News Room - Business/Economics

Posted on 25 Feb 2008

As China's inflation soars, world fears knock-on effects

As China's factory floors feel the pressure from spiralling costs, there is growing nervousness in the rest of the world that the Asian giant's next big export could be inflation.

From air-conditioned US shopping malls to bustling African street markets and remote Asian villages, shoppers have become accustomed over recent years to the vast array of ultra-cheap Chinese goods on offer.

China's trade surplus last year reached 262.2 billion US dollars, a more than 10-fold rise from 2003.

But now a confluence of factors, led by soaring domestic inflation that hit an 11-year high of 7.1 per cent in January, is ramping up the costs of doing business in China, with potential knock-on effects for the rest of the world.

As China's currency has strengthened sharply against the US dollar, the government has scrapped export tax rebates, while more stringent labour laws and even the ice and snow storms in southern and central China have further driven up costs.

"China's inflation is having a domino effect on worldwide inflation, especially in the United States," Li Huiyong, an analyst from Shanghai-based SYWG Research and Consulting, told AFP.

"In the past, (outside) inflation pressures in the US mainly came from oil prices because the US economy is highly dependent on crude oil. Cheap products from China and other developing countries helped to alleviate that pressure.

"Now Chinese goods are no longer as cheap it adds to the inflation pressure in the United States."

Nevertheless, while it is clear that doing business in China is getting more expensive, there is no consensus among economists about how much that will translate into higher price tags for Chinese-made products overseas.

Wang Qing, chief China economist at Morgan Stanley, stressed that Chinese competitiveness was not about to disappear and goods from Asia's most populous nation would remain cheap for years.

This would be the case as products moved up the value chain from toys and clothes to cars and high-tech machinery, according to Wang.

"I don't think the days of cheap Chinese goods are over. The inflation that China is experiencing now has a cyclical component. By that I mean the high inflation won't be sustainable," he said.

"What's more important is that you should not just focus on nominal wage growth, you also need to pay attention to labour productivity growth. That's why I think we shouldn't be too alarmed about this."

And given the long and complex business chain between suppliers in China and overseas consumers, a rise in manufacturing costs does not mean that shoppers will immediately have to pay more for Chinese products.

Aside from cutting their own margins, factories and traders can first look to their clients, many of whom charge huge mark-ups on the wholesale price, to take on more of the financial burden.

For instance, the price of making a branded T-shirt in China may be just a few dollars, but they are typically sold in US malls for 10 or more times that price.

Companies intent on paying bottom dollar for their products could move operations to nations with cheaper overhead costs, such as Vietnam, Sri Lanka or Cambodia.

Alarm bells are definitely ringing in boardrooms across China.

Eating into exporters' profit margins, producer prices jumped 6.1 per cent last month to a three-year high.

Meanwhile, labour wages last year rose 20 per cent and the yuan has appreciated more than nine per cent against the US dollar in the past 14 months.

This has meant that more exporters face bankruptcy unless they lift prices to salvage their disappearing margins, which is just what most plan to do.

According to a survey by brokerage and research firm CLSA, 80 per cent of Chinese exporters intend to raise prices this year in response to higher raw material costs.

"The appreciation of the renminbi (yuan) against the US dollar is a secondary factor driving these price hikes," Shanghai-based CLSA economist Andy Rothman said in the survey.

Yatta Mao, a trade manager at Shanghai-based chemical trading firm Hanren, told AFP the tighter business conditions that have emerged over the past year were making it difficult to survive.

"The yuan appreciation has a huge impact on our business. It costs us much more in the production and delivery costs. What's worse, the export tax rebates of 13 per cent were cancelled so our total costs are up 20 per cent," she said.

And in China's southern province of Guangdong, which borders Hong Kong and is one of the nation's main export hubs, there are deep feelings of pessimism.

Thousands of Hong Kong- and Taiwan-owned factories based in Guangdong are likely to close soon as they seek cheaper overheads elsewhere, said Alexandra Poon, director of policy research at the Federation of Hong Kong Industries.