"We need some further observation," Guo said at a seminar organized by the State Council's Development Research Center (DRC) on Saturday. "But the central bank will remain especially vigilant about price increases."

The remarks came as speculation is running high about a possible rate increase.

The nation's consumer price index (CPI), the key barometer for inflation, topped 5 percent last month. Central bankers had earlier said that the bank would not turn a blind eye when the CPI reached the 5 to 6 percent range.

The index emerged from negative territory only last year, following months of deflationary pressure. But it has increased rapidly in recent months, prompting concerns about inflation at a time of sizzling investment and credit growth.

Fixed investment and loans have continued to soar since the middle of last year, pushing up industrial prices and stretching energy supplies and transportation capacity.

But this frenzied growth eased off significantly in June, cheered by many as a sign that the state's tightening measures are having an impact.

The government has used both monetary policy -- mainly three increases in bank reserve requirements -- and administrative measures such as price curbs and strict land policies to reduce fixed investment and credit growth.

But the economy is still sending mixed signals about the future.

"Monetary performance has seen obvious changes," Guo said, citing the decline last month in money supply and new loan growth, as well as stabilizing interest rates on the money market.

But liquidity remains high in the banking system, with commercial banks' excess reserves, which they set aside for payment needs, at 3.8 percent of their total deposits at the end of last month, he said. That was higher than in September last year, when the central bank announced the first of the three increases in required reserves aimed at restricting banks' lending capacities.

Guo said that excess bank reserves can only be higher today.

What is more important, he noted, is the possibility of fixed investment and credit growth re-accelerating in new forms once administrative controls are relaxed.

Yao Jingyuan, chief economist of the National Bureau of Statistics (NBS), shared Guo's concern. "What is unique about administrative measures is that they yield instant results, but the results tend not to last long," he said.

Businesses may soon be requesting more loans from banks to fund their expansion, using the excuse of alleviating a working capital shortage, Guo added.

Analysts said the government-ordered slowdown in new loans in June mainly came from fewer short-term working capital loans, constraining liquidity at many small and medium-sized enterprises.

Economists are still divided over the prospects for inflation in the coming months and the necessity of an immediate rate increase.

Zhang Zhuoyuan, a senior economist at the Chinese Academy of Social Sciences, predicted full-year CPI growth would be in the 4 to 5 percent range, and a rate hike would be "hardly avoidable."

"Prices are climbing, with the growth rate higher than the one-year deposit rate. Price increases for raw material and industrial goods have also surpassed the one-year lending rate," he said. "That has clearly created a negative real interest rate environment, which makes an interest rate rise inevitable."

Some seminar participants ruled out the possibility of rampant inflation, insisting the current price level remains manageable.

"Our basic judgment is that current inflationary pressures are acceptable and controllable," said Zhang Junkuo, director of the Market Economy Research Institute under the DRC.

China's CPI rose 3.6 percent in the first half of this year, but the increases were 80 percent driven by rises in grain and food prices, according to the NBS. That means the increase in core CPI has been "insignificant," Zhang said.

Although CPI growth is likely to keep above 5 percent in the third quarter, it is expected to subside significantly in the fourth quarter owing to the high price base a year earlier and anticipated increases in grain output.

"For the entire year, 4 percent should be achievable," Zhang said.

(China Daily July 26, 2004)