BEIJING (Reuters) - The World Bank raised its 2010 growth and inflation forecasts for China and recommended a tighter monetary policy as well as a stronger exchange rate to restrain inflation expectations and asset bubbles.
In its latest update on the world's third-largest economy, released on Wednesday, the bank revised its projection of gross domestic product growth this year to 9.5 percent from 8.7 percent in its previous report in November.
For 2011 the bank pencilled in GDP growth of 8.7 percent -- exactly the same rate China enjoyed in 2009 as the economy responded to massive monetary and fiscal stimulus.
The Washington-based lender now expects consumer prices to rise by 3.7 percent on average this year -- it had forecast 2.0 percent in November -- and by 2.8 percent in 2011.
"We think that inflation risks remain modest, in large part because of the global context. Nonetheless, the macro stance needs to be noticeably tighter than in 2009 to manage inflation expectations and contain the risk of a property bubble," it said.
Meeting this year's target of 7.5 trillion yuan in new loans -- down from a record 9.6 trillion yuan in 2009 -- would be important to anchor inflationary expectations.
"Higher interest rates would make the tightening more convincing," the report added.
As for the yuan, a stronger exchange rate would help dampen inflation pressure by lowering the price of imports and toning down demand. It would also help rebalance China's growth towards services and consumption and away from industry and investment.
"Over time, more exchange rate flexibility can enable China to have a monetary policy independent from U.S. cyclical conditions, which is increasingly necessary," the report said.
Yet the bank coupled its stress on the need to contain inflationary expectations with a warning that wrestling inflation down to very low levels might hinder the relative price changes required in such a rapidly growing economy.
"For instance, China needs to increase administrative prices for resources and utilities that are necessary to adjust the structure of the economy. And higher prices for agricultural products and higher migrant wages can help boost rural incomes and reduce urban-rural inequality..." the bank said.
"It would be unfortunate if such desirable developments were suppressed because of concerns about moderate inflation."
China has set a 3 percent inflation target this year, but the bank said a rate of 4-5 percent is not a major problem in many emerging markets in the throes of reform and development.
The bank described the price risks facing China this year as relatively modest. The big macroeconomic dangers were higher asset prices and strained local government finances, stemming from the massive monetary stimulus injected into the economy.
While the dynamics between economic developments and policy responses implied large risks, China's growth prospects are much less uncertain than a year ago, when the global financial crisis was raging, the report said.
As government-led investment slows, the bank expects the composition of growth in 2010 will shift markedly.
Total investment will expand at only half last year's rate, but real estate spending will provide a big boost. Consumption should remain strong. Overall, domestic demand will contribute 9.1 percentage points to this year's projected GDP growth.
Net exports will account for the remaining 0.4 percentage point as global demand for Chinese goods recovers. Last year, by contrast, net exports shaved 3.9 points off headline growth.
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