third quarter. And by that time, the economy would regain growth as many government-invested projects in the energy, hydropower and infrastructure sectors will drive up investments,” said Li.

They also predict that the central bank might hike interests rates again in June or July in view of the high inflation. 

 “We expect that such hikes would only be once or twice for the rest of the year, with the economy gradually turning to healthy growth and low inflation in the third quarter,” said Xie Yaxuan, an economist at Shenzhen-based brokerage, China Merchants Securities.

Flemming Nielsen, a senior analyst at Danske Bank, agreed: “The People’s Bank of China will continue to hike its leading interest rate and the reserve requirement, and the appreciation pace of the yuan against the US dollar will continue to be solid.”

 “CPI inflation is expected to remain elevated at current levels until the third quarter, when it should start to decline markedly. If anything, there is probably some downside risk to inflation due to the recent drop in some food prices in China and the recent correction in some commodity prices on the global market,” he added.