The World Bank sharply raised its forecast for China's inflation on Thursday, saying that while food price pressures were fading, there was a risk of a spillover into wages and the wider economy. The development bank said containing this spread required China to continue its monetary tightening and that it should not be deterred by a moderate slowdown in growth because the economy was still impressively robust.
In a quarterly economic update, it forecast consumer price inflation would average 7.0 percent this year, up from the 4.6 percent projected in February. That would be the highest since 1996 but the World Bank forecast a drop to 5.3 percent in 2009.
Underlining the economy's resilience, the bank also nudged up its projection for gross domestic product growth in 2008 to 9.8 percent from 9.6 percent, with new data revealing more strength in the service sector. Even after the upward revision, the growth rate would still be China's slowest since 2002.
The World Bank's Beijing economists said China had an overall budget surplus last year and had room to spend more to cushion itself from the global slowdown if it became more serious. "A fiscal easing would be better suited than a monetary loosening, given the need to contain inflationary expectations, rebalance the growth pattern and lower the current account surplus," the report said.
The bank took issue with the way China had implemented its tight monetary policy, saying it had primarily called on increases in banks' reserve requirements and credit controls, both of which hamper the development of the banking system.
"Macroeconomic management would benefit substantially from greater room to increase interest rates," the report said. Underlying monetary conditions were still too loose, with lending rates negative, it said. Chinese inflation was 7.7 percent in May, down on the previous month but within striking distance of a decade high and above the one-year yuan lending rate of 7.47 percent.
Beijing has not raised interest rates since December, partly out of concern that higher rates would attract in more hot money. China's pile of foreign exchange reserves soared in the first half of this year to $1.76 trillion. The bank noted an apparent rise in speculative inflows chasing a higher yuan, suggesting Beijing could tighten capital controls and consider sharper currency appreciation.
"So far, China's policy makers have been able to deal with the inflows," senior economist Louis Kuijs told a news conference. A stronger yuan would also help pare China's current account surplus, which hit 11.3 percent of GDP last year and has been the main reason for the cash washing around the country, the bank said.
It forecast the current account surplus would narrow to a still-high 9.0 percent of GDP this year. The bank dismissed the notion that the currency's rise had hurt exports unduly, saying the competitiveness of made-in-China products ran deeper than their price and that Chinese exporters were still gaining global market share. The World Bank calculated that the earthquake that rocked the south-west of China on May 12, killing more than 70,000 people, would have a minor impact on the economy, with damages running to about 0.7 percent of GDP.
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