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China fights inflation amid global crisis

People purchase meat from a market on August 09, 2011 in Jinhua, Zhejiang Province of China.

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Chinese authorities face increasingly tough decisions – a crucial "crossroads" – as inflation rages on the home front while the global recovery slows.

Monetary officials in China are already in the midst of an aggressive campaign to hold down rising prices, at times spooking investors who fear Beijing could tame the engine of the world's growth in the post-recession era. How China reacts going forward will be key to the fortunes of its trading partners.

Annual inflation in China ticked up in July to 6.5 per cent, a 37-month high and a figure that earlier was expected to trigger another interest rate hike and, perhaps, other measures as well.

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But global developments, Standard & Poor's downgrade of U.S. debt and Tuesday's gloomier view of the economic outlook from the Federal Reserve, may change the game for China, America's largest creditor. Chinese policy makers must now consider the impact of a weaker global recovery on its export-driven economy, and whether it could turn their attempts at a gradual and controlled slowing of domestic growth into a much harder landing.

"Right now we are in a situation that poses risk for intolerably slow economic growth together with fairly high inflation," said Mei Jianping, a professor of finance at Beijing's Cheung Kong Graduate School of Business. "I think this really has put China at a crossroads about where China is going to go from here."

The reading of the July consumer price index was only marginally higher than analysts had anticipated, and most say inflation is likely to peak later this summer.

However, alarming for officials who fear public unrest in a country where many still spend more than half their income on food, food prices continue to be the driving force behind the inflation rate. The cost of food alone rose 14.8 per cent last month, from a year earlier up from 14.4 per cent in June. Within that, pork prices, considered an essential in most households, climbed a whopping 56.1 per cent year on year.

"It can't get more expensive than this. It's so expensive now," said meat vendor Luo Xiuhua, cuts of glistening pork belly and rib spread out before her with few customers in sight in the usually bustling halls of Beijing's Sanyuan Li market.

One jin, or half-kilogram, of meat now costs 16 yuan (about $2.50 US), up from 12 yuan two months ago. "People aren't buying as much. It's too expensive now. They only buy a little at a time."

Pork prices are now levelling out following the government's release of some of its strategic reserves, and most analysts believe inflation will begin to ease by autumn. Other numbers released Tuesday also signalled China's economy is slowing , although gradually: Industrial output slowed in July, up 14 per cent year on year compared to 15.1 per cent the month before; retail sales slowed to 17.2 per cent year on year, down from 17.7 per cent in June, and fixed asset investment was up 25.4 per cent.

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"Bottom line: China is cooling but far from collapsing, despite the extreme volatilities that external markets are experiencing," Qu Hongbin and Sun Junwei of HSBC Global Research wrote in a note to clients. "Inflation still outweighs growth as China's top macro risk in the near term. What implications does the recent downgrade of the U.S. sovereign credit rating hold for [the]Chinese economy? Nothing of significance in the immediate term. The recent bout of volatility was triggered more by a lack of market confidence in U.S. and EU policy makers than by a change in global growth fundamentals. Sluggish U.S. growth had already been penciled into our outlook for China before the S& P downgrade."

Should the fears of further downturn materialize, observers warn China will find it more difficult than last time around to stimulate its economy.

"I think China really needs to start thinking very seriously about how to stimulate growth, not just from the public sector but also from the private sector," Prof. Mei said, calling for structural adjustments like tax cuts which would encourage job creation, and further measures to support private business.

"In the short term, my own feeling is I still have confidence in China's growth prospects because the government still has tremendous firepower in its arsenal," he said. "The serious challenge is really long term."

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