China's economy has continued to grow robustly, with some softening recently, according to the World Bank's latest China Quarterly Update released on Friday.

The Update, a regular assessment of China's economy, finds that so far in 2010 the slowdown in government-led investment (GLI) after last year's massive stimulus has partly been offset by strong real estate investment. Household consumption growth has held up well, reflecting a favorable labor market. Leading indicators and industrial production data suggest some moderation of the pace of growth in the second quarter, although that pace is still rapid.

Export volumes have recovered rapidly since the trough in early 2009. Nevertheless, China's trade surplus has declined further due to surging import volumes and declining terms of trade. Inflation has picked up somewhat, but core inflation remains low. However, soaring property prices triggered tough property-specific measures, including tightening access to mortgage financing.

The Update finds that, despite concerns about fiscal risks in some high income countries, the global growth outlook remains favorable, in large part because of the strength in emerging markets. Nonetheless, risks around this global outlook are large.

In China, after a rapid start to 2010, growth is likely to ease, mainly because of a partial normalization of the macro policy stance and the measures towards the property market introduced in April.

"We project GDP growth of 9.5 percent for 2010 and 8.5 percent for 2011, with risks both ways," says Ardo Hansson, Lead Economist for China. "Growth should be less investment-driven this year and benefit from more favorable external trade, while consumption is likely to remain supported by a strong labor market." The external surplus should decline somewhat further this year. Inflation is likely to remain contained this year by the absence of price pressures globally while a wage-price spiral is not likely.

"In light of the robust growth prospects, it makes sense to further normalize the overall macroeconomic stance to contain the key macroeconomic risks," says Louis Kuijs, Senior Economist and main author of the Update. "Substantial uncertainty around a favorable outlook calls for policy flexibility rather than continued stimulus by default." The central authorities are rightly aiming to control lending by local government investment platforms. However, interest rates remain low. China could usefully let interest rates play a larger role in monetary policy.

Looking further ahead, policy making needs to take into account several features of the medium term outlook. Considering the prospects for its key determinants, trend growth is on course to decline in 2010-20, although to a still respectable rate. In setting growth targets for the coming decade, the likely slowdown in potential growth needs to be acknowledged. The expected deceleration of potential growth also places a premium on policies that can increase sustained productivity growth, including via more reallocation of labor, enhanced human capital, and innovation.

Moreover, further reforms are needed to ensure economic growth remains sustainable socially and with regard to energy and the environment. Fiscal policy reforms in several areas are key in this effort. Additional reforms in social protection and labor market arrangements are important both to foster productivity growth and improve social outcomes.

The government's intention to strengthen the role of private enterprises in the economy and remove barriers they face is welcome. In this connection, it would be useful to clarify the role that the government envisages SOEs to play in China's economy.