China's economic growth reached record highs in the second quarter of this year, noted the World Bank's China Quarterly Update which was released today in Beijing. Bert Hofman, lead economist of the World Bank, said China's economy expanded by almost 11 percent in the first half of this year with the growth rate for the second quarter reaching the highest in over a decade.

Hofman noted the persistent existence of an imbalance in the economic growth for the second quarter. Industry continued to outpace services on the supply side and investment remained the main driver of demand. With export growth continuing to outpace import levels, the current account surplus has risen to record highs.

In reaction to recent economic statistics, the Chinese government had implemented a series of measures to cool down the economy, said the report. Such measures include monetary tightening by absorbing liquidity in the interbank market, administrative measures to limit investment in real estate, reinforcement of controls and regulations on investment projects and loosening restrictions on capital outflows.

Hofman said the outlook ahead for China's economy remained favorable. With production capacity continuing to expand in line with demand, inflation low and the current account in surplus, the main policy concern for the Chinese government was not general overheating.

Rather, the policymakers are worried that high investment could cause overcapacity in specific sectors and may affect the banks because loans could turn bad in the future, explained Hofman. However, he also noted that the government could take some comfort from the fact that most investment is financed from profits rather than credit and that the highest investment growth is happening in largely commercialized sectors where private enterprises play a significant role.

However, the continued investment boom does warrant concerns about efficiency. Louis Kuijs, the World Bank's senior economist on China and main author of the Quarterly, said that inefficiency and waste of resources do exist in specific companies and enterprises despite favorable profitability in the whole sector. Measures, including legislative ones are needed to press those whose fates are doomed to failure but are nevertheless continuing to waste resources.

On the external side, key risks are sharper than expected with a slowdown in the US economy and a disorderly resolution of global imbalances.

"The Chinese government may stay the course on current measures and await further evidence of their effects before initiating additional demand-reducing measures," said Hofman. "A drastic slowdown alone would lower imports and boost the current account, creating more problems for monetary policy and trade relations."

A continuation of the recent strengthening of the RMB against the dollar could ameliorate part of this dilemma, as it would raise imports, reduce capital inflows and switch investment to the non-tradables sector. Also, the latest data suggest that the recent measures have started to have some effect on monetary aggregates which have been expanding beyond targets.

As the Consumer Price Index remains moderate and there is no significant wage increases, it is highly unlikely that high inflation may occur, remarked Louis Kuijs. However, he did caution against unbalanced growth accompanying the rapid GDP growth. The current investment boom may give rise to a capital stock that would no longer be viable once relative prices and standards better reflected the government's new priorities, he warned.

China Quarterly Update, August 2006

(China.org.cn August 15, 2006)