It isn't just the weather. China's inflation problem has deeper roots, and getting it under control means taking a harder line with banks.
Consumer-price gains have been topping China's annual target of 3% since May. For much of this time, inflation was dismissed as a blip after unusual summer weather. Because food accounts for a third of the consumer-price basket, the mantra was that a good harvest later in the year would bring the overall figures down.
That hasn't happened, despite a good harvest, and Beijing is changing its tone. Last week, the government declared a shift to 'prudent' monetary policy next year from 'moderately loose' currently. Controlling inflation isn't as simple as capping prices and boosting the supply of agricultural commodities.
Certainly, weather has played a role in the volatility of food prices, but a greater predictor of price changes, including food prices, is money supply. Growth in money supply peaked only last November, and tends to lead inflation by 12 to 18 months.
This observation has two key implications. First, prices could keep rising, because the full impact of last year's unprecedented lending binge has yet to unfold. Second, much of Beijing's anti-inflation efforts to date-- targeting the supply of food-- are beside the point.
The good news is that policy makers have several tools at their disposal to get a grip on money-supply growth. The central bank has already started raising benchmark interest rates and the ratio of deposits that banks must hold in reserve.
The single most important lever, however, is China's annual lending target-- a quota on new credit issued by banks. But pulling this one won't be easy. China's banks have already tested regulators' resolve to enforce the quota by lending out 92% of this year's 7.5 trillion yuan ($1.13 billion) allotment by the end of October.
Sticking to the quota, then, would mean banks have to cut back sharply on lending this month. More likely is that authorities have cut the banks some slack, and some are betting that data for November, expected this week, could show that.
If that's the case, even a lowered quota at the start of the new year won't be taken too seriously. What's more, lending tends to surge in the early months of the year as the quota is reset.
Policy makers' dilemma is that lending has been a key driver of economic growth, and cutting it back may mean accepting lower growth rates. But with total money-supply growth already ahead of official targets, Beijing needs to get serious about the root cause of inflation. That means restoring its authority over the country's banks.
