The World Bank's China Quarterly Update, released on Friday, said that, despite higher than expected growth, there are clear signs of a slowdown in domestic demand. 

"The 9.5 percent growth in 2004 surprised many," said Bert Hofman, chief of the Economics Unit of the World Bank's Beijing office, "but domestic demand and investment growth are clearly slowing down."

The report said that domestic demand was only 8.5 percent more in the second half of the year than the second half of the previous year, and 11 percent higher in the first half of 2004 compared to the same period of 2003. 

The reasons that growth came out at 9.5 percent were cited as the slowdown in imports and acceleration in exports. "The trade balance ended the year US$32 billion in surplus, while back in April it was still balanced."

Hofman said the imports slowdown and waning consumer and producer price inflation were further signs of more sustainable growth. The report saw this as resulting in part from policy measures taken during the year.

The World Bank was optimistic about China's prospects for 2005. The report cited a good world economic environment and robust domestic demand as factors, predicting world GDP to grow 3.2 percent. This would be lower than its record year of 2004, but still healthy. 

The report welcomed the switch from "proactive" to "prudent" macroeconomic policies, noting that there are still risks of a return to higher investment levels because of prevailing low real interest rates and incentives on local governments to pursue growth.

"A prudent monetary policy in our view means that the People's Bank of China should be prepared to raise interest rates again, if and when needed." Bert Hofman said. 

The report also argued that further interest rate reforms could improve rural finance. Currently, lending rate limits still apply to rural financial institutions, making it unprofitable to lend to farmers.

It noted that reforms in urban finances, land management, the intergovernmental fiscal system, and the performance evaluation for local governments are needed to redress the issue of local over-investment. 

The report saw 2005 as not the best year to move to consumption-based indirect taxation, like the VAT system currently being tested in the northeast, because such a reform would encourage investment.

It lauded the rural public finance reforms of the last few years, stating that Rural Fee Reforms have clearly worked to reduce the burden on farmers. The government introduced the reforms in 2001, and over the last few years many provinces have also abolished agricultural tax. 

The report argued that more spending on public services, especially in rural areas as the government is planning, will be good for equity, and could also bring up consumption.

However, it also urged for better management of transfers that have replaced fees and taxes, and argued that some user fees are still warranted. Further measures to increase consumption that the report mentioned are reforms of the rural health system and solidifying the pension system.

(China.org.cn February 5, 2005)