Comment/Fred Hu: Is China's economy dangerously overheated? Despite growing concern around the world, the question is actually more complex than one might think.

Unlike doctors examining a patient, economists are unfortunately unable to use a thermometer directly to take the body temperature of the Chinese economy.

On the basis of a broad array of available macroeconomic data and relevant anecdotal information, however, a careful observer could not conclude that China is heading for economic boiling point.

China's official headline growth rates of real gross domestic product at 9.1 per cent in 2003 and 9.7 per cent in the 2004 first quarter may appear dangerously high, but are not that far out of line with the country's underlying potential growth rate - raised by decades of structural reforms and openness to the world economy. Suspicions are widespread that Beijing's official estimates might have understated actual growth.

An index compiled by Goldman Sachs to track real activity in China suggests the economy might have been growing at a double-digit rate in recent quarters.

Just as an overheated human body would display symptoms of fever, an overheated economy would show inflation.

China registered an annual 2.8 per cent consumer price inflation in the 2004 first quarter, representing a significant jump from the near-zero or negative inflation rates of just two years ago. But a return from the shadow of deflation to positive inflation should be welcomed, not feared. After all, at a single-digit level, Chinese inflation remains relatively mild.

This is particularly true if the official consumer price index (CPI), with its notoriously erratic movement, is properly corrected by filtering out volatility from items such as foodstuffs and energy, the rising prices of which have had a big effect on the Chinese CPI. In any case, China can probably live comfortably with annual inflation of 3-5 per cent without worrying too much about the attendant welfare costs.

Nor is there any clear evidence of rampant asset price inflation across the spectrum. China's domestic equity market is showing some tentative signs of revival after a two-year fall. Combined with inflated domestic asset prices, the home currency can become overvalued in a bubble economy.

Yet the Chinese currency, the renminbi, probably remains undervalued rather than being under pressure to depreciate. As an exception, China's red-hot property market poses a more legitimate concern, especially in large cities where speculative frenzies have pushed up prices of high-end property at double-digit rates in the past two years.

It is true that the current account recorded a small deficit of $8 billion in the 2004 first quarter - the first deficit in a decade. This predictable and salutary swing from a surplus of 3.5 per cent of gross domestic product in 2003 to a deficit has caused quite a fuss, in and out of China - but why?

If overheating is a concern, the fact that China's current account is turning into a modest deficit should be a relief. Whatever the excess domestic demand, it is being met by increased foreign supply via more imports, thereby relieving potential inflationary pressures.

Of course, the first-quarter current account deficit could be transitory in so far as it reflected seasonal factors. But, even if the deficit persists, it is normal for an economy with such high growth potential and strong external fundamentals to run a sustainable current account deficit, say, in the order of 1- 2 per cent of GDP. Precisely because of its healthy current account position, China can probably sustain its high investment rate on the back of its high domestic savings rate and modest long-term capital inflows.

Unlike south-east Asia on the eve of its crisis in the late 1990s, China's current investment boom does not rest on persistently large current account deficits and mounting short-term foreign debt.

The tightness of the labour market is another useful economic barometer, but China faces the opposite problem to labour shortages - massive unemployment. The average jobless rate in urban China has now surpassed 11 per cent and its pool of rural surplus labour is estimated at 200 million to 300 million people.

This is not to deny there are serious troublespots in the Chinese economy: fixed investment, expanding at 42 per cent year-on-year in the latest quarter, is clearly unsustainable. Shortage of supply in raw materials and electricity has already started to cause disruption to manufacturing activities.

While these emerging risks pose tough challenges, there is a range of not-yet-tried, potentially more effective, policy measures the Chinese authorities can contemplate to bring the risks under control.

Overall, the sizzling pace of economic growth remains a manageable problem. Widespread fears that China's economy is irreversibly headed for a hard landing are greatly exaggerated.

Fred Hu is a managing director at Goldman Sachs Asia and co-director of the National Center for Economic Research at Tsinghua University in Beijing.