June 17 (Bloomberg) -- China’s government said the economy is in a “critical” phase as it starts to recover from the worst slump in almost a decade, and pledged to keep spending to sustain growth.

The foundation for the recovery is not yet solid and the global outlook is uncertain, China’s cabinet reiterated in a statement on the government’s Web site today.

Falling exports and profits, industrial over-capacity, and rising unemployment are making it harder to revive growth in the world’s third-largest economy, the State Council said. The central bank scrapped lending quotas in November and has kept interest rates at a four-year low, triggering an explosion in credit to support Premier Wen Jiabao’s 4 trillion yuan ($585 billion) stimulus package.

“The worst of China’s economic slump is over but the recovery might not be a straight upward trend,” said Lu Zhengwei, a Shanghai-based economist at Industrial Bank Co. “The government wants to warn the market not to be too optimistic.”

China’s gross domestic product grew 6.1 percent in the first quarter from a year earlier, the least since 1999. The economy has stabilized, the State Council said today, pledging to continue with a “proactive” fiscal policy and “moderately loose” monetary policy.

World Bank Report

The World Bank will release its latest forecasts for China’s economy tomorrow. In Japan, the government and central bank raised today their assessments of the nation’s economy for a second month after industrial production advanced at the fastest pace in 56 years and exports improved.

China must fully implement stimulus measures and also “prepare for long-term difficulties”, the State Council said.

Accelerating investment, rebounding industrial output and reviving market confidence are evidence that the stimulus is working, the cabinet said.

China will spur domestic demand, including purchases of home appliances and automobiles, “on all fronts,” it said. The government will also guide “stable and healthy” growth of the property market, the State Council added.

The government must prepare extra economic contingency plans, it said.

“More contingency plans are needed in case things worsen unexpectedly or the economy rebounds too fast, leading to an inflation problem,” economist Lu said.

--Li Yanping. Editors: Paul Panckhurst, Matthew Brooker.

To contact Bloomberg News staff for this story: Li Yanping in Beijing at +86-10-6649-7568 or yli16@bloomberg.net

Last Updated: June 17, 2009 07:07 EDT