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Chinese Industrial Output Surges in May, Tightening Seen

China's industrial output surged 18.1% in May from a year earlier, beating market forecasts and hardening the case for further policy tightening to tamp down the world's fastest-growing major economy.

Economists, who had expected output growth to ease to 17.1% from 17.4% in April, said comments late on Wednesday by Premier Wen Jiabao about rising inflationary pressures suggested the government could act swiftly.

"All the indicators are showing that the economy is on the verge of turning to overheating from fairly fast. Premier Wen also warned of that risk yesterday," said Chen Jijun, an analyst at CITIC Securities in Beijing. "I think the government will act immediately to curb the trend. A mix of tools has to be adopted because we know that a single measure is far from enough," he added.

The Shanghai stock market showed no undue concern about the prospect of tighter policy. The Shanghai Composite Index was down in the late morning session, but less than 4% below a record high scaled on May 29 before a sharp correction set in.

Booming exports, sustained fixed-asset investment growth and accelerating retail sales mean factories are firing on all cylinders despite rising interest rates and a government campaign against energy-intensive, polluting industries.

The economy expanded 11.1% in the first quarter, compared with a year earlier, and economists said figures so far pointed to another quarter of double-digit growth.

The National Bureau of Statistics said output of transport equipment rose by 27.1% from May 2006; motor vehicles by 25.7%; machinery by 23.5% and cement 20.7%.

Inflationary Worries

Among possible policy measures, Chen said China could raise interest rates for the third time this year and increase for the sixth time the proportion of deposits that banks must hold in reserve instead of lending out.

Further cuts in export tax rebates and measures targeted at wasteful investment were also likely, he said.

Economists at Goldman Sachs agreed. "We will watch for policy tightening risks, particularly those that come from the National Development and Reform Commission, possibly targeting high
energy-consumption industries," they said in a note to clients.

In a statement issued following a meeting of the State Council, China's cabinet, Wen said rising upward pressure on prices was a striking problem, as were excessive liquidity, runaway investment growth and a supersized trade surplus.

Chen Xingdong, chief China economist at BNP Paribas Peregrine in Beijing, said the conclusion from the cabinet meeting was quite clear.

"Growth seems to have turned from fast to over-heating, and the risk is definitely rising. I think that the most important thing that made them reach this conclusion is inflation."

After consumer price inflation accelerated to 3.4% in the year to May, Chen said policy makers now clearly believed that inflation was going to be a big issue. "There were six points on economic problems in the statement and, in particular, they said that rising price pressures were excessive. That is unusual," he said.

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