China's economic growth has moderated to a more sustainable pace with an expected GDP growth rate of 9.8 percent in 2008, according to the World Bank's latest China Quarterly Update released on Wednesday.

While economic activity in China has moderated in line with the global economy's slowdown, real growth of exports and imports remains robust, the report says. Sharply higher import prices are inflating import values and bringing down China's trade surplus, even as the contribution of net trade to growth remains positive. Despite less buoyant investment, the update shows that China's domestic economy is holding up well.

It finds that headline inflation is receding even as non-food price pressures emerge. In fact, food price increases are already starting to fade from consumer price data. Some spill-over from the higher food prices is flowing into wages and some other prices, while new impact from recent industrial commodity and oil price hikes is in the pipeline. Despite this, generalized spill-over to consumer prices has remained limited and headline consumer price inflation is tipped to recede gradually.

"Amidst weaker and uncertain global prospects, China's growth will be supported by strong international competitiveness and a robust domestic economy," says David Dollar, World Bank Country Director for China. "Global growth is on course to slow further and commodity price-driven inflation has become a complicating factor everywhere. These developments imply considerably more international uncertainty and risks. But China's exports will continue to be supported by China's strong international competitiveness."

The recent Sichuan earthquake – while enormous in human tragedy – is expected to have only a moderate impact on the wider economy.

"We expect China's GDP growth to moderate to a solid 9.8 percent in 2008," Dollar said. "The upward revision to our growth forecast largely reflects revised GDP data showing stronger service sector growth."

The report's main author, senior economist Louis Kuijs said there was no need to ease the overall macroeconomic stance but warned that global uncertainty called for vigilance and flexibility.

"If there is a more serious slowdown than we currently envisage, a fiscal easing could be considered," Kuijs said. Containing the spill-over of raw material price pressures and inflation expectations will require relatively tight monetary policy. China's current macroeconomic situation calls for continued strengthening of the trade-weighted effective exchange rate.

"Bringing prices of fuel closer to levels that reflect the scarcity of energy is important for rebalancing and to reduce distortions."

The report says reducing China's very large external surpluses remain a key policy challenge and notes that the current account surplus is still responsible for most of the external surplus. Reducing the current account surplus would require a set of structural policies to rebalance the overall pattern of growth - a key government objective which has seen only limited progress so far.

Speculative inflows seem to have increased recently and if policymakers consider them to be a problem, they can be discouraged by tightening controls on capital inflows and policies that effectively change exchange rate expectations.

(China Development Gateway June 19, 2008)