ADB Raises PRC Growth Forecast for 2006 to 10.4%

MANILA, PHILIPPINES – Strong growth in investment and exports will propel economic growth in the People’s Republic of China (PRC) to 10.4% this year, ADB says in a major new report.

“The economy posted very rapid growth in the first half with fixed-asset investments, exports, and imports all rising significantly from a year earlier,” said Mr. Ifzal Ali, ADB Chief Economist, at the launch of Asian Development Outlook 2006 Update.

“Even with an interest rate increase in mid-August that followed earlier monetary and administrative tightening measures, we expect second-half cooling to be modest. Our concern is that if the current investment boom continues, it could result in chronic overcapacity,” he said.

The PRC economy grew a faster-than-expected 10.9% in the first half, building on 10.2% growth for all of 2005. The 2006 full-year forecast represents a significant upward revision from the 9.5% growth expected in April, when ADB launched its flagship annual forecasting publication, ADO 2006. PRC is expected to grow 9.5% in 2007.

ADO Update forecasts overall growth for the 43 countries of developing Asia of 7.7% in 2006, up from 7.2% forecast in April.

Investment spearheaded the PRC’s growth in the first half of 2006, with fixed-asset investment surging 29.8% year-on-year, well above the official target. Exports grew 25.2% from a year earlier, while imports rose 21.3%, resulting in a $61.4 billion trade surplus for the first half.

ADO Update notes that the acceleration in growth in the first half has heightened concerns about overcapacity in some industries and the possibility of a painful pullback in economic activity. PRC authorities have tried to cool the economy with various tightening steps, including two increases in the benchmark lending interest rate and restrictions on investment in property. The central bank also has imposed some direct controls on lending and adopted measures to absorb bank liquidity.

Statements by senior Chinese leaders hint at more tightening measures to come, ADO Update says. The likely magnitude and timing of the impact of these measures, however, remains uncertain.

The wider challenge of economic stabilization in the PRC is complicated by a variety of factors. Provincial officials, for example, often have incentives to boost investment, which may be at odds with the goals of the central Government. Furthermore, interest rates in the PRC do not have the same impact on credit demand and allocation as they do in a full market economy.

Constraints on the effectiveness of monetary and fiscal policies, and difficulties in fine-tuning administrative controls create significant uncertainty surrounding the outlook for 2007, according to ADO Update. The rate of increase in the trade surplus is projected to moderate as export growth slows alongside somewhat softer conditions in the world economy.

Despite rapid economic growth, consumer price inflation has remained tame. This reflects the supply-side nature of the current upswing and a rapid expansion of industrial capacity, ADO Update says. A good grain harvest also helped keep prices in check. Inflation is now expected to average 1.6% in 2006, down from the 2.3% forecast in April. Inflation is forecast at 1.8% in 2007.

“Risks to the outlook are finely balanced,” said Mr. Ali. “If investment doesn’t slow, growth in 2007 could again surprise on the upside, raising the possibility of more difficult adjustments later. But if the authorities brake too hard, GDP growth could fall by more than forecast.”

PRC has had mixed success in reining in growth. In 1989-1990, when the Government stopped approving new investment projects, GDP growth slumped from about 12% to 4%. In contrast, in the late 1990s, the Government successfully engineered a soft landing, with growth slowing from above 12% to 7%-8%.

ADO Update also examines widening income inequality in the PRC. “While some deterioration in income distribution is inevitable as the PRC moves from a largely agrarian and centrally planned economy to an urban-based, industrialized market economy, the degree to which the gap has opened is a concern,” it says.

Measures that lift rural incomes and the quality of life in the countryside should help ease such pressures. More public resources are needed for the provision of affordable safety nets and other social protection mechanisms for those who cannot protect themselves against shocks and risks, ADO Update notes.

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