China's overheating economy stokes fears for global inflation

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Fears of overheating and escalating inflation in the Chinese economy sent equity and commodity markets around the world tumbling yesterday, as the country returned to double digit growth rates.

Some £1trillion in loans by local banks helped the Chinese economy to record growth of more than 10 per cent last year, though escalating inflationary trends have raised fears about the sustainability of such expansion in her overheating economy.

The Chinese National Bureau of Statistics said the economy of the People's Republic expanded by 10.3 per cent in 2010, compared with about 1.7 per cent in the UK and 2.5 per cent in the US.

It means China has returned to double-digit growth, having fallen back during the world recession to 9.2 per cent in 2009 and 9.6 per cent in 2008. China has averaged growth of around 10 per cent for the past 20 years, leaving it on some measures as the world's second-largest economy behind the US, having overtaken Japan and Germany this decade. The world's "two-speed" recovery continues.

Apart from the export-driven boom that has seen China accumulate more than $2trn in reserves, recent attempts by the Beijing government have been targeted at boosting domestic consumption, and it has actively encouraged the many state-controlled banks at a national and regional level to lend extraordinary sums. According to the statistics bureau, Chinese banks loaned 7.95trn yuan (£755bn) last year, with another 3trn or so of yuan loans made "off balance sheet", according to estimates produced by the credit ratings agency Fitch.

While some of this has fuelled rising consumption among the emerging middle classes – and contributed to the rising price of food globally – much seems to have gone into a real estate bubble that many analysts fear will burst before long, with unknowable consequences for China and the world economy. Other funds may have gone into "prestige" infrastructure projects that yield little or no financial or economic returns.

China's investment rate of 70 per cent of GDP is high even by developing economy standards, and three or four times the proportions usually encountered in the West. The Government has set a target for borrowing of 7.5trn yuan in 2011, which will trim growth in money supply which is now running at 50 per cent. Retail price inflation eased slightly in December, but the pressure of rising commodity prices – in large part stimulated by China's breakneck growth – seems certain to push it higher. Inflation stood at 4.6 per cent in December, after cresting a two-year high of 5.1 per cent in November. On average, inflation ran at 3.3 per cent over 2010, but it is expected to rise this year.

Moreover, much inflationary pressure may be disguised in an economy where national and regional officials still have the authority to intervene in markets and distort price signals. The authorities in Beijing may be even more concerned by the real estate bubble that has seen property prices in her sprawling eastern metropolises rise by annual rates of 30, 40 or 50 per cent in recent years. A property crash would not only harm those Chinese who have invested in property but also the banks that lent into that boom, though the residential mortgage market is less developed than in the West. More generalised concerns about the prospects for China saw stock markets around the world take a hit yesterday. Commodity prices also softened.

He Yifeng, an analyst at Hongyuan Securities in Beijing, said: "Overheating signs have already emerged in the Chinese economy. The government may have to take measures to cool off economic activity soon."

Against a background of "currency wars", the Chinese press hailed this week's meeting of presidents Barack Obama and Hu Jintao as "successful".