Officials face balancing act as rising inflation threatens economic gains

China's economic growth will rebound slightly over the next quarter driven by recovering global demand and accommodative policies, but concern over rising inflation may result in tightening measures, experts said.

The economy was forecast to expand 8.2 percent in the second quarter, up from an estimated 8 percent in the first three months, according to a quarterly report published by the Bank of China on Thursday.

The prediction was backed by the rising profits of large industrial enterprises, which rose 17.2 percent year-on-year to 709.2 billion yuan ($114.1 billion) in the first two months, mainly driven by the power, oil refining and steel sectors, according to the National Bureau of Statistics.

"The economic rebound lacked momentum in the first quarter due to slowing consumption and investment, but the stabilization of these two will boost growth in the second quarter," the bank's report said.

In addition, exports grew "unexpectedly", and there was a significant increase in the trade surplus in the first two months, which was $44.4 billion compared to a $4.9 billion deficit last year.

However, such a growth trend lacks sustainable momentum amid an unstable global economic recovery, the report said.

The report also predicted that the Consumer Price Index, a key gauge of inflation, would pick up by 0.5 percentage points to an average of 3.2 percent in the second quarter from the previous quarter, as a result of escalating food prices and resource price reform.

The pressure also comes from imported inflation as a result of the quantitative easing widely adopted by governments globally, which generated excessive global liquidity and pushed up commodity prices.

"Given these factors, we forecast a neutral macroeconomic policy to seek a balance between stabilizing growth and guarding against inflation," said Wen Bin, a senior researcher with Bank of China's Institute of International Finance.

"Interest rates will remain unchanged throughout the whole year, and there will be no room for further reductions in the bank reserve requirement ratio in the first half of this year," he said.

But David Leung, general manager of wealth management and priority & international banking, consumer banking at Standard Chartered Bank (China) Ltd, said that the monetary authorities would probably increase interest rates by 25 basis points in the fourth quarter, then hike rates again by 50 points in the first quarter of next year, increasing inflationary pressure.

Leung said China could maintain GDP growth of 8.3 percent throughout the entire year, with inflation controlled below 4 percent.

The Asian economy would be driven by China's economic recovery, before strengthening against the backdrop of improvements in the US economy, he said.

Continuous monetary loosening worldwide would inject further liquidity and support the global market, especially capital markets, he said.

"Therefore, more hikes in interest rates would be considered as signals of an even stronger rebound, which would boost corporate credit ratings and further shore up the stock market."

But some analysts are not so optimistic.

Yao Wei, China economist at Societe Generale CIB, said: "Loan growth in the banking system will be a damaged by the tightening of the property sector, and non-bank credit growth will cool as a result of stricter regulation of shadow banking activities."

This will lead to tighter liquidity conditions and slower economic growth later in the year, she said.

The Bank of China report also estimated that the renminbi exchange rate would rise further, mainly due to strong demand for the currency amid an inflow of hot money.

"The renminbi exchange rate will climb steadily and become more elastic. It is expected to appreciate by about 3 percent against the US dollar to 6.1 by the end of 2013, and to 6.18 by the end of second quarter," Wen said.

He added that there is room for more widening of the renminbi's daily trading band against the US dollar set by the central bank, which is currently 1 percent.

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