Expansion of credit leaves the growth of the real economy far behind, increasing the number of risks the economy must face. The possibility of an asset bubble created by the overgrowth of liquidity presents the most immediate dilemma.

One of the biggest challenges China now faces is that current conditions may facilitate an asset bubble, Ba Shusong, Deputy Director of the Research Institute of Finance of the Development Research Center of the State Council (DRC), said on a China Central Television interview.

Among the 7.37 trillion yuan of newly granted loans, a substantial portion flowed to the capital market, leading to the soaring stock and real estate markets, Ba said. Without other investment channels, the money can only remain in the capital market.

"Seeing from the present situation, there is no tendency for the easy monetary policy to change, and the growth of credit in the next two years will still be fast. This bubble may be bigger than the one in 2007," Ba said.

Wei Jianing, Deputy Director of the Department of Macro-Economic Research of the DRC, said at the Sohu Economist Forum on July 24 that at present, the structure of credit flow is very unreasonable. While an increasing number of loans are being granted, SMEs are crying for credit funds.

"When investigating the matter we found out from some localities and banks that about 50 percent of the credit funds went to the stock, real estate and bill markets, and among the other half that went to the real economy, most was used in the projects invested by local governments. Such a structure of credit flow is a concern to us," Wei said.

A commentary by Xinhua News Agency also warned that China should be vigilant against the expansion of asset bubbles. The Chinese monetary policy should aim at not only economic growth, but also the quality and sustainability of economic increase in the long term, the Xinhua article stated. China's advantage in dealing with the economic crisis is its high deposits and low debts, compared with Western countries. The Chinese Government is capable of expanding expenditures and picking up the economy.

The article also points out that the key point for government investment lies in driving up social investment. If the government does not control the overflow of market funds, the opportunity for steady economic transformation will be lost once the bubble bursts.

Inflationary awareness

The Chinese economy has picked itself up after bottoming out, but since a large amount of money has been poured into the real estate and stock markets, once the real estate and stock bubbles burst, inflation will emerge, said renowned economist Cheng Siwei at an award ceremony on July 19, 2009 in Beijing.

According to Cheng, the country should be cautiously optimistic about the present upswing of the economy. A variety of problems still exist and the ever-present risks of inflation should not be ignored.

Although the current inflation rate is not high, the general public needs to realize that this was only due to the large amount of money flowing into the real estate and stock markets, Cheng said. Once the real estate and stock bubbles burst, it will cause a dramatic change to the inflation rate.

Similar instances had plagued China before. During the early months of 2007, liquidity was excessive, but due to the real estate and stock markets' money absorbtion, the inflation rate remained considerably low. By the end of that year, however, the stock market had collapsed and the real estate market became more sluggish. Inflation eventually became an issue in early 2008.

The inflationary pressure in China should decrease within six to nine months, although the expansion of credit has greatly increased expectations on inflation, Wang Tao, chief China economist of UBS Securities Co. Ltd., said in a group interview on July 21 in Beijing. The fact that some of the loans are used for fiscal functions was also a cause for uncertainty concerning the risks of inflation in the mid term.

While promoting investment to expand domestic demand and ensure economic growth, "cooperation between banks and the government" becomes more justifiable, Wang said. The practice of local governments carrying out infrastructure investment projects through large amounts of bank financing allows bank credit to play a quasi-fiscal function. Expansion at the local level may freeze or at least hinder the monetary policy of the central bank, making it more difficult to control inflation through policy implementation.

The prudent forecast by Wang may not be completely accurate, as inflation is already appearing, Wei said.

One of the main characteristics for this year's bank credit is the incredible rate at which loans have been expanded. The 7.37-trillion-yuan increased loans have already surpassed the target set at the beginning of this year. Past instances of competitive credit granting in the 1980s and 1990s yielded negative results. A large number of loan extensions in 1984 were followed with inflation in 1985, while the first half of 1993 saw inflation reappear after an extensive number of loans were granted in the previous year.

A large amount of money has already been poured into the market, inevitably bringing pressure of price hikes. And while the present social demand may be inadequate, with many industries facing production capacity surpluses together with the high price level in the same period last year, China still doesn't see obvious inflation from the consumer price index (CPI) and producer price index.

Prices have subsequently started to show clear signs of increase in China. Statistics released by the National Development and Reform Commission on July 21 showed that the average ex-feedlot price of pork in large and medium-sized cities reached 10.77 yuan ($1.58) per kg on July 15, up 2.49 percent from the previous week.

Grain prices are experiencing hikes as well, as figures released by the National Bureau of Statistics on July 20 showed that grain prices have been steadily increasing on a month-by-month basis in the first half of this year. From January to June, the monthly growth rates were 0.2 percent, 1 percent, 1.5 percent, 0.4 percent, 0.8 percent and 0.6 percent, respectively. The grain prices have increased for six consecutive months, with the aggregate growth reaching 4.9 percent.

"Since grain prices are closely related to prices of many agricultural and sideline products, the continuously increasing grain prices should bring attention to the situation," the NBS warned.