Fears of Unrest As Inflation in China Hits 12-year High

Inflation in China soared again last month to 8.7%, the highest rate in almost 12 years, sparking heated debate about the causes and the authorities' potential response.

Analysts believe that much of the jump in the consumer price index, which follows a record 7.1% reading in January, is due to disruption from fierce winter storms. But the rise is still well above analysts' predictions of about 8% and follows last year's tripling of the annual rate to 4.8%.

The trend poses a huge challenge not just for China - given the role of rocketing prices in triggering previous social unrest - but also for other countries, which fear importing inflation as the cost of Chinese products rises. The producer price index hit a three-year high of 6.6% last month.

But while some analysts think another rise in interest rates is imminent, others believe the central bank will hold off in the short term after raising interest rates six times and banks' reserve requirements 10 times in 2007, apparently to little avail.

The National Bureau of Statistics said food costs rose 23.2% last month, compared with February 2007 - a huge increase in a country where households spend a third of their income on food. There is also concern that expectations of inflation are fueling the surge.

Chen Jijun, an analyst at CITIC Securities in Beijing, told Reuters: "After so many months of big rises ... the risks are high that China will see more broad-based inflation. Though non-food inflation is only 1.6%, it has been accelerating."

Monetarist explanations of the problem are gaining ground. Hong Liang and Yu Song, analysts with Goldman Sachs in Hong Kong, cited rapid money supply growth as the main driver of inflation and expect a modest interest rate rise.

But Michael Pettis, a former banker and now professor of finance at Peking University, said rate hikes had failed and, like the appreciation of the yuan, may have exacerbated the problem. "If you stick money into a Chinese bank account, you get 4% interest and 8-10% appreciation over the year. In the US you get 2%," he said.

Only a "maxi-revaluation" - abruptly raising the yuan's value by 15-20% - would halt hot money inflows, he said. "It's a bad option, but the rest are worse."