Will China’s Measures to Combat Inflation Hurt Economic Growth?

As China’s (NYSE:FXI) economy continues to grow, Beijing looks to fight the nation’s persistently high inflation by stabilizing prices, no mean task given the complex and volatile state of the global economy. China’s GDP rose 9.5% in the second quarter over the same period last year, exceeding economists’ expectations by 0.1%, thanks to high domestic consumption and investment.

However, that is the slowest rate of growth for China (NYSE:FXI) since 2009 in the midst of the global recession. China has raised interest rates and regulated bank lending in order to ease inflation, and the country’s high GDP figures show that they could still do more to combat inflation without completely stifling growth.

Some economists think inflation will ease in the second half of the year, though prices for many popular food staples have been climbing, while others expect the central bank will raise interest rates again and most expect further increases in bank reserve ratios.

Many Chinese citizens are worried about the government’s position on squashing inflation because the nation is already in a precarious situation, with Europe and the U.S., two of China’s biggest export customers, witnessing economic slowdowns that could hurt China’s own economic growth. New export orders were already down in June.

However, domestic demand remains high, and industrial output rose 15.1% in June over the previous year, up from May’s 13.3% year-over-year growth and beating market expectations by 2%. That should allay some fears that the government’s attempts to combat inflation will cause economic collapse. Fixed-asset investment grew 25.6% in the first six months of 2011 from the previous year, and retail sales grew 16.8%. Strong local demand helps insulate China from he volatility of other economies, but it can also increase price pressures.

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Inflation averaged 5.4% in the first half of 2011, well above the government’s 4% target for the year. In June, inflation reached 6.4%. Last week, China raised bank note rates for the third time this year. The central bank has raised benchmark interest rates five times since October. In that time, it has lifted banks’ reserve requirement ratio on nine occasions.

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