China’s economy is on a solid footing, despite weakening global demand, thanks to long-standing drivers of growth such as urbanisation, the central bank said on Friday.

As a result, the world’s fourth-largest economy is likely to retain its momentum in the second half of the year after growing 10.4 per cent in the first six months, the People’s Bank of China (PBOC) said.

In its second-quarter monetary report, the PBOC said Chinese exports were likely to weaken as clouds gathered over the world economy.

It warned of growing risks of recession in the euro zone and said the United States was likely to go through a long period of low growth as its economy adjusted to past excesses.

’Currently, the international environment is getting tougher and more complicated. Many economies face a dilemma of having to stabilise prices while safeguarding growth,’ the report said.

China, too, still faced many structural problems and quite serious inflationary pressure, a combination that made it very difficult for policymakers to steer the economy.

’But with the combined forces of industrialisation, urbanisation, internationalisation and the upgrading of consumption and of industry, our economy will continue to enjoy robust internal vigour and strength,’ the central bank said.

Despite the optimistic tone, the report said turbulence in global financial markets warranted close attention. The still-unfolding US credit crisis and monetary policy adjustments in Western economies could well cause a reversal of capital flows to emerging markets, it said.

’China will strengthen the monitoring of abnormal cross-border capital flows and fend off large-scale capital outflows,’ the report said, in a departure from the bank’s usual stress on the dangers of speculative capital inflows.

No clues

The report gave few clues as to the direction of policy. The PBOC restated its long-standing formula that the yuan’s exchange rate would be kept basically stable at a reasonable, balanced level and it said monetary policy would be fine-tuned in line with domestic and global conditions.

The PBOC also reaffirmed its commitment to fighting inflation alongside ensuring stable growth.

It said inflation as measured by the GDP deflator, the broadest gauge of prices pressures in the economy, was 8.6 per cent in the first half of 2008, up from 4.2 per cent a year earlier.

Recent increases in government-set fuel and electricity prices would add 0.7 percentage point to consumer inflation, the PBOC said. But it made a powerful plea for energy prices to be increased to international levels.

Cheap energy was a major reason for China’s unbalanced growth because it boosted investment and exports, which in turn stoked inflation. ’Making timely adjustments to fuel prices and perfecting the energy pricing mechanism will help China fundamentally ease inflationary pressures,’ the bank said.

The PBOC said it was still struggling to absorb excess cash generated by China’s twin current and capital account surpluses.

’We need to adopt a mix of tools to absorb banking liquidity and improve the impact and effectiveness of liquidity controls where necessary,’ the report said.-Reuters