Oct. 23 (Bloomberg) -- China is likely to tighten credit to avoid bubbles in the fastest growing major economy, the Asian Development Bank’s assistant chief economist said.

There is a “clear sign that the expansion of credit seen in the first half of this year will be reined in,” Joseph Zveglich said in an interview in Tokyo yesterday. “In terms of when to exit from monetary expansion, they are going to have to look carefully not just at consumer prices but also at what’s happening in asset prices.”

China’s economy grew 8.9 percent last quarter, the fastest pace in a year, led by a record $1.27 trillion in new loans and a $586 billion stimulus package running through 2010, the statistics bureau said yesterday. The government this week signaled that inflation concern will play a greater role in setting policy.

“The monetary expansion has two aspects. One is a reduction in policy rates and the other is keeping liquidity in the system,” Zveglich said. “What we are likely to see is that that second side will be reined in somewhat.”

Central bank Vice Governor Ma Delun said this week that inflation pressures are gradually building and inflows of capital from abroad will complicate monetary policy. Qin Xiao, chairman of China Merchants Bank Co., wrote in the Financial Times that it’s “urgent” for the central bank to tighten policy to avert asset-price bubbles.

Reserve Requirements

China may raise banks’ reserve requirements, or the proportion of deposits that lenders have to set aside as reserves, as early as the end of December, according to economists including Kevin Lai at Daiwa Institute of Research in Hong Kong. Lai said the People’s Bank of China may begin raising interest rates in the first quarter of 2010.

Urban fixed-asset investment climbed 33.3 percent in the first nine months from a year earlier, the statistics bureau said in yesterday’s report, as the stimulus measures spurred the construction of roads and power plants. Consumer prices fell 0.8 percent in September from a year earlier, the smallest drop since declines began in February.

The ADB estimates the world’s third-largest economy will expand 8.2 percent this year and growth will accelerate to 8.9 percent in 2010, assuming the nation keeps its fiscal package.

China needs to foster domestic demand to become the driver of growth in Asia, and as part of those efforts it should make its currency more flexible, Zveglich said.

“For China to become an engine for the region, it has to be more of a destination for final goods, not just the last stop on a production network that is aimed at the U.S. and Europe,” he said. “The direction is good but as of right now, China has not yet fulfilled that potential.”

To contact the reporter on this story: Toru Fujioka in Tokyo at tfujioka1@bloomberg.net; Tatsuo Ito in Tokyo at tito@bloomberg.net.

Last Updated: October 22, 2009 22:08 EDT