CURE FOR COMPLICATIONS

Containing inflation has been listed as the top priority of China's macro-economic policy this year. But analysts are divided over the likely course of inflation, with some expecting it to subside during the summer as supply constraints ease and others foreseeing a long struggle.

Likening inflation to a "complication" triggered by excess liquidity around the world and domestic economic-restructuring policies that are also changing (and raising) the cost structure, managing director Zhang Ning at UBS Global Asset Management said that China needed a cocktail of therapies.

"Though unable to curb inflation, the administrative interventions will slow it down and prevent it from becoming malignant," he said. His list of therapies would include a stronger yuan to accompany what he expects will be lower capital inflows, as well as incentives for capital outflows.

By accelerating the appreciation of the yuan, China could ward off at least some imported inflation, curb its rocketing trade surplus to ease the inflationary pressure exerted by massive foreign exchange reserves, and cut demand for oil, metals and grain, curbing domestic price hikes, Zhang explained.

SOAKING UP LIQUIDITY

China's central bank, the People's Bank of China, used six interest rate hikes and 10 reserve requirement ratio increases last year to tighten monetary supply. As of January 25, the reserve requirement ratio rose another 50 points to 15 percent, the highest level in 24 years.

Also, the Ministry of Finance stepped up its treasury bond issues last year to an aggregate 2.35 trillion yuan (about US$325 billion), an increase of 1.46 trillion yuan from 2006.

However, analysts have warned that in some respects, China is going against the grain: although other countries may also be cutting taxes, they are also trying to stimulate their economies with looser monetary policies to cushion the impact of what is increasingly expected to be recession in the United States.

Experts have said that China must walk a fine line in trying to curb inflation without throttling back growth. In particular, they've warned against excessive reliance of monetary controls. Smaller companies in China have already started to feel the pinch of monetary tightening, with many finding it difficult to secure bank loans, economist Wang Zhihao with the Standard Chartered Bank noted.

"If the authorities are to carry out tightening measures throughout 2008, the Chinese economy might possibly suffer a serious double-whammy impact, with the domestic demand- and export-oriented sectors equally affected," said Wang Qing, Morgan Stanley's Chief Economist for Greater China.

Another factor is the government's determination to restructure the economy with a move toward better quality and higher value-added activity. The policies intended to implement this goal range widely, from energy conservation to the protection of employees' rights, but they all have a common effect: lifting the country's production costs.

Officials have acknowledged that China is unlikely to be the cheapest country any longer.

Calling this rebalancing a "substantial one-off adjustment that may result in benign inflation," UBS's Zhang warned that the government must weigh the possible adverse impact of price intervention and not be too hasty with a sweeping economic transformation.