A Chinese baby smiling in front of the portrait of former Chinese leader Mao Zedong at Tiananmen Square in Beijing
© AFP/File Peter Parks

SHANGHAI (AFP) - In its latest quarterly update on China, the Washington-based group also revised its projections for growth in 2007 to 9.3 percent from 8.5 percent.

"The outlook for China's economy remains favorable," it said.

"With production capacity continuing to expand in line with demand, inflation low, and the current account in surplus, the main policy concern is not general overheating.

"Policymakers are worried that high investment could cause overcapacity in specific sectors, and may affect the banks because loans may turn bad in the future."

Amid serious concerns in Beijing that fixed asset investments levels of nearly 31 percent in the second quarter remain too high, the bank said investment coming from profits and not bank credit was a good thing.

"The authorities can take some comfort from the fact that most investment is financed from profits rather than credit, and that the highest investment growth is taking place in largely commercialized sectors," it said.

It warned however that the ramped up investment levels did pose questions about whether Asia's second largest economy and the world's fourth largest was using its money wisely.

"The continued investment boom warrants concerns about efficiency, making more moderate growth desirable," it said.

Regulators in Beijing have taken a spate of recent cooling steps, including an interest hike in April, to take the steam out of the economy which expanded by 10.9 percent in the first half of the year.

As such, signs that some of these macro-economic policies were beginning to bite could be seen in monetary indicators and a slowdown in the number of projects being approved, the World Bank said.

But it warned Beijing against pushing too hard or too fast with economic curbs as it could risk creating more problems.

"From a macroeconomic perspective, the need to slow down the real economy significantly is not clear-cut," it said.

"A drastic slowdown alone would lower imports and boost the current account, creating more problems for monetary policy and trade relations."

It reiterated long-standing recommendations for making the currency more flexible as a step to solving some of the difficulties.

"Continuing the recent strengthening of the Renminbi (yuan) against the dollar may ameliorate part of this dilemma, as it would raise imports, reduce capital inflows, and switch investment to the non-tradables sector," it said.

Among the other risks for China's export driven economy is a potential slowdown in demand in the United States for Chinese goods, especially in the face of the Chian's fast-rising trade surplus, the World Bank said.

"Key risks are a sharper than expected slowdown in the US economy and a disorderly resolution of global imbalances," it said.

The bank proposed three initiatives to lessen the knocks for China's economic machine.

It said more measures were needed to stimulate domestic consumption and increase the efficiency of investment. Making the services sector more attractive than manufacturing was also necessary.

Institutional reforms were also needed to give local decision makers stronger incentives and better tools to pursue economic rebalancing.

©AFP