China’s Social Stability Threatened by Inflation

Annual inflation in China hit 5.5% in May. This figure is the highest in almost three years and threatens the government’s desire to maintain the increase of price index (CPI) below 4% for 2011.

On the day of publication of these figures, the country’s central bank announced that the reserve requirement ratio of commercial banks increased to 21%. Chinese monetary authorities preferred the lever to lock a portion of the money supply rather than the interest rate. Adjusting the cost of credit in the coming weeks is not excluded, it would be the fifth since last October.

This measure was considered this week by some analysts of investment banks as a beneficial initiative designed to control the economy that showed signs of overheating.

Inflation is certainly a worldwide concern, but in the aftermath of a major economic crisis, one would think that a price increase, due to a demand that exceeds supply, is rather a symptom of recovery. China has committed two years to change the structure of economic growth and seeks to escape its dependence on exports, to rely more on domestic demand. From this perspective, inflation may be the result of an increase in domestic purchasing power and finally illustrate the ability of China to finally capitalize on its tremendous potential.

When the “bad” inflation is threatening social stability in China

But this increase in inflation does not accompany an acceleration of economic growth. The growth rate of Chinese, 10.3% in 2010, is expected to fall below 10% this year. Although strong growth appears to follow the reduction of trade surplus, exports and economic growth slows: China fails to shift its growth on a solid base of consumers inside its borders.

This “bad” inflation, which does not illustrate an acceleration of the economy, the “stagflation” which was the sign of the crisis that hit the West in the 1970s, is bad for the economy but especially for the fragile social stability.

This level of inflation was announced when uprisings occurred in Guangdong province which hosts 145 million migrant workers in the country. It is precisely for migrants, mainly from Sichuan, who reacted violently to an incident between police and a pregnant street vendor in the city of Zengcheng. Other demonstrations followed, including in Chaozhou, where hundreds of workers were demanding their arrears of pay. 19 people were arrested after the riots and the authorities has increased the budget for “public safety” by 13, 8%.

The causes of inflation

Core inflation in China is likely to worry the government, in search of growth capable of ensuring stability in the country. This inflation finds its source in rising food prices. It puts pressure on the entire population, including the poorest households.

This acceleration in inflation is partly due to the drought in recent weeks: besides the difficulty of irrigating the fields, shortages of electricity related to the decline in river flows were observed in some areas. The power plants have to ration energy supplies and prices have been mechanically pulled up.

The consumer prices have also included the increase in commodity prices, largely dependent on fluctuations in international markets.

Finally, the major recovery plan launched by China in the wake of the financial crisis seems to further fuel price increases. The 4,000 billion yuan injected by the government continue in effect to compensate for the willingness to tighten credit.