China's Economy Grows at Fastest Pace in 12 Years

July 19 (Bloomberg) -- China's economy grew at the fastest pace in 12 years in the second quarter and inflation surged, prompting speculation the government will raise interest rates and push the currency higher to cool growth.
Gross domestic product expanded 11.9 percent from a year earlier, the statistics bureau said in Beijing today, exceeding all estimates of 23 economists surveyed by Bloomberg. Inflation climbed to 4.4 percent in June, the fastest since September 2004, breaching the central bank's 3 percent target for a fourth month.
Growth was powered by investment in factories and real estate that the government has been unable to cool with two rate increases this year and restrictions on bank lending. Allowing the yuan to strengthen may also help quell tensions with the U.S. and Europe, which say China's record exports reflect the unfair advantage of an artificially low currency.
``Accelerating inflation and a rebound in fixed-asset investment heighten the risk of overheating,'' said Wang Qing, chief China economist at Morgan Stanley in Hong Kong. ``Demand in key sectors is not outstripping supply yet, but the government is concerned.'' Wang expects an interest-rate increase ``any time from now.''
The yuan rose to as much as 7.5615 against the dollar, the highest since China abandoned a decade-old peg to the dollar in July 2005. It traded at 7.5632 at 5:34 p.m. in Shanghai, from 7.5639 before the report was released. The currency has climbed 9.4 percent since the link ended.
Clinton, Obama
That isn't enough for some U.S. lawmakers. Presidential candidates Senators Hillary Clinton and Barack Obama plan to co- sponsor legislation pushing for faster gains in the yuan.
``What they really need to do is accelerate the pace of currency appreciation,'' said Frank Gong, an economist at JPMorgan Chase & Co. in Hong Kong. ``One major reason for the strong growth is the expanding trade surplus.''
Liang Hong, senior economist at Goldman Sachs Group in Hong Kong, increased her 2007 GDP forecast to 12.3 percent from 10.8 percent. Calyon, the investment banking unit of Credit Agricole SA, raised its forecast to 11.2 percent from 10 percent.
``Our forecasts assume decisive policy tightening taking place in the second half of 2007,'' said Goldman's Liang, predicting two more 27-basis-point interest-rate increases this year, a reduction in the amount of money available for lending and other measures to restrict investment.
Interest Rates
``China will continue to strengthen and improve macro- economic controls in the second half of this year'' to keep money supply and lending under control, said Li Xiaochao, spokesman for the statistics bureau.
The central bank is expected to increase the benchmark one- year interest rate from 6.57 percent and the deposit rate from 3.06 percent at least once this year, according to 21 of 25 economists surveyed by Bloomberg News last month.
China's economy accounts for about a 10th of global growth and its appetite for commodities drove the prices of nickel and iron ore to records this year. Premier Wen advocates ``moderate'' measures to cool growth. He wants to avoid a sudden slowdown that could throw hundreds of thousands out of work and ignite social tension in the world's most populous nation.
A shortage of pigs following an outbreak of disease and surging international grain prices were among the main drivers of China's inflation, complicating efforts of the central bank to contain unpopular price increases.
Food Prices
Food inflation accounted for 2.5 percentage points of the overall 3.2 percent inflation for the first half, the statistics bureau said.
Rising food prices, high stock and property prices and excessive liquidity from the nation's record trade surplus ``may in combination push inflation further,'' said Li.
``Tightening monetary policy isn't going to immediately rectify rising food prices,'' said Jing Ulrich, chairwoman of China equities at JPMorgan Chase & Co. in Hong Kong. ``The government will have to use different methods.''
The government will increase the supply of poultry, beef and eggs and tighten controls on corn exports, the National Development and Reform Commission, the country's top planner, said this week.
Inflation has fueled some stock-market speculation because it outpaced returns on bank deposits, encouraging households to bet on equities. The key one-year deposit rate is 3.06 percent. The benchmark CSI 300 stock index has gained 87 percent this year.
Stock Market
To make savings more attractive, lawmakers last month passed legislation that will allow the cabinet to scrap or reduce a 20 percent tax on interest income. In May the government raised stamp duty on share trades to cool the stock market.
The CSI 300 has fallen about 11 percent since its June 19 record. The index declined 0.58 point to 3807 at the close in Shanghai. The yield on the 10-year bond fell 2.1 basis points to 4.41 percent as of 3:00 p.m., according to the China Interbank Bond Market.
Fixed-asset investment in urban areas jumped 26.7 percent in the first half from a year earlier, up from 25.3 percent in the first quarter.
China is also trying to encourage consumer spending by raising minimum wages and improving social security. Retail sales rose 16 percent in June from a year earlier after gaining 15.9 percent in May.
``Investment growth is likely to moderate, given continued monetary and administrative tightening,'' said JPMorgan's Gong. ``Retail sales have been accelerating this year and we expect this momentum to carry'' into the second half.
Industrial output climbed 19.4 percent in June, the most in a year, after increasing 18.1 percent in May.
Consumer Spending
China exported $112.5 billion more than it imported in the first six months, an increase of 84 percent from a year earlier.
That inflow of money pushed China's foreign reserves, the world's largest, to $1.3 trillion at the end of June and quickened money supply growth. Banks lent 2.5 trillion yuan in the first six months of 2007, 80 percent of last year's total.
The export- and investment-driven economy is drawing closer to replacing Germany as the world's third largest. Gross domestic product expanded 11.1 percent in 2006 to 21.09 trillion yuan ($2.79 trillion). Germany's economy was valued at $2.89 trillion.