Economists say inflation to slow, warn of high local government debt

Without waiting for the release of official statistics, investment institutions are releasing estimates about how China's economy fared in July.

In all likelihood, the consumer price index, a measure of inflation in the consumer market, will show a year-on-year increase rate of 1.7 percent in July, the first time such a figure has dipped below 2 percent in two and a half years. If the estimate proves accurate, the rate will also be down from the 2.2 percent year-on-year rate recorded for June.

Among the estimates made by economists surveyed by the business information website Caixin.com, the lowest rate of increase predicted for the July CPI was 1.5 percent.

Meanwhile, the producer price index, a measurement of inflation in production materials, was expected to record a negative 2.5 percent rate of change, indicating that further price declines are likely to be seen in the consumer market in the coming months.

At the same time, Ministry of Commerce data show that food prices, which used to be the main driver of inflation, increased at a mild pace in the last week of July.

Other estimates said China had a trade surplus of $31.6 billion and issued 863 billion yuan ($135.6 billion) in new loans during the month.

While inflation is no longer as great a threat as it was in the early months of the year, economists are divided about how long the current low CPI can last.

Their doubts arose in part after many government agencies decided to embark on aggressive investment plans in an attempt at accelerating the country's economic growth, which has been slowing since the beginning of the year.

Will these projects be tantamount to a Chinese version of quantitative easing?

And will they, in due course, again drive up the prices of production materials and lead to a new round of inflation?

Even worse, will they add to the already heavy debts that are weighing on many provincial and municipal governments?

Economists and business commentators are anxiously discussing these possibilities.

Rather than the central government, which took steps to stimulate the economy in late 2008, local governments are now the entities adopting policies meant to stimulate economic growth - a trend commentators have deemed "4 trillion yuan program 2.0".

That name refers to the stimulus policies Beijing enacted in response to the financial troubles that bedeviled Wall Street in 2008.

Through those, 4 trillion yuan ($635 billion) in new government investments were used to sustain China's economic growth.

By Aug 2, 30 provinces, municipalities and autonomous regions had issued reports concerning their fixed-asset investments in the first half of the year. Of those, 26 saw their investments increase at a rate that was faster than the national average increase, according to China Enterprise News, a newspaper run by the China Enterprise Confederation and Chinese Enterprise Directors' Association.

The southwestern province of Guizhou saw its fixed-asset investment increase by 58.1 percent year-on-year. Shanghai, in contrast, recorded a growth rate of 4.5 percent.

The newspaper quoted an official in the National Development and Reform Commission as saying that even though the central government has no plans to adopt a stimulus package similar to the one it had in late 2008, local governments have come up with their own versions of financial stimulus.

Much as Beijing did a few years ago, many local governments' stimulus spending is going into large-scale public-works projects.

"We may be racing recklessly toward an abysmal state of government indebtedness," Ye Tan, an independent business commentator, told the newspaper National Business Daily.

She noted that 24 cities introduced ambitious urban development investment programs from June to July. Those have a combined budget of almost 500 billion yuan.

On July 25, Changsha, capital of Hunan province, introduced plans to make various important investments. The city listed 195 projects, which are expected to be undertaken at a cost of nearly 830 billion yuan.

Many economists expressed reservations about the "4 trillion-yuan program 2.0".

According to Zhao Xiao, an economics professor with the Beijing Institute of Technology and a former National Development and Reform Commission official, Chinese local governments' debts increased by as much as 40 times in 13 years, hitting 10.7 trillion yuan by the end of 2010.

Much of that spending has been slow to generate significant returns and is therefore considered to be largely unsustainable, Zhao said.

Local governments' stimulus plans are likely to lead to even worse overcapacity in some industries and even worse government debt, he said.

Zhao cited research suggesting that China's credit-to-GDP ratio is now as high as 123 percent, higher than that of the United States, whose credit-to-GDP ratio is about 60 percent. In 2012, local governments' debt-to-asset ratio is expected to exceed the danger point of 20 percent, increasing to as much as 26.6 percent.

China will have to pay a high price, Zhao warned, for its twisted and lopsided understanding of Keynesian economics.