Source: Bloomberg

Carnegie’s Michael Pettis spoke on Bloomberg Television’s On the Move Asia about China's economy, central bank monetary policy, and currency. China’s consumer prices rose 5.3 percent in April compared to a year earlier, exceeding the government’s full-year target for a fourth straight month.

The Relationship Between Inflation and Interest Rates

Although China's April inflation figures were slightly lower than the previous month, Pettis noted that many experts had predicted inflation rates would peak in July or August of this year. Thus, it remains to be seen whether inflation has started a long-term declining trend. Pettis added that although it may seem counterintuitive, raising interest rates may not be an effective way for Beijing to stem inflation, since such an action will increase household income and consumption, thus adding to inflationary pressure.

The Need for Comprehensive Rebalancing

In order to rebalance its economy, Pettis suggested that Beijing needs to adopt a comprehensive approach that includes revaluing its currency, raising interest rates, and raising wages. Although wages are rising in real terms, after adjusting for inflation and productivity growth differentials, "the currency is barely appreciating in real terms," Pettis said. Most importantly, although nominal interest rates have gone up, real interest rates have actually been negative. Thus, Pettis stated, "In the aggregate, it is very hard to say that China is rebalancing."

These continued imbalances were discussed in a recent IMF report which noted that consumption growth in China slowed last year, Pettis noted. Moreover, massive increases in investment in China are becoming increasingly misallocated and ineffective, which historically has always been associated with an unsustainable rise in debt. If such trends continue, this excessive investment will pose a serious threat to China's growth.