China will become the biggest driver of global economic activity this year for the first time, the International Monetary Fund said yesterday as it raised its already bullish forecasts for growth.

China is the world’s fourth-largest economy, but accounts for only 5 per cent of the global economy on market-exchange rate terms.

However, it is projected to grow by a blistering 11.2 per cent this year, far above the predicted 2 per cent expansion of the US economy. It will make the largest contribution to the world’s growth rate of any country, the IMF said.

The forecast was set out in an update to the IMF’s World Economic Outlook first published in April. The IMF raised its forecast for international growth in both 2007 and 2008 to 5.2 per cent, from 4.9 per cent, and said that more than half of growth was now coming from emerging markets.

China would provide a quarter of the annual growth rate of the world economy, while China, Russia and India together will account for more than half of world growth this year, the report said. Next year China’s growth rate was forecast to fall back, but only to a still very strong 10.5 per cent.

By contrast, US growth was revised down slightly, from an earlier forecast of 2.2 per cent, although the IMF said it expected growth in the world’s largest economy to pick up next year to 2.8 per cent.

The report also tipped Britain’s GDP to expand by 2.9 per cent before slowing to 2.7 per cent next year. Growth in the eurozone was predicted to be 2.6 per cent this year and 2.5 per cent in 2008.

Charles Collyns, deputy director of the IMF’s research department, said: “This year for the very first time, with its very strong growth expected, and with the growth slowdown in the United States, China will be contributing the largest part to the increase in the global growth measured at market exchange rates as well as purchasing parity terms.”

He added: “China seems to be going from strength to strength at this point. It’s hitting on all cylinders.”

The world body gave warning that faster growth meant that supply constraints were developing, heightening the risk of inflation, although price rises remained contained for now.

Central banks were now more likely to tighten monetary policy than in the April outlook.

Mr Collyns said: “There are concerns that inflation pressures may be picking up, and central banks will need to respond quickly and in a for-ward-looking way to these pressures.”

The report outlined a largely benign scenario for the US sub-prime mortgage market, arguing that while defaults and foreclosures had led to increased uncertainty, the risks appeared to be contained and should not pose a wider risk to the world economy.

Jaime Caruana, the IMF’s director of monetary and capital market development, said that the process of adjusting to the higher than expected level of defaults had not yet run its course.

The report said that lending discipline had weakened in the corporate credit market. Credit risk “has begun to translate into higher market risk” for sub-prime mortgages and highly leveraged loans, it said.

However, the report said that markets were avoiding panic by discriminating between loans according to the strength of their underlying fundamentals.

“In sum, risks have increased and credit markets could remain volatile in the period ahead with a further repricing of some credit products,” the IMF said in its financial market update. “However, so far, our assessment is that this risk is likely to remain largely contained.”

Mr Caruana said financial markets are “almost around average volatility”.

11.2% - Economic growth forecast for China this year

Source: International Monetary Fund’s World Economic Outlook

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