Analysis: China's tightening shows global rebalancing at work

(Reuters) - The inflationary pressures that prompted China to raise interest rates for the third time in four months are evidence that the imbalances destabilizing the global economy are slowly but surely being ironed out.
China's current account surplus, though shrinking, will not melt away overnight. Finance ministers from the Group of 20 major economies who are meeting next week are still likely to urge China to let the yuan's nominal exchange rate rise faster.
But economists said the same inflationary forces that triggered Tuesday's quarter-point rise in interest rates by the People's Bank of China were inexorably hastening the shift toward consumption and away from exports that the United States and Europe have long urged.
"This broader story of rising inflation in China contributes to global rebalancing," said Ashley Davies, an economist with Commerzbank in Singapore. "China is getting more expensive relative to the West."
An unprecedented surge in money and credit growth in 2009 to fight the downturn induced by the global financial crisis is the root cause of China's rising inflation.
The economy is now growing too fast for comfort, helping to push up global energy, food and commodity prices that in turn are feeding back into domestic inflation.
In addition, wages, which have long risen at a double-digit pace, are climbing ever faster: employers are having to compete for a shrinking pool of young migrant workers willing to quit the family farm and toil long hours in often Dickensian conditions a long way from home.
So much, so familiar. China has suffered worse bouts of inflation in the recent past, notably in early 2008.
What is new is that manufacturers appear to be finding it increasingly tough to increase productivity faster than wages.
"It's not just the inflation rate. It's what's happening to wages and productivity that is probably the key," said Michael Buchanan, chief non-Japan Asia economist with Goldman Sachs in Hong Kong.
MARGIN SQUEEZE
Exporters can absorb a rise in unit labor costs relative to those of their competitors only for so long. Eventually profit margins disappear and firms switch production to the domestic market or move to a country where costs are cheaper.
"Up until quite recently, even when you saw strong nominal wage growth, productivity growth was even stronger," Buchanan said. "More recently, that may no longer be the case."
So buoyant wages, apart from providing fuel for domestic consumption, should further erode China's current account surplus, which fell to a five-year low in 2010 of 5.2 percent of GDP from 6.0 percent in 2009.
"It's a good thing for the world and for China if you do see wage growth outstrip productivity growth going forward," Buchanan said.