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China’s Currency, Inflation & the Supply Chain

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.”

8 comments on “China’s Currency, Inflation & the Supply Chain

  1. stochastic excursion
    February 22, 2011

    China received a significant brow-beating as it moved its currency policy to be less dependent on the dollar.  I hope there is more than bluster and the saber to the United States' strategy for maintaining the dollar's solvency.  Forward-thinking people might have foreseen the shift in posture in China from a growth potential as an emerging economy, to a cash-rich economy looking to invest.  Are American industries appealing as an investment?  There might also be some rumbles if China moves to take something close to a controlling interest in some industries.  That might awaken protectionist sentiment in quarters where it has been deafeningly silent on that note up to now.

  2. SunitaT
    February 22, 2011

    Nicole,

     Dont you think this is a very good oppurtunity for US high-tech manufacturers to shift the jobs back to US, because inflation in China coupled with rise in crude pricess will push the manufacturing costs higher. Only question is if this rise is comparable to the extra manufacturing costs incurred onsite.

  3. Ms. Daisy
    February 22, 2011

    It is just a matter of time for the companies that moved to China to start reconsidering their move and beat a retreat. Obviously the Chinese economy that is heating up will eat out of these companies bottomline, but more importantly is the Chinese policy of favoring Domestic development and consumption at the expense of the multinational manufacturing companies.

    The party is winding down for these companies and will soon be at the mercy of the rising Yuan.

  4. Barbara Jorgensen
    February 22, 2011

    I think the biggest implication is the “outflow” of money mentioned in the article–where will China start making investments? Will we see Chinese companies locating in the US or Europe?

  5. Ms. Daisy
    February 22, 2011

    China is currently heavily invested in West African countries like Nigeria. It is buying up Rare metal mines and investing in manufacturing in these places. This is a win-win for China. It is able to spend its wealth that it amassed from manufacturers that moved in from the West thereby cooling its economy and on the other hand products that are shipped to these developing countries are now manufactured and sold there. That is also a savings on shipping! 

    China is in a really good place if it is able to keep its internal turmoil in check. I am told Chinese investments are also extending into East Africa. Definitely, China is on the move and it has the money to buy up all that China needs.

  6. The Source
    February 22, 2011

    Tirlapur,

    I just can't say whether it's a good opportunity for U.S. high tech manufacturers to uproot themselves from China and establish a geater manufacturing presence in the U.S.  The sheer size of China's population – 1.3 billion peope – is reason enough to keep U.S. manufacturing plants in that country as well as outsource manufacturing there.  China's middle class is growing and the low cost of production, in part due to China's low wage rates, is still an important benefit to U.S. manufacturers.

    Another consideration is that U.S. manufacturers may look to other low cost production nations like Egypt, for example, which holds great promise with its 82 million people, low wage rates and an attractive exchange rate (one U.S. dollar is worth approximately six Egyptian pounds).

    We may find that the new winds of change in the Middle East may create brand new opportunities that make more investment sense to U.S. manufacturers than establishing more manufacturing plants in America.

  7. Adeniji Kayode
    February 23, 2011

    China has more places to invest into apart from U.S. and Europe.

    The rate at which China is expanding her tentacles in the market place in Africa is alarming.

  8. tsimakis
    February 23, 2011

    Im not sure why the US continues to allow China to eat our lunch.

    We helped build China and we are captive to them

    due to our borrowing with them.

    The U.S. must get its house in order.

    We have had weak leadership for the past 12 years.

    We need a new Ronald Reagan and fast.

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