Recent financial articles have focused heavily on one aspect of the US Treasury Department’s foreign currency report: its determination that China was blameless of currency manipulation.
Much less attention was paid to the document’s analysis of China’s changing economy and its increasing inflation rate, which is a factor US electronics manufacturers operating in China need to be cognizant of as they mull over supply chain strategies.
The document — “Report to Congress on International Economic and Exchange Rate Policies” — was published earlier this month and focused on international economic and foreign exchange developments in 2010. It found that last year was one of major economic shifts aimed at rebalancing China’s economy.
The report comes in the aftermath of the June 2010 decision by the Chinese government to resume a policy of gradually allowing the value of China’s currency, the yuan renminbi, to be determined by market forces. Prior to that, China’s currency was pegged to the US dollar.
Since then, the yuan (as of January 27) had appreciated by a total of 3.7 percent against the dollar. The report also noted that “inflation in China is significantly higher than it is in the US (in the second half of 2010, the annual rate of CPI inflation was more than 5 percentage points higher in China than in the US), the [yuan] has been appreciating more rapidly against the dollar on a real, inflation-adjusted basis, at a rate which, if sustained, would amount to more than 10 percent per year.”
China’s soaring inflation rate could have significant implications for US electronics manufacturers' profit margins. Even a 1 percent rise in inflation can cause cost disruptions at every stage of the supply chain from the price tag for component parts to the distribution of goods to the final sale of the product.
Here are key comments from the report:
- Throughout 2010, China shifted to less stimulative monetary and fiscal policies in an attempt to contain rising prices in both goods and property markets. China’s fiscal deficit decreased from 2.3 percent of GDP in 2009 to 1.6 percent in 2010, as rising growth boosted revenues. Total bank lending growth fell from a record high of 31.7 percent in 2009 to 19.9 percent in 2010, while broad money (M2) growth fell from 27.8 percent to 19.9 percent.
The People’s Bank of China (PBOC), increased the amount of reserves that large commercial banks are required to hold at the central bank, from 15.5 percent of total deposits at the beginning of 2010 to 19 percent as of mid-January 2011. The PBOC also raised China’s benchmark 1-year lending rate 50 basis points from 5.31 percent to 5.81 percent, although this increase was less than the rise in the inflation rate.
Despite these policy measures, the inflation rate continued to climb and there are signs of rising inflation expectations. China’s consumer prices rose 4.6 percent year-over-year in December 2010, up from 1.9 percent in 2009. Non-food consumer price inflation reached 2.1 percent year-over-year in December 2010, its highest level in over ten years.
To fend off inflation and cool down its heated economic growth, China’s central bank in Beijing raised interest rates this month, increasing its benchmark one-year deposit rate by a quarter of a percentage point to 3 percent. While China’s monetary policies continue to change, the country’s fiscal policies are also undergoing significant policy modifications. Currently, plans are afoot to shift the focus from one of satisfying foreign consumer demand to one of generating greater domestic consumer demand.
Preliminary reports of China’s next 5-Year Plan, to be announced in March, indicate China will spend more on health and education, increase and more strictly enforce minimum wages, allot more funds to private sector investment in services, expand access to financial products for households and small businesses, and increase taxes on carbon and pollution-intensive industries, according to the US report.
While US high-tech manufacturers develop plans to mitigate risks in a continuously changing Chinese economic environment, supply chain executives must closely monitor the potential impact of these policies, not only on supply and demand, but also on their profit margins. Lael Brainard, US Under Secretary of the Treasury for International Affairs alluded to this fact at the recent US-China Business Council's “Forecast 2011” Conference.
“What is more interesting today is the choices China will make as it navigates the transition from an economy powered by foreign export demand to one that unleashes the purchasing power of domestic consumers; from a large magnet for foreign investment inflows to a growing source of investment outflows; and from adoption and adaptation of foreign technology to an innovation society,” Brainard said. “As China navigates this transition, the choices it makes matter for America’s economic interests.”