Intercedent Insight: December, 2010

Critical influences on the domestic economy in 2011 will be inflationary trends in the food sector which are expected to create upward pressure on the cost of industrial salaries.

The People’s Bank of China’s hiking of official interest rates by 0.25% in mid-October did little to contain inflation. UBS is predicting an average inflation rate in 2011 of between 4 to 4.5%.  Meanwhile, Bank of America Merrill Lynch also raised its CPI projection for next year from 3.6 to 4.5%.

China’s average per capita expenditure on food as a percentage of household expenditure (Engle’s Coefficient) in the first three quarters of the current year was 40% up from 37% in 2009 - high when compared to the United States or South Korea where per capita household expenditure on food is approximately 12.5%.

At the start of this year, the outlook for grain prices was already of concern due to loss of agricultural land, rising food consumption, depletion in the quality of agricultural soil, and renewed control over fertilizer usage to mitigate water pollution.   However, by the end of the year, food price rises are likely to surpass the Government’s high-end forecast of 10.1% over 2009.

Illustrating the problems it faces, the Government took recent action to control food prices using various tools including auctioning soybeans from the National Grain Reserve and using its Food Reserve Fund to subsidize domestic suppliers.

Given its emphasis on encouraging domestic consumption, the start of China’s next Five Year Plan in 2011 may also provide additional upward pressure on household inflation.

These inflationary pressures will be of concern to international companies involved in labor intensive manufacturing and sourcing in China with production costs predicted to rise next year. 

Already under pressure from the strengthening Renminbi, increased labor costs will also likely further erode the thin margins of Chinese exporters.

It may also trigger international prices for grain, food oil, and other key staples to rise stimulated by further imports of these items that would be released by the Government into the market to keep domestic food prices stable.

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