China is deeply concerned about the potential global fallout from the US subprime crisis, which could make balancing growth and fighting inflation more challenging, Premier Wen Jiabao has said.
Although Wen warned it would be difficult to keep inflation within Beijing's 4.8 per cent target, he said he was confident the government would succeed at its main task this year – checking price rises while engineering stable growth.
But he highlighted the increasing uncertainties brought about by the subprime debacle, which has spawned a fall in the dollar, slammed stock markets worldwide and fed into a surge in oil prices.
"I am closely watching and feel deeply worried about the global economic situation, especially the US economy," Wen cautioned after the closing session of the National People's Congress, or parliament.
"What concerns me now is the continuous depreciation of the dollar and when the dollar will hit bottom."
The dollar is trading near 13-year lows against the yen and record lows against the euro, after the US Federal Reserve has repeatedly cut interest rates.
Wen said that Beijing would have to take the changing economic landscape into account when deciding on further policy steps, despite its having switched to a "tight" monetary policy at the end of last year to curb excessive growth in investment and credit.
While many other countries are facing a credit crunch, China is struggling to contain a surge in liquidity stemming from its massive trade surplus.
"Global economic developments cannot but have an impact on China. Therefore, at the same time as pursuing these policies, we must pay close attention to international economic developments and, based on changing trends, be flexible and timely in adopting corresponding countermeasures," said Wen.
He stressed the need to walk a fine line between fighting inflation, which hit a nearly 12-year high of 8.7 per cent from a year earlier in February, and slamming on the brakes too hard. An abrupt slowdown in output would contradict efforts to create at least 10 million new jobs a year, he said.
He did not specify what role the yuan could play in fighting inflation, but noted that it had strengthened by about 15 per cent against the dollar over the last two years, with the pace of appreciation accelerating recently. The yuan was trading at 7.0853 per dollar yesterday, meaning it has strengthened a further 14.5 per cent against the dollar since the landmark revaluation in July 2005. Some economists say it needs to strengthen significantly more to help fend off inflows of cash and hence fight inflation.
"Maintaining stable and fairly fast economic growth while curbing inflation is not a target just for this year, but for the next five years," Wen said.
"The outcome of these policies must be viewed in the medium to long term. It is very difficult to see them in a short one or two months."
* The longer oil prices remain above $100, the worse things are likely to get for the dollar.
With the greenback hitting all-time lows and no end to its slide in sight, oil exporters are likely to shift a larger share of revenues into other currencies.
That weakens the dollar further, making dollar-denominated oil more costly for Americans. Inflation fears also prompt investors to buy commodities as a hedge and favour stronger currencies.
It's what Morgan Stanley global currency strategist Stephen Jen called a "vicious circle".
Greg Salvaggio, an FX trader at Tempus Consulting in Washington noted: "A lot of the premium in commodity prices now is directly correlated to dollar weakness, and you need to see a dollar turnaround for oil prices to pull back and US growth to start to pick up again."
If that doesn't happen, some worry that investors could stop buying US Treasury debt, causing interest rates to spike, inflation to worsen and living standards to slide.
That's troubling news, particularly now that economists believe the United States has already entered a recession that may prove more persistent and painful than any since the 1930s.