The economy is showing signs of improvement, according to an economic report released Tuesday by the National Bureau of Statistics on the four months of the year.

Between January and April, urban fixed asset investment continued to expand rapidly – though at a slower speed – internal retail and consumption kept at a robust and steadily growing momentum, and trade was recovering with more balanced imports and exports.

The consumer price index grew 2.8 percent and the producer price index 6.8 percent from last year. Housing prices in 70 major Chinese cities increased 12.8 percent from last year. Industrial output expanded by 17.8 percent. Renminbi loans surged by 774.0 billion yuan (US$113.32 billion), up 29 percent from a year before. The trade deficit since March has stopped.

But the equity market presented a different scenario. China's A-Share and H-Share markets drastically plunged despite the rebound of the international stock market. The benchmark Shanghai Composite Index plummeted to its lowest point of the year.

The inconsistency between the overall economy and stock market can be explained as follows:

First, despite China's apparent growth, worries and doubts about China's sustainability have begun to dominate recent international media reports. Problems do exist in the Chinese economy, and they put China's growth at stake. The core issue is the real estate bubble. Once the government can properly curb the real estate market by making it more residence-oriented, the industry will begin fueling the country's growth again in the following decades. By then, the country's economy will be on a sound and healthier development track.

Second, the central bank will implement a tight monetary policy with regard to interest rate and the renminbi's appreciation. The fast-growing CPI and PPI in April directly lead to the market estimation of an interest rate rise. China's current CPI calculation mechanism makes food prices a principal factor. This year, the abnormal weather condition in most parts of the country greatly affected the agricultural production, pushing up food prices. Also, droughts and floods in the south also tightened the food supply.

PPI, a precursory index, predicts the CPI in the following period. PPI shows a 6.8 percent growth in April, a sign of inflation. But this concern may be unnecessary. In China, PPI takes a longer industrial chain to influence CPI. Moreover, the alarming PPI has more impact on housing prices than on regular commodity consumption. The reverse works, too: a drop in property prices will bring down PPI.

Interest rate and renminbi's appreciation are also the market focus. Considering the current high CPI, the central bank is unlikely to modify interest rates. As far as renminbi's appreciation is concerned, it has said it will base the rate on the market and apply a fluctuating but regulated foreign exchange mechanism to ensure that the value of the renminbi remains stable.

This is the first time China has changed its diction in discussing foreign exchange policy, suggesting a loosening of policy. But because of the volatile international financial market, renminbi appreciation will follow a very cautious path.

This year, China's monetary policy relies more on the quantity of circulating money, particularly on bank loan optimization. An overly tight monetary policy therefore is unlikely, nor would the bank let loans grow as widely as in 2009.

Yi Xianrong is a researcher with the Institute of Finance and Banking under the Chinese Academy of Social Sciences.

(This post was first published in Chinese and translated by Maverick Chen.)

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