Outlook for 2011-15

• There is little likelihood of significant political reforms in the forecast period (2011-15), as China's leaders will concentrate on maintaining stability during the transition to a younger generation of political leaders in 2012-13.
• Strained relations between China's majority Han ethnic group and Tibetan and Uighur minorities are unlikely to improve. The government will maintain a hard line against separatism, stoking wider ethnic grievances.
• The economy performed unexpectedly strongly in 2010, and the Economist Intelligence Unit now estimates real GDP growth in the year as a whole at 10.2%. Growth will slow to an average of 8.4% a year in 2011-15.
• Wage inflation will remain rapid in the forecast period, helping to support private consumption. But investment, notably in the property sector, will decelerate from the high growth rates that were recorded in 2009.
• China will continue to come under strong pressure to allow a rapid and more meaningful increase in the value of the renminbi. However, the currency is likely to appreciate only slowly against the US dollar in 2011-15.
• Consumer price inflation is expected to remain a major policy issue in 2011, as the government struggles to contain a strong increase in food prices. Inflation is expected to average a manageable 4% in 2011­15.
• Although export growth has rebounded strongly in 2010, the outlook for exports is clouded by the uncertain global economic environment.

Monthly review

• China is coming under pressure to do more to bring North Korea to heel. This follows the North's artillery attack on the South Korean island of Yeonpyeong in November.
• In the past month the Chinese government has launched a high-profile campaign criticising the decision to award the Nobel Peace Prize to a Chinese dissident, Liu Xiaobo.
• Fears are mounting that China's economy could be overheating, amid rising inflationary pressures in the economy. This follows the announcement that inflation reached a 28-month high of 5.1% year on year in November.
• Rising inflationary pressures have prompted the government to shift its monetary policy stance from "appropriately loose" to "prudent".
• Total vehicle sales in the first 11 months of 2010 were up by an impressive 34% year on year, at 16.4m. This puts China on course to be the biggest automotive market in the world for the second successive year.

The Chinese Communist Party (CCP) will continue to dominate the political scene in the forecast period (2011-15). The CCP monopolises political power in China and suppresses any challenge, real or perceived, to its authority. It has proved highly successful in maintaining its dominant position. The CCP controls the institutions of law and order, the security apparatus and the media. As a last resort, it can count on the armed forces to guarantee the continuance of its rule. Consequently, threats to the party-state structure are likely to remain subdued in 2011-15. However, factional rivalry is a potentially destabilising factor within the upper echelons of the party. During the early part of the forecast period more overt jostling between factions is likely in the run-up to the 2012 party congress, which will see the installation of a new CCP leadership.

Social tensions will continue to be generated by a number of issues, including unemployment, poor working conditions, environmental pollution, late payment of wages and benefits, illegal eviction from homes and land, official corruption and abuse of power. The majority of protests take place in the countryside, where illegal land seizures from farmers are a major problem. However, the rural population tends to be poorly organised and easily controlled by the state security organs, so that such protests pose little threat to national political stability. Social spending, especially in rural areas, has been increased in the past few years, and further rises in expenditure are likely. This will go some way towards reducing tensions.

Unrest in urban areas could pose a greater threat, but the CCP suppresses non-governmental organisations that might co-ordinate or channel social discontent. The government's strategy of punishing those who lead protests while trying to alleviate the underlying causes of social unrest has also proved highly effective-the authorities took many steps to cushion the painful social impact of the slowdown in economic growth in 2008-09, for example. Yet in an economic or political crisis it is possible that unrest could suddenly coalesce in a fashion that would be hard to control without bloodshed.

Separatist forces will remain weak, but ethnic unrest will probably erupt occasionally in the ethnic-minority regions of Tibet and Xinjiang, and related incidents of terrorist violence elsewhere in China are possible. Violence by Tibetans in early 2008 was followed in mid-2009 by race riots in Xinjiang in which nearly 200 people were killed. Separatism in Xinjiang poses a greater risk of escalating into a full-blown insurgency than unrest in Tibet, given the proximity of Xinjiang to separatist and Islamist groups in Central Asia. However, a new generation of Tibetans is less receptive to calls from their own leaders (including the Dalai Lama) for a peaceful approach, and this increases the potential for violence. Both regions are likely to see further protests. The Dalai Lama is growing old, and the Chinese authorities will be concerned that his death could provide a catalyst for further Tibetan instability. The government continues to take a harsh approach, including the use of the death penalty, to curbing separatist or ethnic unrest. It is also increasing development spending in Xinjiang and Tibet in an attempt to pacify these regions by boosting economic opportunities, although this tactic has failed there in the past.

Since the current leadership, headed by the president, Hu Jintao, and the premier, Wen Jiabao, came to power, a collective-style government has emerged. New figures were "elected" to both the party and the government leadership line-ups in 2007-08. The next reconfiguration will begin in late 2012, when the CCP's 18th congress will select a new party leadership. This will be followed by the installation of a new state leadership in early 2013. The vice-president, Xi Jinping, was appointed to the position of vice-chairman of the powerful Central Military Commission (which oversees the armed forces) in October, confirming his status as heir-apparent to Mr Hu. The current executive vice-premier, Li Keqiang, who is regarded as being Mr Hu's favourite among the upcoming generation of cadres, looks set to succeed Mr Wen. However, the top tier of the future leadership does not look to be as ideologically cohesive as the current government. Factional struggles are likely to be intense in 2012-15 as the new leaders seek to establish their independence from their predecessors and compete among themselves for control of the political agenda.

Neither Mr Hu nor his successor is likely to countenance a meaningful opening up of the electoral process. Editorials in a leading CCP newspaper, the People's Daily, in October and November indicated that the government would continue to reject multiparty elections and the constitutional separation of powers in 2011-15.

The 2008-09 international economic downturn, which China weathered more successfully than many other nations, has boosted the country's self-confidence on the international stage. China has adopted a more forceful stance on a range of issues, such as global warming, Taiwan, Tibet, exchange-rate policies and global liquidity levels. China's greater assertiveness means that further confrontation is likely in 2011-15. Its clashes with its neighbours will encourage them to look more often to the US for political support. China will be a crucial participant in global negotiations, but it is extremely sensitive to perceived slights, interference in its internal affairs and what it views as efforts to curb its rise. This, coupled with the weak influence within China of the Ministry of Foreign Affairs, will complicate attempts to improve international relations.

China's claim on Taiwan will remain a crucial foreign policy issue for the government. But military escalation of the dispute looks increasingly unlikely, as economic ties have deepened and China has adopted a less aggressive posture towards the island. Even if pro-independence forces take power in Taiwan, the status quo looks set to continue. Ties with Japan will remain problematic, owing to lingering tensions over Japanese occupation of China during the second world war and disputes over maritime territory. However, both governments will try to improve relations in the longer term. China's expanding international interests have been highlighted by increased activity in fields such as peacekeeping and anti-piracy patrols. This trend is likely to continue, but the greatest source of the country's influence on the global stage will come from the desire of foreign governments and companies to tap its vast market and to attract Chinese investment.

In response to a rise in activity in the housing market and an acceleration in inflation during the second half of 2010, the government has started to tighten policy. Further incremental tightening is likely in 2011, as the authorities try to maintain steady economic growth while keeping inflationary pressures in check. Fiscal policy will continue to exert a drag on growth, as the central government's traditionally conservative fiscal instincts reassert themselves amid an effort to address the risks associated with the recent surge in local government debt.

Distortions in the economy will remain a major policy challenge in 2011-15. In particular, growth will continue to rely on unsustainably high rates of investment. The government will look to moderate increasing social inequality; an important CCP policy meeting in October stressed the need to raise incomes and "reasonably adjust income distribution". Officials may support workers' efforts to secure pay rises, and could seek to use the tax system more effectively to redistribute wealth. But state welfare services will remain underdeveloped, and efforts to increase spending in this area will make frustratingly slow progress. The state-owned sector benefited from a far higher level of policy support than the private sector during the 2008-09 economic slowdown. Although this support will diminish in the next couple of years, the public sector will continue to enjoy preferential treatment, for example in terms of access to credit and support from government policy.

China is expected to record a budget deficit equivalent to 2.3% of GDP in 2010. The situation will improve in 2011­15, as spending on emergency stimulus-related infrastructure projects (which have risen sharply in 2009-10 as the government has attempted to support economic growth during the global downturn) comes to an end. But expenditure on education, healthcare and pensions will rise substantially, in line with the government's "harmonious society" programme. Revenue growth will also remain strong as the economy continues to expand rapidly.

The government's fiscal position is not as healthy as the headline figures suggest, and concerns persist about the transparency of official data on the public finances. The extent of off-budget expenditure is difficult to quantify, and the quality of data relating to local governments in particular is in doubt. Local government finances are likely to have deteriorated as a result of recent stimulus spending, and the debt burden of the investment platforms that local governments created to channel this expenditure will become heavier in 2011-15 as interest rates rise. An even greater problem is the government's many contingent liabilities, which include the cost of pension provision and potential future losses by the state-owned banking sector.

Amid growing concern about rising inflationary pressures, in early December the government altered its monetary stance from "appropriately loose" to "prudent". This came after the People's Bank of China (PBC, the central bank) had raised benchmark one-year lending rates by 25 basis points, to 5.56%, in October-the first interest rate rise since December 2007. As worries grow about inflation, interest rates are likely to be increased steadily during 2011-12. However, the government's ability to control credit expansion through the state-owned banking sector means that quantitative controls on monetary and credit expansion are arguably more important in policy terms than the lending rate. The government will thus implement further increases in bank reserve requirements early in the forecast period to ward off an acceleration in inflation. In addition to reserve requirements, banks will also be subject to monthly and quarterly credit quotas. The Economist Intelligence Unit forecasts that credit expansion will be managed carefully in the next couple of years to slow the pace of money supply growth. The target for new lending in 2011 will be set lower than the goal of Rmb7.5trn (US$1.2trn) for 2010. The use of such quantitative means of controlling bank lending is not ideal, as credit quotas penalise small and medium-sized enterprises in the private sector that lack political connections. The PBC will seek to move towards a system that relies more strongly on interest rates in 2011-15.

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Real GDP growth is estimated to have accelerated to 10.2% in 2010, from 9.1% in 2009. This stronger growth has been driven by rising activity in most parts of the economy, thanks to loose credit conditions and a government-backed stimulus package that has boosted investment. Economic expansion will slow to 8.8% in 2011 as stimulus spending comes to an end and policy tightening leads to a slowdown in property investment growth. Weakening demand in major OECD markets will also serve to dampen export growth. However, strong income growth will support consumption. Low or negative real interest rates and relatively loose credit conditions will also encourage high-value consumer purchases.

During 2012-15 GDP growth will slow to an average of 8.3% a year. This will largely reflect slower investment growth, as more cities in China reach the stage at which mass redevelopment becomes less necessary and economically costly. The contribution from net exports will also weaken as a strengthening renminbi, anaemic growth in many developed economies and declining Chinese competitiveness cause export growth to slow relative to import expansion. However, high levels of job creation and rising wages should ensure sustained rapid growth in consumption. The ongoing expansion of social services (and in particular healthcare, education and pension provision) will support growth in state spending, although a return to fiscal conservatism will act as a brake on public expenditure growth. There remains the risk that China could suffer a sharp economic correction in 2011-15. The frothy housing market and ongoing massive overinvestment are the most likely sources of potential problems. The government's capacity to counteract economic crises is strong, as it proved in 2008-09, but its ability to do so without aggravating the imbalances that already threaten the economy is less certain.

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Controlling inflation is now the government's main policy challenge. In November year-on-year consumer price inflation reached 5.1%, its highest level since July 2008. The recent acceleration in inflation is being driven by higher food prices, which are largely a result of unusual weather patterns in parts of China. More worryingly, core inflation has also started to creep up in recent months. We estimate average inflation at 3.3% in 2010 and forecast that the rate of price increases will remain elevated during the first half of 2011. Strong liquidity growth and booming demand (which has helped to eliminate the output gap that appeared during the 2008-09 downturn) are other factors contributing to the recent sharp rise in inflation. Headline inflation will average a manageable 4% in 2011-15.

However, the risks to our forecast remain largely on the upside. The main danger concerns the volatility of food prices (which account for a large share of the consumer price index basket in China). Local agricultural prices are vulnerable to the vagaries of the weather-particularly in China, but also internationally. In any case, food prices will rise as agricultural land becomes scarcer and the cost of other farming inputs increases. Another risk is that if economic growth were to strengthen unexpectedly, this might eliminate excess capacity from product markets, enhancing companies' ability to raise prices. In addition, the large salary increases that firms are having to offer to keep workers-and, in some cases, to end industrial disputes-may put upward pressure on consumer prices as well as raising manufacturing costs.

Producer prices have increased sharply in 2010 as a result of strong domestic demand, recovering global prices for raw materials and policy-driven increases in state-mandated prices for fuel and utilities. Producer price inflation will cool in 2011-15 owing to greater stability in international oil and commodity prices. There is a danger that speculative asset price bubbles, notably in property or equity markets, could emerge in the forecast period. The risk is aggravated by negative real deposit interest rates, which encourage savers to put their money in other saving and investment vehicles.

China is coming under intense pressure from its main trading partners, most notably the US, to allow the renminbi to appreciate more rapidly. US legislators recently passed a bill in the House of Representatives (the lower house of Congress) that would allow the US government to punish countries that manipulate their currencies by imposing tariffs (it is, however, unlikely that the measure will become law). As evidence that the Chinese government manipulates the exchange rate to support exports, critics of China's policies point to the country's rapid accumulation of foreign-exchange reserves-which rose by a record US$194bn in the third quarter of 2010-owing to persistently large current- and capital account surpluses.

The Chinese government is likely to remain highly cautious in the area of exchange-rate policy, and is not expected to bow to foreign pressure for a substantial revaluation. However, it will allow the renminbi to appreciate gradually during the forecast period. Despite the problems that this will cause for exporters, renminbi appreciation is desirable, as it should help to reduce the surpluses on China's capital and current accounts, which are contributing significantly to domestic and global economic imbalances. The average exchange rate in 2010 is estimated at Rmb6.77:US$1, and the renminbi is forecast to appreciate against the US dollar by an average of 3.5% a year in 2011-15.

China's current-account surplus stood at a massive US$297bn in 2009, but as a proportion of GDP it has been falling since 2008 and stood at 6.1% in 2009. The surplus is forecast to continue to shrink relative to GDP in 2011-15, but it will remain fairly constant in US dollar terms, and we expect it stand at US$314.2bn, equivalent to 2.5% of GDP, in 2015. Although merchandise exports are forecast to expand rapidly in the forecast period, by 11.9% a year on average, this will be well below the supercharged pace of export growth in the period preceding the global financial and economic crisis. A large proportion of China's imports consists of components that are assembled in the country before being shipped abroad again, and imports and exports therefore tend to expand at similar rates. However, a growing proportion of imports will be consumed domestically in 2011-15, and, at an average of 14.3% a year, import growth will outpace export expansion. The trade surplus will therefore fall, but at US$217.6bn in 2015 it will remain substantial.

The services deficit will widen considerably in 2011-15, largely reflecting an explosion in overseas travel by Chinese tourists. In addition, the economy's growing sophistication will see demand for imports of professional services increase rapidly, although exports of services will also grow, reflecting the increasing earnings of Chinese companies working on infrastructure projects overseas. The income account will post a huge surplus in the forecast period thanks to the income earned on China's enormous stock of foreign-exchange reserves, which will continue to rise. These inflows will dwarf the income debits associated with the country's large stock of inward foreign direct investment. However, such outflows will grow as the number of foreign firms operating in China expands rapidly and their revenue rises strongly. The current transfers surplus will remain in the black in 2011-15, reflecting the high level of remittances from overseas Chinese.

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Despite international condemnation of North Korea's artillery attack on the South Korean island of Yeonpyeong in November, which left two marines and two civilians dead, China has remained conspicuously neutral on the issue. China's role as North Korea's only true remaining ally is nevertheless an increasing source of embarrassment to it. Although the Chinese authorities have expressed concern over the latest incident, they have refused to condemn North Korea, instead calling for both the North and the South to do more to ensure peace on the Korean peninsula. China's unwillingness to blame North Korea publicly for the attack (following a similar refusal to hold the North responsible for sinking a South Korean frigate, the Cheonan, in March) comes despite growing international pressure.

Many in the international community would like China to do more to bring its ally to heel, especially given the leverage that it enjoys as North Korea's largest aid provider and main trading partner. The Chinese authorities have many reasons to be concerned about North Korea's recent behaviour. China's efforts to portray itself as a responsible global power are suffering owing to its provision of economic aid and diplomatic support to a rogue state. In addition, there are fears in government circles that North Korean brinkmanship could overshadow the visit of the Chinese president, Hu Jintao, to the US in January 2011. Moreover, China's support for the North Korean regime is getting in the way of a burgeoning economic relationship with South Korea. China did not establish formal economic ties with the South until 1991, but the value of its bilateral trade with South Korea reached US$156bn in 2009, compared with just US$2.7bn with North Korea.

There are, however, a number of reasons why there is unlikely to be a sudden reversal in China's stance towards its long-time ally. Despite three decades of economic reform and modernisation in China that has opened the country up to the rest of the world, Chinese ties with North Korea remain close. The two countries fought together during the Korean war, prompting China's then leader, Mao Zedong, to declare that China and North Korea were as close as "lips and teeth". Military ties are especially close, and the influence of the Chinese People's Liberation Army has been crucial in ensuring continued political support for North Korea from China, despite the diplomatic trouble that it causes.

China is also worried about the potential implications of regime change in the North, the most likely outcome of which would be the reunification of the two Koreas-a scenario that the Chinese government is thought not to be keen on. It regards North Korea as a valuable bulwark between itself and South Korea, largely because of the thousands of US troops that are stationed in the South. Chinese military planners would regard the possibility of a US military presence on their doorstep with horror. In addition to these fears, the authorities are concerned that a sudden implosion of the North Korean government could lead to a destabilising flood of refugees across the border into north-eastern China. According to some estimates, up to 300,000 refugees have already crossed the border from North Korea into China. The collapse of the regime would lead to an estimated 3m more people fleeing North Korea, and many of them would head to China.

During the past month the Chinese government has launched a high-profile campaign criticising the decision to award the Nobel Peace Prize to a Chinese dissident, Liu Xiaobo. Mr Liu was recently sentenced to 11 years in prison for "subverting state power", after he was found guilty of writing a political manifesto, Charter 08, which called for political reform in China. Mr Liu first came to public attention during the 1989 Tiananmen Square demonstrations, when he helped to persuade some student demonstrators to leave the square instead of confronting the army. In an attempt to discredit the Nobel prize-giving ceremony, China has used both official and unofficial diplomatic channels to issue sinister but unspecific warnings of "consequences" for countries choosing to send representatives to the award ceremony for the prize in the Norwegian capital, Oslo.

Despite the criticism, the ceremony went ahead in early December, with the non-attendance of Mr Liu symbolised by an empty chair; the last time a chair had been left empty in this way was in 1935, when Adolf Hitler had forbidden a German pacifist, Carl von Ossietzky, to attend the ceremony. China's diplomatic efforts ensured that 16 of countries refused their invitations to attend the ceremony (the Chinese government returning its own invitation unopened). The nations that decided not to send representatives included countries whose economies are heavily dependent on trade and investment links with China, such as Sudan, Sri Lanka and Iraq, as well as states that have problems of their own with political dissidents, including Egypt, Russia and Vietnam. The number of countries refusing to turn up would have been higher, at 17, had not Serbia decided to attend the ceremony at the last minute as a result of strong pressure from the EU and the US.

China's use of undiplomatic language-the Norwegian Nobel Committee were described as "clowns" engaged in a "farce"-is unlikely to have been persuasive abroad, although domestically the government's control of the press has enabled it to successfully depict Mr Liu as a traitor. China's response to this year's Nobel Peace Prize award, the setting up of a rival "Confucius Peace Prize" by a shadowy committee of local businessmen, contained elements of farce itself, as the recipient of the prize, Lien Chan, a former premier and vice-president of Taiwan who has been praised by China's ruling Communist Party for fostering links with the Chinese mainland, failed to turn up to receive his prize and apparently did not even know he had been awarded it.

There is little doubt that in terms of international public relations the whole episode has been a disaster for the Chinese government, which has put itself in a position in which it has been possible to compare it to some of the 20th century's most brutal regimes, including Stalin's Soviet Union, Hitler's Germany, Poland under martial law, and Myanmar under the current military junta. Unfortunately for Mr Liu, the publicity generated by the decision to award him the prize means that he is likely to remain in jail for some time.

The Economist Intelligence Unit's 2010 democracy index ranks China 136th out of 167 countries (unchanged from its score in the 2008 index), putting it in the class of governments considered "authoritarian" regimes. This places China in the uncomfortable company of countries such as Egypt, Angola and Vietnam. China's failure to engage in any substantive form of electoral process involving its people is the main reason for its low overall score of 3.14 (out of 10). The government's mistrust of popular engagement in politics also results in a poor political participation score of 3.89, reflecting-among other factors-the absence of a multiparty system. The civil liberties category also receives a very low score, at 1.18, highlighting the subordination of judicial, trade union and religious bodies to the all-dominating Chinese Communist Party (CCP). The poor score for this category is also partly a result of China's lack of freedom in areas such as the Internet, newspapers and broadcast media.

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There will be no meaningful political reform

China's low overall democracy index score obscures respectable performances in government functioning and political culture for a country of China's level of development. This partly reflects a compromise whereby the Chinese people have tacitly accepted a very low level of political freedom in exchange for competent economic management by the CCP government. Officials, especially in central government, work hard to remain alert and responsive to public concerns. However, should there be a sharp slowdown in the economy at some point during the next few years, it would challenge this bargain and would lead to a notable increase in social unrest. China scores 0 in the electoral process category. This low score is justified by the fact that even though a major transfer of power will take place in 2012-13, with a new president and prime minister set to be appointed, the decision on who to select for the posts will be made entirely by top leadership of the CCP and will involve no consultation with the public. Meanwhile, corruption and a growing gulf between the country's political leaders and the mass of the public whom they are meant to represent-the most obvious consequences of the failure to introduce political checks and balances-will continue to be major problems. Against this background, the government is likely to grow less tolerant of political dissent. This, as well as the efficiency of the security forces, means that the chances of political reform remain extremely slim. On a more positive note, underlying social development, including the emergence of civil-society groups and legal and media activism, is likely to make gradual progress, especially at the local level, despite the heavy restraints imposed by the CCP leadership.

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Democracy index 2010: Democracy in retreat, a free white paper containing the full index and detailed methodology, can be downloaded from www.eiu.com/DemocracyIndex2010.

Note on methodology

There is no consensus on how to measure democracy, and definitions of democracy are contested. Having free and fair competitive elections, and satisfying related aspects of political freedom, is the sine qua non of all definitions. However, our index is based on the view that measures of democracy which reflect the state of political freedom and civil liberties are not "thick" enough: they do not encompass sufficiently some crucial features that determine the quality and substance of democracy. Thus, our index also includes measures of political participation, political culture and functioning of government, which are, at best, marginalised by other measures.

Our index of democracy covers 167 countries and territories. The index, on a 0-10 scale, is based on the ratings for 60 indicators grouped in five categories: electoral process and pluralism; civil liberties; functioning of government; political participation; and political culture. The five categories are interrelated and form a coherent conceptual whole. Each category has a rating on a 0-10 scale, and the overall index of democracy is the simple average of the five category indices.

The category indices are based on the sum of the indicator scores in the category, converted to a 0-10 scale. Adjustments to the category scores are made if countries fall short in the following critical areas for democracy:

• whether national elections are free and fair;
• the security of voters;
• the influence of foreign powers on government; and
• the capability of the civil service to implement policies.

The index values are used to place countries within one of four types of regime:

• full democracies-scores of 8 to 10;
• flawed democracies-score of 6 to 7.9;
• hybrid regimes-scores of 4 to 5.9;
• authoritarian regimes-scores below 4.

Fears are mounting that China's economy could be overheating, amid rising inflationary pressures. This follows the announcement that inflation reached a 28-month high of 5.1% year on year in November. Talk of measures to help to stabilise prices dominated the agenda of the government's annual Central Economic Work Conference, which set policy goals for 2011. After the meeting had concluded on December 12th, a policy statement spoke of a shift from "appropriately loose" monetary policy in 2010 to "prudent" policy in 2011. This underscored the fact that the government is strengthening its focus on tackling inflation and keeping liquidity growth under control.

The People's Bank of China (PBC, the central bank) has traditionally tried to keep prices and liquidity in check using quantitative controls on monetary and credit expansion. Given the government's ability to control credit expansion through the state-owned banking sector, quantitative controls are as important in policy terms as the lending interest rate. The PBC has raised banks' reserve requirements six times in the past year; the most recent rise, on December 10th, was the third in a month, taking the ratio for big banks up to 18.5%. In contrast, the benchmark lending rate has been raised just once in 2010. Given the fact that real interest rates on one-year deposits in China are now negative, and that worries are growing with regard to rising inflation, the probability of more rate rises early next year is increasing.

The Chinese authorities' fears that inflation could accelerate further were not helped by the decision in November by US authorities to launch a fresh round of quantitative easing. The decision by the Federal Reserve (the US central bank) to begin a new phase of quantitative easing in effect signals that it is preparing to keep interest rates at their current, ultra-low levels for some time to come. This has fuelled concerns that there could be a flood of hot money from the US to faster-growing parts of the world economy, such as China, in search of higher returns.

China's policy of internationalising its currency, the renminbi, has made huge progress in the past year, and an offshore market for renminbi-denominated products at last seems to be taking shape. The most recent move towards internationalising the renminbi came in late November, when Russian and Chinese government officials announced that their two nations would conduct bilateral trade in each other's currencies.

The start of the current round of liberalisation dates back to the end of 2008, when reforms were launched permitting renminbi-denominated trade between specified border regions in China and a number of foreign-currency markets, including Hong Kong, Macau and several South-east Asian countries. In June 2010 the government increased to 20 the number of Chinese provinces that are allowed to conduct renminbi trade-together, these provinces account for almost all of China's external trade-and allowed them to conduct such trade with any external market.

In November consumer price inflation in China reached 5.1% year on year, its highest level since July 2008. Higher food prices were largely to blame, but core inflation also picked up. Coming after a series of data releases showing rapid growth in investment and production, the latest inflation figures have added to worries about potential economic overheating. Food prices surged by 11.7% year on year in November, up from 10.1% in October, accounting for nearly three-quarters of the increase in headline inflation. The main drivers of higher food prices were increases in grain prices (which were up by 14.7% year on year in November) and in the cost of fresh fruit (prices for which were up by 28.1% in November, compared with 17.7% in October). Non-food prices also rose at a faster rate in November (at 1.9% year on year) than in October (1.6%), although overall they remained fairly subdued. Higher residence costs, largely reflecting rising rents, accounted for most of the boost to non-food-price inflation. There are also fears that the official inflation data underestimate the rate of inflation in China and that the true rate could be much higher.

The recent sharp rise in inflation is part of a broader trend. Also in November, producer price inflation surged to a five-month high of 6.1% year on year, while industrial production growth rose to 13.3% and money supply (M2) expanded by 19.5%. Similarly, government statistics covering 70 cities show that housing prices were up by 0.3% month on month and 7.7% year on year in November.

Chinese policymakers pay especially close attention to inflation data, given the potential implications for social stability. High inflation in the late 1980s contributed to the rise in popular unrest that culminated in the 1989 Tiananmen Square democracy movement and the subsequent bloody suppression of the protests. The fact that the current inflationary spurt is being driven by higher food prices will be of particular concern to the government, since this will hit poorer consumers hardest.

Another worry for the government is property price inflation and the problem of affordability in many of China's big cities. A report by the prestigious Chinese Academy of Social Sciences (CASS), based on a survey of 35 large and medium-sized cities conducted in September, shows that high property prices mean that 85% of urban Chinese are unable to afford to purchase their own homes. Although some cities have seen prices rise faster than others, the CASS report showed home prices running at 8.8 times average disposable income (a figure dwarfed by the ratios in the capital, Beijing, and Shenzhen, which stood at 22 and 18 times the average disposable income respectively). This multiple is far in excess of anything seen in the US in 2006 (where a property bubble touched off the recent global financial crisis), although it is more common in emerging markets for house prices to stand at high multiples of average earnings.

Demand for vehicles in China, already the world's largest market for cars, continues to boom. In 2009 China became the world's biggest market for vehicles (including passenger cars, trucks, buses and sports-utility vehicles), surpassing the US for the first time, with total sales of 13.6m, up by 46% on the previous year. Although sales growth in 2010 has decelerated, in the first 11 months of the year sales still grew by an impressive 34% year on year, to reach 16.4m. The strong performance in 2010 has put China on target to achieve more car sales in a year than any other country. The previous record was set by the US in 2000, when 17.4m vehicles were sold.

Sales of passenger cars alone reached 1.34m in November (the largest number recorded in a single month, beating the previous monthly record, achieved in January 2010, when 1.32m cars were sold. Overall, car sales in China in November were up by 29.3% year on year, representing an acceleration from the previous month and the fastest rate of sales growth since April. Part of the reason for the unexpectedly strong growth recorded in November was a rumour that some of the measures introduced to stimulate sales in late 2008 and early 2009 during the worst of the global economic crisis are to expire at the end of 2010. This has encouraged customers to bring forward their purchases to before the end of the year. The measures concerned include a tax rebate for small cars and subsidies for car buyers from rural areas, as well as a scheme under which motorists trading in their existing vehicle for a new one receive a subsidy.

The Chinese government is keen to encourage the development of more environmentally friendly cars and for China to become the green-car capital of the world. The development of a low-carbon economy is set to be one of the main goals in China's next five-year plan, which will cover the period from 2011 to 2015. China arguably already leads the world in several areas of green energy, such as wind power and solar water heaters, and it looks likely that the electric-vehicle market could be next. China has targeted the sale of 1m so-called clean-energy cars a year by 2015. The country also wants to become the world's largest producer of clean-energy cars within the next decade.

Earlier this year the Ministry of Finance launched a two-year programme to promote hybrid-engined cars and electric vehicles in five cities, namely Shanghai, Hangzhou, Changchun, Shenzhen and Hefei. Buyers of domestically built electric vehicles in these cities will receive subsidies to the value of Rmb60,000 (US$8,900) per vehicle, while purchasers of certain Chinese-built petrol-electric hybrid cars will receive up to Rmb50,000 per vehicle. At the same time, the Chinese government is investing huge sums of money in installing numerous recharging points for electric vehicles. At least four cities are currently hosting trials of recharging stations.

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Please see graphic below

Please see graphic below

Please see graphic below

Please see graphic below

Land area

9,561,000 sq km

Population

1.32bn (end-2007; official estimate)

Main towns

Population (millions) of main urban areas

Shanghai: 15.6 Chongqing: 5.1

Beijing (capital): 13.1 Wuhan: 4.9

Guangzhou: 11.0 Harbin: 4.8

Shenzhen: 8.5 Shenyang: 4.4

Dongguan: 6.5 Chengdu: 3.8

Tianjin: 5.2 Zhengzhou: 3.5

Climate

Continental, with extremes of temperature; subtropical in the south-east

Weather in Shanghai (altitude 4 metres)

Hottest months, July and August, 23-33°C (average daily minimum and maximum); coldest month, January, -1 to 9°C; driest month, September, less than 5 mm average rainfall; wettest month, June, 160-165 mm average rainfall

Language

Mainly putonghua, or Standard Chinese, based on northern Chinese (the Beijing dialect known as Mandarin); local dialects and languages are also used

Measures

The metric system is used alongside certain standard Chinese weights and measures, of which the most common are:

1 jin = 0.5 kg 2,000 jin = 1 tonne

1 dan = 50 kg 20 dan = 1 tonne

1 mu = 0.0667 ha 15 mu = 1 shang = 1 ha

Currency

Renminbi (Rmb), or yuan. Rmb1 = 10 jiao = 100 fen. Average exchange rate in 2009: Rmb6.83:US$1

Fiscal year

January-December

Time

8 hours ahead of GMT

Public holidays

New Year, January 1st-2nd; Chinese New Year, February 13th-19th; Qingming Festival, April 3rd-5th; Labour Day, May 1st; Dragon Boat Festival, June 16th-18th; Mid-Autumn Day, September 22nd; National Day and Mid-Autumn Festival, October 1st-8th

Official name

People's Republic of China

Form of government

One-party rule by the Chinese Communist Party (CCP)

The executive

The state council, approved by the legislature; state council members, including the premier, may serve no more than two consecutive five-year terms

Head of state

A president and a vice-president are approved by the legislature for a maximum of two consecutive five-year terms

National legislature

Unicameral National People's Congress (NPC): 2,989 delegates are selected by provinces, municipalities, autonomous regions and the armed forces. The NPC approves the president and members of the state council, as well as the membership of the standing committee of the NPC, which meets when the NPC is not in session. All arms of the legislature and the executive sit for five-year terms

Regional assemblies and administrations

There are 22 provinces, four municipalities directly under central government control and five autonomous regions. These elect local people's congresses, and are administered by people's governments

National elections

The current government line-up was approved at the NPC meeting in March 2008. A new party leadership will be announced at the 18th national congress of the CCP in late 2012. The new government line-up will be announced in March 2013 at the NPC, when Xi Jinping and Li Keqiang are expected to take over from Hu Jintao and Wen Jiabao as president and premier respectively

National government

The politburo (political bureau) of the CCP sets policy and controls all administrative, legal and executive appointments; the nine-member politburo standing committee is the focus of power

Main political organisation

The CCP, of which Hu Jintao is the general secretary

Politburo standing committee members

Hu Jintao

Wu Bangguo

Wen Jiabao

Jia Qinglin

Li Changchun

Xi Jinping

Li Keqiang

He Guoqiang

Zhou Yongkang

Heads of selected state ministries and commissions

President: Hu Jintao

Vice-president: Xi Jinping

Premier: Wen Jiabao

Vice-premiers:

;Li Keqiang

;Hui Liangyu

;Zhang Dejiang

;Wang Qishan

Commerce: Chen Deming

Finance: Xie Xuren

Foreign affairs: Yang Jiechi

National Development & Reform Commission: Zhang Ping

Central bank governor

Zhou Xiaochuan