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By Tiger Tong, Contributor
On February 19, data released by National
Statistics Bureau showed China’s consumer price index (CPI) in
January surged 7.1 percent year on year, a new 11-year high.
A day before, it was reported that Japan’s
Nippon Steel, JFE Steel and South Korea’s Posco had agreed to pay
Brazil’s Vale do Rio Doce (CVRD), the world’s largest ore
supplier, 65 percent more for iron ores than they paid in 2006. The
three steel makers were the world number two, three and four largest
steel maker measured by 2006 production. It is an unstated rule that
Chinese steel makers will have to accept similar price hikes.
On the same day, crude oil futures was settled
at $100.01 a barrel on the New York Mercantile Exchange, the first
time it closed above $100 a barrel in history.
The first news alone might not sound too awful.
The disproportional weighting of foods in the CPI basket (about
1/3) makes China’s CPI figure a bit misleading. In January, like
the previous few months, inflation was mainly driven by food
(18.2-percent surge in January). Excluding food sector, China’s
inflation in January would only be 1.5 percent, though it was still
0.5-percent higher than that of the first half of 2007.
But the other two news certainly does not bode
well to China, who just beat the United States to become the
world’s second largest goods exporter and probably take the place
of Germany to become the world’s largest exporter in this year.
Behind the ascendance of China as the world’s
factory is the influx of foreign investment. In 2007, foreign
invested enterprises accounted for 57 percent of China’s exports
and 52 percent of the trade surplus. But the “China price,” by
which foreign investors to increase their profit margins and also
helps the world less concerned about inflation, is about to lose its
competitive edge.
The strong economic development and rapid growth
of private vehicle ownership has turned China to a big oil consumer
and importer. Since 1993, China has become an oil net import
country. Since 2003, China has replaced Japan as the number-two oil
consumer after the United States. In 2007, China imported 3.26
million barrels per day of crude oil, 12.4-percent higher than 2006.
With a flat domestic production, its dependence on imported crude
oil rose from 19 percent in 1999 to 47 percent in 2007.
At the same time, the fast urbanization and
industrialization in China also make it the world’s biggest
consumer and producer of steel. In 2007, China produced 489 million
tons of steel, a 15.7-percent increase on 2006. It accounts for 36.4
percent of the world production, more than double its share in 2001.
As a result, China’s thirst for iron ores reached a new high. In
2007, China imported 383 million tons of iron ores, 17.4-percent
higher than that of 2006. Imported iron ores accounted for more than
50 percent of China’s consumption.
As two most important commodities, crude oil and
iron ores, their price hikes will certainly increase China’s
domestic inflation pressure and erode the production cost advantages
of Chinese exports.
At the same time, some measures that aim at
making China’s economic development more balanced and more
sustainable will increase production costs in China further. From
this year, China adopts a new corporate income tax code, which will
increase the tax of low-end foreign manufacturers. Also from this
year, China adopts a new labor law to better protect workers, which
some investors claim might increase 20 percent to 30 percent of
staffing cost.
And there will be more upwards pressure to China
prices. For example, currently, electricity tariffs are temporarily
frozen to avoid adding more pressure on inflation. According to
policy, China’s electricity tariffs are supposed to be linked to
the coal price if it reaches a certain level. In the long run, to
levy higher electricity tariff is inevitable if the Chinese
authorities want to fully reflect the environmental cost, as
China’s power sector is the largest polluter.
There is no doubt that some foreign investors
will choose to relocate their production plants to other countries,
like Vietnam. But China will be still attractive as an investment
destination. However, the rising staffing costs is creating a bigger
market for foreign investors, as the domestic consumption may be
pushed up higher by the employees’ growing disposable income. At
the same time, the industry clustering formed in the past 30 years
might not be something other countries can achieve in a short period
of time. Expected acceleration in RMB appreciation will certainly be
a bonus on top of these factors.
More importantly, the adjusted production cost
in China will help to phase-out some low-end foreign manufacturers
in China, which will allow their Chinese counterparts to play a
bigger role in the market. It will benefit the Chinese people more
without further intensifying the problem of raw materials and energy
shortfall.
On February 19, data released from the Ministry
of Commerce show that in January, utilized foreign direct investment
more than doubled compared to the same period last year, reaching
$11.2 billion. But one month might not be long enough to make good
judgment. Time will tell as to which side of equation to invest in
China will prevail.
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Tiger Tong is analyst with China Knowledge, a
premier provider of trade and investment information on China.
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