<P><FONT size=6>BNP 百富勤：通货膨胀是主要宏观风险 </FONT></P>
<P><FONT size=5>China inflation a key macro risk</FONT></P>
<P><FONT size=6>08.06 8页</FONT></P>
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<P>Inflation is key macro risk in the next few quarters. It is not purely food<BR>driven as in 2004; loose monetary conditions, a tight labor market and rising<BR>inflation expectations all make inflation in 2007 more sticky and difficult to<BR>control. The market will wake up to inflation risks and potential policy<BR>response.<BR>Further acceleration of China inflation poses a grave challenge to macro<BR>stability and market valuation; we are looking for CPI to hit 5.2% in July and to<BR>rise to 5.6-6.0% in August. CPI is unlikely to moderate much in 4Q this year as<BR>severe flood-draught hit autumn harvest. For 2007, overall CPI could reach<BR>4%, breaching the government comfort zone of 3%.<BR>The government is certain to treat the inflation issue extremely carefully as<BR>inflation has been the biggest trigger for social instability in China since the<BR>1940s. If CPI persisted at above 5%, or even spiked to 6%+, this would pose<BR>big macro uncertainties. Premier Wen Jiabao has shown up on TV reviewing<BR>grocery markets a few times to underscore the severity of the issue.<BR>We see inflationary key uncertainties in the China macro picture as follows:<BR>1) China risks overheating and inflation rears its ugly head, pushed not only<BR>by food and energy costs. Different from 2004, asset reflation is fuelling<BR>inflation expectations in the population. Labor costs are surging close to<BR>18%, outpacing productivity growth.<BR>2) This could be the end of the Goldilocks era of high growth/benign inflation.<BR>Low inflation was a prerequisite for easing monetary policy in the past<BR>three years and underpinned hefty valuation multiples. Since 2005, China<BR>has been focusing on slowing the nominal appreciation of the RMB,<BR>preferring low rates and to unleash excessive liquidity through forex<BR>intervention. Now, containing domestic inflation is increasingly paramount<BR>as this could have dire political and social implications. In an inflationexternal</P>