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. 
 
INVESTMENT BANKS INTERESTED BUT NOT CONCERNED...YET 
--------------------------------------------- ------ 
 
 
BEIJING 00005578  003 OF 003 
 
 
¶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