Coming in for a landing

Strange reports started popping up in the Chinese media in mid-April that farmers were unable to sell their produce due to low prices. During April the price of food in China increased by 11.5%， yet the price a farmer could get for Chinese cabbage had， according to one report， dropped from RMB 3-4(USD 0.46 – 0.62) per kilo to around RMB 0.1 per kilo.

Chinese media reports cited three causes for the collapse of prices in Chinese cabbage: cyclical behaviors in farming – high prices lead to overplanting and thus a subsequent crash in prices; unusual weather patterns resulted in cabbage coming to the market simultaneously in the North and South (regional growing seasons are usually separated by a few months); and an excess of middle men.

These issues are all a matter of market access. Farmers are unable to sell directly to larger markets， and where the weather is different， farmer behavior is different， not to mention middle men have to compete harder for the farmer’s produce. It is this sort of issue that is behind much of China’s attempt to control prices. What looks at first like a question of supply， demand and excess liquidity， is instead a complex problem that involves balancing a partially open， partially closed market.

Total consumer price inflation hit 5.3% in April， with non-food inflation rising only 2.7%. Non-food inflation has been slowly trending upwards， while food inflation has more or less vanished because of price caps. A better harvest， after last year’s drought， means price growth should return to normal within the next six months. The price of coal has also made its way above the government’s price caps， with reports of power shortages along the Southeastern coast.

Despite high inflation， the central government has kept monetary policy somewhat loose， as bank lending increased 17.5% in April， against nominal GDP growth of roughly 16%. There has been some mopping up of liquidity， with a reserve ratio requirement hike in the middle of May， but this was mostly done to deal with trade deficit， not money already in the system.

There is some debate over whether further tightening is necessary. Food price inflation has been dropping， and the global recovery has stalled. April’s Purchasing Manager Index (PMI)， a measure of industrial activity， dropped from 53.4 to 52.9. The finished goods inventories component was at 50.8. If it hovers at around 50 for any length of time， it would imply a need for inventory destocking. Real estate sales dropped by 10%， though investment remained high， at 35%， due to a shift in the industry from commodity housing to social housing.

Still， the Chinese economy faces some risk of overheating. Capacity increased quite rapidly in the past six months， as exports grew 29.9% year-on-year in April， and the trade balance， after a few low months， hit USD 11.4 billion. Power consumption is growing at almost 20% a year in areas where the fastest industrial growth is taking place， and non-food inflation， while not incredibly high， has been stubborn.

While some of these trends have taken the form of sudden shocks， which the government has been forced to deal with through direct market intervention， many have underlying long-term issues， which the government is attempting to manage by removing itself from the market. Among them， the most talked about is the trade balance. This only supplies liquidity to the market through government interventions in order to keep the price of the RMB steady， and while the government has been increasing the number of interventions， it has also been increasing the value of the RMB， thus intervention has become less needed. The value of the currency rose 0.5% against the dollar last month.

Agriculture is likely to be the next place where the government has to take action. The government’s long-stated goal of self-sufficiency in agriculture is quickly becoming unfeasible. China has 7% of the world’s arable land to feed 20% of the world’s people. With meat consumption rising， China has recently begun importing grain for feeding livestock， a trend that looks to continue. While this could limit China’s ability to put price caps on food， it should increase profitability of local farms， and make the overall market less vulnerable to small weather shocks.