"The economy posted very rapid growth in the first half with fixed-asset investments, exports, and imports all rising significantly from a year earlier," said ADB chief economist Ifzal Ali at the launch of Asian Development Outlook 2006 Update.

    "Even with an interest rate increase in mid-August that followed earlier monetary and administrative tightening measures, we expect second-half cooling to be modest. Our concern is that if the current investment boom continues, it could result in chronic overcapacity," he said.

    China's economy grew by a faster-than-expected 10.9 percent in the first half, building on 10.2 percent growth in 2005, according to China's National Bureau of Statistics.

    The 2006 full-year prediction for China represents a significant upward revision of the 9.5 percent growth forecast in April, when ADB launched its flagship annual forecasting publication, Asian Development Outlook (ADO) 2006.

    ADO Update forecasts overall growth for the 43 countries of developing Asia will be 7.7 percent in 2006, up from the 7.2 percent forecast in April.

    Investment spearheaded China's economic growth in the first half of 2006, with fixed-asset investment surging 29.8 percent year-on-year, well above the official target. Exports grew 25.2 percent over the previous year, while imports rose 21.3 percent, resulting in a 61.4 billion U.S. dollar trade surplus for the first half.

    The bank said that the acceleration in growth in the first half has heightened concerns about overcapacity in some industries and the possibility of a painful contraction of economic activity.

    The Chinese authorities have tried various tightening initiatives to cool the economy, including two increases in the benchmark lending interest rate and restrictions on property investment.

    The central bank also has imposed some direct controls on lending and adopted measures to absorb bank liquidity.

    It said statements by senior Chinese leaders hint at more tightening measures to come, but the magnitude and timing of these measures remain uncertain.

    The wider challenge of economic stabilization in China is complicated by a variety of factors, said the bank.

    Provincial officials often have incentives to boost investment, which may be at odds with the goals of the central government, said the bank.

    Furthermore, interest rates in China do not have the same impact on credit demand and allocation as they do in a full market economy, the bank said.

    Constraints on the effectiveness of monetary and fiscal policies, and difficulties in fine-tuning administrative controls create significant uncertainty surrounding the outlook for 2007, according to the update.

    The rate of increase in the trade surplus is likely to moderate as export growth slows alongside somewhat softer conditions in the world economy, it said.

    Despite rapid economic growth, consumer price inflation has remained tame. This reflects the supply-side nature of the current upswing and a rapid expansion of industrial capacity, said the bank.

    A good grain harvest also helped keep prices in check. Inflation is now expected to average 1.6 percent in 2006, down from the 2.3 percent forecast in April. Inflation is forecast to be 1.8 percent in 2007.

    "Risks are finely balanced," said Ali.

    "If investment doesn't slow, growth in 2007 could again surprise on the upside, raising the possibility of more difficult adjustments later. But if the authorities brake too hard, GDP growth could fall more than forecast," said the bank.

    China has had mixed success in reining in growth. In 1989-1990, when the government stopped approving new investment projects, its GDP growth slumped from about 12 percent to 4 percent.

    By contrast, in the late 1990s, the government successfully engineered a soft landing, with growth slowing from above 12 percent to 7 percent to 8 percent.

    The update also examines widening income inequality in China.

    "While some deterioration in income distribution is inevitable as the PRC (China) moves from a largely agrarian and centrally planned economy to an urban-based, industrialized market economy, the degree to which the gap has opened is a concern," said the bank. Enditem