The latest economic indicators released by the central government on Wednesday suggest that monetary policies will remain "appropriately tight" in the second half.

China's real GDP growth in the second quarter as well as industry production and retail sales data for June came in better than expected, supporting the view that the economy remains on track to grow about 9 percent in 2011 - albeit with uncertain external demand posing some downside risks.

While policies are likely to remain biased towards tightening for some time given the persistent inflation risks, I think the probability of "over-tightening" is small, given the government is aware of such risks and likely will tolerate a bit of increased inflation in 2011.

That said, I continue to believe that slower growth is needed to keep inflation under control and I expect annual growth to slow to below 9 percent (at 8.7 percent) in the fourth quarter. Meanwhile, GDP growth is expected to slow further to 8.7 percent in 2012 from 9.3 percent in 2011.

Economic growth slowed from 9.7 percent year-on-year in the first quarter to 9.5 percent in the second quarter, which is better than the market consensus of 9.3 percent.

Growth momentum has also stabilized, with quarter-on-quarter growth edging up to 2.2 percent in the second quarter from 2.1 percent in the previous quarter. The stabilization in momentum came a quarter earlier than expected, reflecting a sharp rebound in industry production (IP) growth in June to 15.1 percent year-on-year.

Meanwhile, retail sales climbed 17.7 percent year-on-year, better than the market consensus of 17.0 percent while fixed asset investment (FAI) growth came in lower than expected at 25.6 percent after posting upside surprises during most of the first half of 2011.

The stronger-than-expected growth and the higher-than-expected June CPI/PPI suggest that inflation remains the dominant risk at this juncture. I believe policies will be "appropriately tight" in the second half of 2011 to contain inflation while taking into account the lag in monetary policy, as well as increased external uncertainties.

The government's mid-year assessment of the economic situation is that economic growth remains relatively fast and stable, with the key challenges identified as: elevated inflationary pressure, tight SME financing, intensified power supply and demand imbalances in some regions, and difficulties experienced by some companies in production and business operations. These views (based on an official statement posted on Tuesday) reflect opinions following four State Council economic assessment forums held by Premier Wen Jiabao during July 4-11. These involved provincial officials, corporate leaders and economists, and were confirmed by the official data release on Wednesday.

With China being the world's largest exporter, policymakers closely monitor external developments and factor them into their decisions. Double-dip concerns contributed to the delayed interest rate hike in 2010. External risks have clearly increased in recent weeks, with disappointing US data. Barclays economists now look for a 1.5 percent US GDP growth in the second quarter, and have lowered their GDP forecast for Europe in the second half. At this stage, however, I believe external risks have yet to be a major factor affecting China's monetary policy. The government has focused on domestic inflationary risks, particularly food (pork and agriculture) supplies and liquidity normalization. A further deterioration in external growth prospects likely would make Chinese policymakers more cautious. However, I believe they are unlikely to loosen policy - by cutting interest rates or reducing banks' reserve requirement ratios - given elevated inflation and capital inflow pressures.

The author is vice-president and China economist at Barclays Capital Asia Ltd. The opinions expressed here are entirely her own.

(HK Edition 07/14/2011 page2)