Will China's Rising Inflation Put Pressure on Monetary Authorities To Revalue the Yuan?

Inflation in China is beginning to focus attention once more on its foreign exchange peg. The Chinese Yuan has remained close of 8.3 Yuan to the US dollar since the devaluation of January 1994.

Consumer prices in August were 5.3% above August of a year ago, the same rate as in July. The year over year increase has risen steadily since February of this year.

Producer Prices have shown even greater year over year increases. In August the rise was 6.8% compared with 6.4% in July. The year over year increase has risen steadily since October, 2003. The first chart shows the year to year increases in consumer and producer prices. (These data are from the Haver's EMERGEPR, database, which provides country sourced data.)

Until now the monetary authorities have resisted foreign pressure to appreciate the exchange rate; and, instead of fighting inflation with rising interest rates that would favor a higher Yuan, they have relied on credit controls to dampen inflationary pressures. The second chart shows the sharp fall in the year to year change in deposit money bank's claims on the private sector since early 2003 and the stability of the bank's prime lending rate. (These data are from Haver's IFS database, which provides data supplied by the International Monetary Fund.)

The government has contended that it needed time to ensure that an orderly process would accompany any revaluation of the currency. With inflation rising and the controls now in danger of disrupting investment and growth, the government may finally resort to raising interest rates and allowing some flexibility in its exchange policy.