Controlling inflation remains a top priority for China's policy makers and June's Consumer Price Index rose 6.4% from a year earlier, a 3-year record. This has been largely attributed to soaring food costs, which in turn have been largely attributed to unfavourable weather conditions. Yet what exactly is the link between bad weather and inflation?

Drought

This year China faced a severe drought in March-May which was reportedly the most severe in 50 years. The drought affected eight provinces in northern China, severely impacting most of China's wheat-producing regions. This impacted China’s economy, affecting agricultural production and prices through lower output and higher irrigation costs. Yet it also created expectations for higher inflation and inspired more speculative activity. The outcome was higher prices for food and raw materials. In Hubei province the price of rice increased by 20% in May to RMB 2.6 per kg. In Hunan province locally produced lotus root also climbed 20% during the same period to RMB 4.2 per kg. In the city of Wuhan the average price of 20 monitored vegetables climbed 7.3% in one month and additionally the price of cabbage almost doubled in May to RMB 2.22 per kg, according to China’s Ministry of Agriculture.

The drought also brought water levels in some of the country's biggest hydropower producing regions to critical levels, and partially because of this China is currently facing the most severe power shortage in the last seven years. This exerts pressure on coal-fired power plants to increase production, at the time of globally rising coal prices. All this contributes to increasing power prices, which will increase the cost of production, which will make manufacturers charge higher prices, which causes inflation to rise. Its all linked in a spiralling chain reaction.

Flooding

At the beginning of June the drought suddenly gave way to weeks of serious flooding which, according to some farmers, was the worst in the past 20 years and has left vast areas of Hubei and Zhejiang with more than 432,200 hectares of farmland flooded. 7,000 homes have either been damaged or have collapsed and the financial damage could amount to around USD 930 million. This has reduced vegetable output by 20%, which caused shortages of grains and fruits. As a result, at markets in Hangzhou, the provincial capital of Zhejiang, the prices of some fruits, vegetables and grains have risen by as much as 40% since early June, according to Xinhua. In the south of China the floods also pushed up the average wholesale prices of 18 staple vegetables by 2.3% as a whole, with the wholesale price of cabbage increasing first by 20.3% and then by a further 17.9%.

This has also impacted pork prices, which have steadily increased, partially due to the shortage of grain, which is mainly attributed to corn (the main feed of hogs), the production of which was severely affected by both floods and the drought. All this contributed to pork prices in June rising 57.1% y-o-y.

Is it all about food?

So is China's rising inflation overbearingly about rising food prices, which based on the above, are clearly very susceptible to factors like droughts and floods? The answer seems to be an unequivocal yes. Food prices have been the biggest driver of China's inflation, constituting nearly two-thirds of the rise in CPI. Food prices rose 14.4% in June from a year earlier, up from an 11.7% in May, and as long as they are edging upwards, all the other prices will follow in their wake. 

The China-Australia trade relationship is well-known for the flow of natural resources from Australia to China. Yet in the other direction, China has in the last decade become the leading supplier to Australia of machinery and electronic equipment. The two bubble charts below in Figure 1 illustrates the progress that China has made from 2000 to 2009 in becoming Australia’s leading supplier of machinery and equipment. In 2010, machinery and electronic equipment accounted for 39% of the total (see Figure 2), and China went from supplying 4% of Australia’s imports of these items in 2000 to 21% in 2010 (see Figure 1).