While China's economy has continued to feel the brunt of the global crisis, very expansionary fiscal and monetary policies have kept the economy growing respectably, according to the World Bank's latest China Quarterly Update released on Thursday.

The Update, a regular assessment of the Chinese economy, finds that the fiscal stimulus is centered on the infrastructure-oriented "4 trillion yuan" stimulus plan while the monetary stimulus has led to a surge in new bank lending. Government-influenced investment has soared. Market-based investment has lagged, although positive signs have emerged in the real estate sector. Consumption has held up well. Very weak exports have continued to be the main drag on growth, while import volumes have recovered in the second quarter of 2009 as raw material imports rebounded.

Global growth prospects remain subdued even as signs of stabilization have emerged. Financial markets have become less strained and there are prospects for stabilization of activity. However, a rapid global recovery seems unlikely and uncertainty remains. The risk of global deflation seems low, although spare capacity will continue to put downward pressure on prices of manufactured goods. Monetary policymakers in major countries should in principle be able to prevent inflation from rising in the medium term, although risks remain, including political ones.

"Growth in China should remain respectable this year and next, although it is too early to say a robust sustained recovery is on the way," said Ardo Hansson, Lead Economist for China. "Government influenced investment will strongly support growth in 2009. However, there are limits to how much and how long China's growth can diverge from global growth based on government influenced spending."

The Update finds that market based investment is likely to continue to lag for a while because of a squeeze on margins amidst spare capacity in many manufacturing sectors. Prospects for real estate activity appear reasonably good, but consumption is unlikely to pick up speed. In all, the World Bank thinks that China's growth is unlikely to rebound to very high single digit rates before the world economy recovers convincingly, and projects GDP growth of 7.2 percent in 2009.

"China can have the confidence to focus on forward looking policies and structural reforms," said Louis Kuijs, Senior Economist and main author of the Update. "On current projections it is not necessary and probably not appropriate to add more traditional stimulus in 2009. One reason is that the fiscal deficit is on course to be significantly higher than budgeted this year and additional stimulus now would reduce the room for stimulus in 2010."

At the same time, in a changed global setting, with more subdued global demand and thus less export growth, China needs more growth from domestic demand -- consumption in particular. Also, relative prices need to change, notably those of natural resources. The Update concludes that transition to more consumption-led, service sector-oriented, and labor-intensive growth requires policy adjustments that: (i) help channel resources to sectors that will grow in the new setting, instead of to sectors that have traditionally been favored and done well; and (ii) support thriving domestic markets and successful, permanent urbanization. Such reforms could be pursued all the more boldly and successfully if they are flanked by a well-functioning public finance system and social safety net.

To read the full report, please visit:

http://download.chinagate.cn/en/pdf/090618.pdf

(China Development Gateway June 18, 2009)