A new World Bank report projects GDP growth in China will be 8.2 percent in 2012 and 8.6 percent in 2013. The China Quarterly Update, released Thursday, says that the prospects for a gradual adjustment of growth remain high.

"China's gradual slowdown is expected to continue into 2012, as consumption growth slows somewhat, investment growth decelerates more pronouncedly and external demand remains weak," says Ardo Hansson, Lead Economist for China. "The risks of overheating are moderating, increasing the prospects to achieve a soft landing."

The China Quarterly Update, a regular assessment of China's economy, identifies as the key near-term policy challenge the need to facilitate a soft landing and sustain growth. Key risk factors include the weak and uncertain growth prospects of high-income economies and the evolution of the ongoing correction in China's property markets. Sufficient policy space exists to respond to downside risks, but any policy response would need to be carefully crafted keeping in mind longer-term effects and objectives.

The Update notes that the burden of any policy response should in the first instance fall on fiscal policy, with measures supporting consumption first priority. Reserve requirements could be tweaked further to ease the availability of credit, but policy rate action should best be reserved for potential downside scenarios since real interest rates are already accommodative. Administrative measures have been helpful in cooling the property market. Looking ahead they should be substituted by market-based measures that raise the cost of capital and expand the range of investment opportunities.

China's longer-term outlook will depend on its management of central structural challenges. As the traditional drivers of growth weaken over time, GDP growth may gradually slow. Sustaining strong per capita income growth requires invigorating underlying fundamentals of growth, especially productivity improvement. To enhance the scope for competition and to redefine the source of China's competitive advantage from low cost to higher value on the strength of innovation will be key.

In the past rapid growth and structural change has come at the price of economic, social and environmental imbalances. Looking forward it will be important to sustain the ongoing shift in focus from the rate of growth towards the quality of development.

In this respect, Philip Schellekens, Senior Economist and main author of the Update observes: "the current episode of cyclical weakness shows the limits of China's export-, credit- and investment-led growth model. As already predicated in the 12th Five Year Plan, strong progress on the structural reform agenda will help China achieve the objective of improving the quality of its development."