>China inflation risk rises as spare capacity dwindles

Beijing - Signs are emerging that spare industrial capacity in China is shrinking, removing what analysts until recently saw as a lid on inflation and encouraging Beijing to tone down some of its stimulus policies.

The global financial crisis aggravated Beijing's perennial worries over excess capacity, which forced down prices for most of last year and prompted Premier Wen Jiabao to describe it in September as the biggest problem facing China's economy.

But data due Thursday are likely to show that consumer prices rose more sharply in December than November and that on-year economic growth quickened to more than 10% in the last quarter of 2009.

Some analysts still say that excess capacity, which could lead to job losses, will help contain inflation in China this year, and that the recent pickup in consumer-price inflation is due largely to rising food prices after recent heavy snow storms disrupted transport.

But power shortages and fast-rising industrial production indicate that demand for goods, such as cars, is growing and may run up against supply constraints as excess capacity dwindles.

"By November and December, actual industrial production levels had already exceeded potential levels," said Sun Wen, an economist with Citic Securities Co. Citic last week raised its 2010 consumer-price inflation forecast to 3.2% from 2.6%.

Inflation could rise as demand begins to outstrip supply, and policymakers appear to realize the situation is changing. Premier Wen Jiabao told a meeting of the State Council Tuesday that the government must "closely watch changes in supply and demand in the market, form an accurate judgment of the situation and increase the precision and effectiveness of macroeconomic policies."

Already, Beijing has raised the share of deposits banks must keep at the central bank, guided money-market interest rates higher and pressured banks to cut back lending. Rising inflation risks could encourage authorities to further tighten monetary policy through interest-rate hikes, for example, and even to curb investments they consider redundant.

Inflation in China also could add to price pressures abroad as Chinese companies import materials such as iron ore and copper to build new plants, while other companies cover rising costs by raising prices on the shoes, T-shirts and mobile phones they sell overseas.

Growing production also indicates that capacity is being used up. Helped by a low base of comparison, industrial output in November rose 19.2% from a year earlier, the fastest growth since June 2007.

But the rapid industrial growth is hitting some speed bumps.

"The unusual early arrival of electricity-supply shortages also reflects that the recovery in manufacturing activities is probably faster than we would have expected," Goldman Sachs economists said in a research note last week. Goldman raised its 2010 consumer-price inflation forecast to 3.5% from 2.4%.

Some economists, however, say spare capacity remains and will help keep inflation to around 3% this year. That's up quite a bit from the 0.9% drop in the first 11 months of last year, but still mild compared with a 5.9% rise in 2008.

"It's too early to say that the economy is overheating," Standard Chartered Bank economist Jinny Yan said.

Source: COMMODITIESCONTROL