China on Wednesday voiced confidence that the economy has recovered from the global financial crisis, sending its clearest signal yet that it might gradually unwind its ultra-loose pro-growth policies.

The State Council, China's cabinet, said the economy had performed better than expected in the first nine months of the year and that recovery had been consolidated.

The language marks a shift from the cabinet's repeated insistence in recent months that the world's third-largest economy, though turning for the better, had not yet consolidated its recovery or was not yet on a solid footing.

It sends out a clear message that growth is no longer a problem for the Chinese economy, said Zhang Xiaojing, a researcher with the Chinese Academy of Social Sciences, the government's top think-tank.

But the cabinet also pledged consistency, reaffirming the active fiscal policy and appropriately loose monetary policy it adopted after exports plummeted a year ago when the Lehman Brothers collapse brought the financial crisis to a climax.

China has put this stance into practice with a 4 trillion yuan ($585 billion) stimulus package and an unprecedented surge of bank lending.

However, the statement also put inflation squarely back on the government's agenda, saying it was important to manage inflation expectations in coming months alongside securing steady economic growth.

Zhang said China's policy was now entering a period of normalisation, though a blanket tightening was still not on the cards.

Since the State Council has highlighted the inflation issue, the central bank will have to react, Zhang said. At the very least, fine-tuning will be more apparent.

Fine-tuning in China often refers to the use of open-market operations by the central bank to manage liquidity, as opposed to interest rate changes or strict bank lending controls.

INFLATION

Analysts expect that China's consumer prices will start rising soon in year-on-year terms after being in deflationary territory for most of 2009, but most expect only moderate inflation next year.

With maintaining economic growth no longer in doubt, the government has started to make the management of inflation expectations its top priority, said Lu Zhengwei, chief economist at Industrial Bank in Shanghai.

Earlier on Wednesday, China's top banking regulator, Liu Mingkang, urged banks to be more reasonable in their lending and to brace for a policy shift.

You must quickly establish and perfect liquidity risk management systems and pay close attention to the possible impacts on market liquidity of international capital flows, macro-economic trends and policy adjustment, he said.

His comments followed a speech by central bank Governor Zhou Xiaochuan last week in which he said that China's very easy monetary stance had been a necessary response to the global financial crisis and could not continue indefinitely.

GROWTH

China will announce its third-quarter gross domestic product on Thursday and economists polled by Reuters expect it to have grown 8.9 percent from a year earlier.

China's banks, almost all of which are state-owned, have been in the front line of economic revival efforts, issuing 8.67 trillion yuan ($1.27 trillion) in new loans in the first nine months of the year, 75 percent more than in all of 2008.

Much of the credit has been channelled into government-backed infrastructure investment and some analysts have expressed concerns about how the money will be repaid.

Another senior banking regulator said on Wednesday that the lending binge need not lead to a rise in bad debts, so long as banks manage their assets well.

The comments by Li Fu'an, a CBRC director, underscored how Beijing thinks it can guide banks through the dangers without implementing drastic tightening. He said banks could manage their portfolios by securitising assets and rolling over loans.

If banks use these tools, the loans will not turn into bad assets on their balance sheets, he said. We need to see if banks can make preparations early enough.

The expansion of banks' loan books has been so rapid that banks' non-performing loan ratios fell sharply in the first nine months of the year.

Banks are on track to lend about 10 trillion yuan ($1.47 trillion) this year, or a third of annual GDP, but the big question is how they will pace their lending in 2010.

Few think this year's clip is sustainable, but a steep drop-off will leave projects already started thirsting for cash.

Yin Zhongqing, deputy head of the finance and economic committee under the National People's Congress, was quoted in local press on Wednesday as saying that new local-currency loans next year would not be lower than 8 trillion yuan. ($1=6.825 Yuan)

China Inflation