China will have difficulty keeping inflation under 5%

Beijing: China will be doing well if it can keep inflation below 5 per cent this year, influential former lawmaker Cheng Siwei said, one of the starkest warnings yet about price pressures facing the economy.

While it is "imperative" to increase interest rates, he said this might not be feasible, marking a rare admission about how Beijing feels that its hands are tied on monetary policy.

With expectations rising for yuan appreciation, higher rates would only serve to attract more speculative capital to China and add to the economy's excess liquidity, the former vice-chairman of the national parliament told Reuters in an interview.

As a result, Cheng said China must try to coordinate policy with other major economies, to increase interest rates at the same time as the United States, the euro zone and Japan. He said G20 meetings at the end of June would provide a good opportunity to discuss this coordination.

Economists argue that China's decision to peg the yuan to the dollar is what constrains its independence on monetary policy. Cheng acknowledged this line of reasoning, but said reform of the currency was not a simple matter and that the government should only gradually move to a freely convertible currency.

Although Cheng is no longer an official, he is still well connected in Beijing and has knowledge of thinking at the highest levels of government.

The government is targeting an average of 3 per cent consumer price inflation this year.

Officials have repeatedly stressed that managing inflationary expectations is a priority, but have, at the same time, maintained that price pressures are under control after inflation averaged 2.2 per cent in the first quarter.

Cheng was less sanguine. "Last year, China paid a heavy price in order to ‘protect eight'," he said, referring to the stimulus spending and explosion of bank lending unleashed in 2009 to ensure that the economy would not slip below the government's target of 8 per cent growth.

"The result is that we have an inflation risk," he said. "Last year, if we had not done this, the economy would have been in bad shape. It was necessary. So it is now a question of balance. This year, we are talking much less ‘protecting growth'."

China will fully exit from its stimulus policies in the second half of 2010, he said.

An official with the National Bureau of Statistics told Reuters yesterday that China should have no difficulty achieving 9 per cent economic growth this year but needs to beware of mounting inflation.