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### Viewing cable 07BEIJING5578, INFLATION SPIKE GETTING ATTENTION FROM LEADERSHIP, MEDIA,

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
07BEIJING5578 | 2007-08-23 07:50 | 2011-08-23 00:00 | UNCLASSIFIED//FOR OFFICIAL USE ONLY | Embassy Beijing

`

    VZCZCXRO7774
    PP RUEHCN RUEHGH RUEHVC
    DE RUEHBJ #5578/01 2350750
    ZNR UUUUU ZZH
    P 230750Z AUG 07
    FM AMEMBASSY BEIJING
    TO RUEHC/SECSTATE WASHDC PRIORITY 1212
    INFO RUEHOO/CHINA POSTS COLLECTIVE
    RUEATRS/DEPT OF TREASURY WASHDC
    RUEHC/DEPT OF LABOR WASHDC
    RUCPDOC/USDOC WASHDC
    RUEHGV/USMISSION GENEVA 1934
    RUEHFR/AMEMBASSY PARIS 4153
    RUEHRC/USDA FAS WASHDC

` `

    UNCLAS SECTION 01 OF 03 BEIJING 005578

    SIPDIS

    SENSITIVE
    SIPDIS

    E.O. 12958:  N/A
    TAGS: ECON EFIN PGOV ETRD EINV CH
    SUBJECT: INFLATION SPIKE GETTING ATTENTION FROM LEADERSHIP, MEDIA,
    AND PUBLIC

    SUMMARY
    -------

    ¶1. (SBU) With CPI inflation hitting a ten-year high of 5.6 percent
    in July, there is now widespread concern among the public, extensive
    coverage in the media, and evident attention from China's senior
    leadership to rising prices.  The spike over recent months is
    generally viewed as resulting from short-term food price shocks, but
    some economists are also drawing attention to excess liquidity and
    other structural factors that could lead to a longer-term and more
    chronic problem.  Premier Wen Jiabao has become publicly involved,
    in particular engaging in a series of activities related to
    addressing rising pork prices.  Septel lays out the continuum
    between viewing the inflation issue as a supply-shock problem, a
    monetary policy challenge, or both.  END SUMMARY

    INFLATION HITS 5.6 PERCENT IN JULY
    ----------------------------------

    ¶2. (SBU) CPI inflation accelerated to 5.6 percent year-on-year in
    July to mark China's largest increase in prices since February 1997.
     The July figures were prefaced by a steady build up in CPI
    inflation through the first half of 2007, with June registering a
    33-month high at 4.4 percent.   Prior to 2007, the CPI had been
    holding steady at 1.5 percent per year in 2005 and 2006.  Many
    analysts now project China's CPI to reach between 3.5 and 4 percent
    this year.

    ¶3. (SBU) Core inflation remains quite low, however, and non-food
    prices increased only 0.9 percent in July year-on-year after rising
    1.0 percent in June.  Food prices surged 15.4 percent in July,
    accounting for the lion's share of the CPI increase (approximately
    one-third of China's CPI basket is derived from food prices).  In
    particular, rising demand for pork (for which the price increased by
    45.2 percent) and eggs (30.6 percent) has driven food inflation.
    Corn prices also have increased dramatically with rising demand for
    livestock feed and ethanol for biofuels.  In addition, vegetable
    prices increased 18.7 percent in July following recent flooding in
    South China.

    INFLATION UNDER THE MEDIA MICROSCOPE
    ------------------------------------

    ¶4. (SBU) The CPI increases have attracted increasing media attention
    with inflation-related articles running on a daily basis.  The July
    CPI surge was a front-page headline in the Beijing News (Xin Jing
    Bao), with a full page devoted to coverage on the inside.  In one
    article, Beijing University Economics Professor Song Guoqing stated
    that the CPI increase demonstrates an obvious trend towards
    overheating in the economy.  Xin Jing Bao had first warned in a May
    30 article that food price increases were beginning to exert
    inflationary pressure.  A July 31 editorial in the English-language
    China Daily stated that policymakers are increasingly challenged on
    how to strike a balance between stabilizing prices and refraining
    from undue market intervention.

    GOVERNMENT FOCUSED ON MANAGING EXPECTATIONS
    -------------------------------------------

    ¶5. (SBU) In order to address the public's concern, the Chinese
    Government has sought to reassure consumers during July and August.
    Warning that "inflationary risks are trending higher," the PBOC's
    2nd Quarter report pledged to moderately tighten monetary policy in
    order to keep a lid on prices and prevent expectations of rising
    inflation.  Tackling the supply side, a State Council circular on
    August 2 aimed to boost pork supplies and mitigate food inflation by
    establishing a subsidy system for sows and providing sow insurance.
    (Note:  The General Manager of New Hope Group, one of China's
    largest livestock feed processors, told Econoff on August 7 that the
    regulation would have a positive impact on pig production.  End
    Note.)

    ¶6. (SBU) The State Council also took measures to offset costs for
    the poorest citizens in both urban and rural areas, issuing new
    regulations on the minimum standard of living allowance (dibao),
    raising the subsidy in urban areas by RMB 15 (USD 2) in July and
    then announcing in August that the benefits under the new national
    dibao program for rural areas should take local food prices into
    account.  Ma Kai, Chairman of the National Development Reform
    Commission (NDRC), however, tempered expectations that welfare
    subsidies would be sufficient to offset rising prices, stating at a
    work conference on July 30 that prices would continue to rise in the
    face of demand pressures.

    BEIJING 00005578  002 OF 003

    PREMIER WEN'S PERSONAL INVOLVEMENT
    ----------------------------------

    ¶7. (SBU) Premier Wen Jiabao has become increasingly focused on CPI
    concerns in the months since the pork price shock was first
    reported.  With a view towards maintaining social stability,  Wen's
    activities have focused on pork prices and have included the
    following:

    --On May 26, Wen visited pork production facilities and markets in
    Shaanxi Province and met with provincial officials to discuss price
    control efforts.

    --On June 13 and again on July 25, Wen chaired separate State
    Council Working Conferences where he focused on stabilizing pork
    market supply.

    --Wen made front page news after he visited two Beijing agricultural
    wholesale markets on August 4 and stated that the CPI increase has
    caused concerns for all walks of life.

    ¶8. (SBU) According to Wang Tongsan, Director of the Institute of
    Quantitative and Technical Economics at the Chinese Academy of
    Social Sciences (CASS), Wen's interest in the issue has been
    important to demonstrate to the public that the leadership is
    concerned about rising prices.  The current preoccupation of most
    government officials on their own political futures in the run-up to
    the National Party Congress, however, suggests that the government
    is not likely to implement new measures to curb inflation until
    November, stated Wang.

    FIVE REASONS TO BE CONCERNED
    ----------------------------

    ¶9. (SBU) Wang agreed with other analysts that the pork price spike
    is temporary and serves only as a trigger for the recent CPI
    increase. However, he also pointed to structural factors that could
    lead to a "more and more serious" long-term inflation problem.  He
    discussed five underlying economic factors that raise concern:

    --cost-push inflation: as indicated by the increase in the CPI now
    being higher than the PPI for the first time in recent memory;

    --demand-pull inflation: as demonstrated by excess growth in the
    money supply and residents' income rising faster than the GDP growth
    rate for the first time in several years;

    --energy savings and pollution reduction targets: these will
    increase the cost of production;

    --rapid growth in the economy: (especially investment growth) GDP
    grew at 11.9 percent in the first half of the year, a rate generally
    viewed as above longer-term potential.  Investment growth was more
    than double GDP, at approximately 25 percent; and

    --the rise in international prices for oil, grain, and milk as well
    as other staple products.

    ¶10. (SBU) According to Wang, CPI inflation will not break through 5
    percent in 2007 but may reach 4 percent.  He referred to China as
    "entering an inflationary period," which he said would become a
    problem for the Central Government's macroeconomic regulation
    efforts.  Wang dismissed the argument that the low core inflation
    figure indicates that the inflation problem is limited to food
    products, stating that the CPI reflects price increases that impact
    the lives of average Chinese and thereby affect social stability.
    It is also important to acknowledge that the CPI as an instrument
    does not accurately capture all inflation in the economy, he said.
    Asset prices (especially stocks and real estate) are also causes for
    concern, he said.

    ¶11. (SBU) Wang expressed concern for inflation's impact on China's
    rebalancing efforts, but he does not believe there will be a
    significant influence on export prices.  He instead reiterated the
    oft-heard view that China needs to increase domestic consumption by
    increasing residents' incomes.  Raising domestic consumption in
    rural areas will be particularly important for minimizing the impact
    of price increases.  Subsidies to farmers, however, might be
    counterproductive as they cause consumption demand to rise and
    trigger inflation in the countryside.

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    ¶12. (SBU) UBS, JP Morgan, and Citibank all have expressed interest
    in China's CPI in recent weeks, but none have said China currently
    has a persistnt inflation problem.  With most of the inflatin to
    date coming from meat and eggs -- both commodities that are
    susceptible to temporary supply shocks due to disease -- the
    evidence points to a short-lived inflationary episode, wrote UBS's
    Jonathan Anderson in a recent research note.  After the July CPI
    figures were announced on August 13, JP Morgan's Asian Economic
    Research team, supporting a widespread view, stated that the spurt
    in food prices might keep headline CPI elevated in the near term but
    is not likely to persist.

    ¶13. (SBU) In question is whether the CPI figures merely reflect a
    supply side shock or suggest a deeper problem brewing related to
    excess liquidity entering the economy.  The economists are by and
    large focusing on the former and are not arguing that China's robust
    GDP growth (11.9 percent in 1H07) or rapidly accumulating foreign
    exchange reserves (over USD 1.3 trillion) suggest that overheating
    or an increasing money supply are behind a new inflationary trend.
    Several analysts stated, however, that problems may be on the
    horizon.  Goldman Sachs observed after the People's Bank of China
    (PBOC) issued its 2nd Quarter Monetary Policy Report that recent
    anecdotal evidence suggests that inflationary pressures are
    spreading rapidly into other consumption items.  Credit Suisse also
    cautioned that high headline inflation potentially could impact
    inflationary expectations and eventually affect non-food items in
    the long run.

    COMMENT
    -------

    ¶14. (SBU) Post will continue to follow China's CPI story as it
    unfolds with future reporting to focus on the impact of price
    increases in rural areas, the potential for exporting inflation, and
    the monetary policy response.  Chinese leaders clearly are concerned
    not only about the impact of price increases on macroeconomic
    regulation but also potential ramifications for social stability.
    For now, the food price spike appears to have triggered short-term
    inflation, but price fluctuations over the long-term will continue
    to merit attention.  END COMMENT.

    PICCUTA

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