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January 25, 2011

McKinsey has six predictions for China in 2011

Gordon Orr, a director in McKinsey’s Shanghai office, peers into 2011 and finds ways China may once again surprise the world

1. Inflation in food prices will take longer than expected to control.

Chinese consumption patterns are shifting as people become wealthier—more meat eating requires more cereals to feed the animals. The food supply chain, running at the limit, is close to breaking, and the pressures this problem creates will lead to further food quality crises. A major second- or third-tier Chinese city will see demonstrations over food price rises, unemployment, or both, on a much larger scale than anything that has occurred in recent years.



2. Middle-class bankruptcies will expand dramatically.

All that is needed for a wave of bankruptcies is further interest rate rises (targeting inflation) that result in a blip down in house prices just as mortgage payments rise. We have seen this before across major cities in Asia.

3. Minimum wages will rise, but productivity gains will outstrip labor costs. The profitability of industrial enterprises remained high at the end of 2010—indeed, higher, in many cases, than it had been a year earlier, despite the minimum-wage increases rolled out in 2010—and will probably remain high. Yet a government seeking to enhance its stature with lower-income workers will find that increasing minimum wages, perhaps by 15 to 20 percent, is an easy lever to pull.

4. China’s economic growth will be lower than expected.

5. China will step up its “invest out” program in the new five-year plan. The government may well seek to double the country’s cumulative outbound investment within the next five years.

6. The state will again try to reduce its ownership role in business. If the government relaunches its program to sell off more of its stake in companies, domestic share prices will probably decline or at least remain flat. The program will also soak up much of the liquidity currently supporting Chinese IPOs, thus reducing the ability of entrepreneurs to cash out quickly through them

Wall Street Journal tries to estimate the real Chinese Inflation

The inflation that Beijing regularly reports doesn't capture the true price pressures in China's economy. (by Ms. Choyleva is a director at Lombard Street Research)

China does not publish a consumer spending deflator. But there's another measure, the GDP deflator, that similarly relies on calculating the difference between two sets of data. In the last three months of 2010, the deflator made inflation out to be 7.3%, compared with 4.7% using the CPI. Yes, GDP statistics aren't accurate in China either: Real GDP growth has shown unnatural stability over the past few years. But if the 7.3% inflation the GDP deflator calculates is an overestimation, this has to mean that real GDP growth is higher than the 9.8% Beijing officially clocked for the last quarter—which is dangerously high, strengthening the fear of overheating China bears have been raising of late.

Regardless of Beijing's claims of prudent economic management, excess money is sloshing around and overheating China's economy, thanks to the huge monetary overhang from China's post-2008 stimulus.

Beijing clearly panicked when the global financial crisis hit and stepped on the monetary accelerator. It halted the ascent of the yuan by re-pegging to the dollar in mid-2008 (so that exports could become cheaper), it stopped sterilizing the still-massive foreign exchange inflows (so these inflows directly entered the money supply) and ordered banks to lend historic amounts of credit. The increase in broad money was a massive 39% of GDP in 2009 and 30% in 2010, compared with a previous peak of 27% in 2003. The Chinese express alarm over Western quantitative easing efforts these days, but China's own monetary loosening beats all that.

Investors in 2008 marveled at the way Beijing mobilized to combat the crisis. Now they should be concerned about the inflation this mobilization has wrought.

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