The World Bank raised its growth forecast for China this year to 9.5 per cent, although it warned that tighter monetary policy and a stronger currency were needed to prevent bubbles and rising inflationary expectations.

In a generally upbeat assessment of the Chinese economy which played down some of the concerns prevalent among investors at the moment, the bank raised its forecast for 2010 from the 8.7 per cent it predicted in its last quarterly report in November.

“China's economy held up well in the global crisis, and the growth prospects for this year and next year are quite good,'' said Louis Kuijs, senior economist in the bank's Beijing office.

Mr Kuijs said China needed to adopt a tighter monetary policy this year, given the strong rebound in the economy, however he played down the risk that inflation – which has risen strongly in recent months – would surge this year. The bank expects inflation to be 3.5-4 per cent in 2010.

Moreover, he said China could tolerate a rate of inflation a little bit above the 3 per cent target the government had set. The bank said in its report that in many developing countries an inflation rate of 4-5 per cent was not a problem.

It was important, however, that the central bank kept to its target for new loans this year of Rmb7,500bn ($1,098bn, €799bn, £717bn) he said, in order to prevent the economy from overheating and to control inflation expectations after record new credit last year of Rmb9,600bn. The authorities should also place more emphasis on using interest rates to dictate monetary policy, rather than instructions to the banks on how much to lend, he said.

The bigger potential risks this year were in the property market, where prices have been rising, and in local government finances after they invested heavily in infrastructure projects.

The bank said these investments by local governments could lead to a surge in bad debts, however in the past infrastructure investments had created additional growth and been paid for through land sales and higher tax revenues.

”Given China's solid macro position, we think the local government problems are not large enough when you put them together to cause systemic stress on China's economy,” Mr Kuijs said.

A stronger currency would help damp inflationary pressures and rebalance the economy away from exports and investment and more towards domestic consumption. “Over time, more exchange rate flexibility can enable China to have a monetary policy independent from US cyclical conditions, which is increasingly necessary,” the report said.

China's current account surplus, which fell sharply as a proportion of GDP from 9.4 per cent in 2008 to 5.8 per cent last year, was likely to remain at a similar level in 2010.