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PRESS RELEASE

China: With the Macro Outlook Remaining Favorable, More Focus Can Be Put on Rebalancing the Economy, Says World Bank Report

August 15, 2006




BEIJING, August 15, 2006 - Growth reached record highs in the second quarter, notes the World Bank’s China Quarterly Update. China’s economy expanded by almost 11 percent in the first half of 2006, with growth in the second quarter the highest in over a decade. Industry continues to outpace services on the supply side, and investment remained the main driver of demand. With export growth continuing to outpace import growth, the current account surplus rose to record highs. Monetary aggregates expanded beyond targets, although more recently slowing down somewhat.

The authorities have implemented a series of measures to cool down the economy in reaction to recent economic statistics. 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 controls on capital outflows.

The outlook for China’s economy remains favorable. With production capacity continuing to expand in line with demand, inflation low, and the current account in surplus, the main policy concern is not general overheating. Rather, policymakers are worried that high investment could cause overcapacity in specific sectors, and may affect the banks because loans may turn bad in the future. The authorities can take some comfort from the fact that most investment is financed from profits rather than credit, and that the highest investment growth is taking place in largely commercialized sectors. But the continued investment boom warrants concerns about efficiency, making more moderate growth desirable. On the external side, key risks are a sharper than expected slowdown in the US economy and a disorderly resolution of global imbalances.

"The authorities may stay the course on current measures, and await further evidence of their effects before initiating additional demand-reducing measures,” says Bert Hofman, Lead Economist for China. "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 Renminbi against the dollar may 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. Internationally, if the slowdown starts to affect China’s growth prospects, the authorities might want to reconsider their macroeconomic stance.

More policy focus can be put on rebalancing the economy. “Although rebalancing is a medium term objective of the authorities, there are reasons to give it more prominence,” says Louis Kuijs, Senior Economist on China and main author of the Quarterly. Many of the measures that can help rebalance the economy also support desirable macroeconomic adjustment.” Moreover, the current investment boom may give rise to a capital stock that would no longer be viable once relative prices and standards better reflect the government’s new priorities. The package of policies that would promote rebalancing includes (i) measures to stimulate domestic consumption and increase the efficiency of investment; (ii) measures to increase the relative attractiveness of producing services (non tradables) over manufacturing (tradables); and (iii) institutional reforms to give local decision makers stronger incentives and better tools to pursue rebalancing.

Media Contacts
In Beijing
Li Li
Tel : (86-10) 58617850
Lli2@worldbank.org


PRESS RELEASE NO:
2006/47/EAP

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