CHINA might be through the worst after its 22-month austerity drive, Merrill Lynch senior economist Nicholas Kwan says. He said the economy had entered a more stable period. 'A full soft landing may still take time to materialise, but much of the heat behind the economy's imbalances has already been removed,' Mr Kwan said. Merrill Lynch expected China's economy to ease further in the next few months. 'It is very likely the worst of this economic cycle is already over,' he said. Inflation has been falling in China, from 27.7 per cent at its peak to 22.4 per cent in February, year-on-year. Prices of non-food items, making up 50 per cent of the consumer price index, appeared to be rising at a relatively moderate 12.5 per cent. Food prices were up 36 per cent year-on-year in January. 'In the long term, price stability would require better fiscal and monetary disciplines and further rationalisation of the price system, but much of the short-term price pressure should retreat with a slowing economy,' Mr Kwan said. The investment bank is expecting gross domestic product growth in 1995 of nine per cent to 9.5 per cent, against 11.1 per cent in 1994. It forecast a growth of between 8.5 and nine per cent in 1996. The inflation rate of 21.5 per cent in 1994 was expected to decline to between 17 and 17.5 per cent in 1995 and 9.5 and 10 per cent in 1996. Inflation was set to fall because the impact of two major shocks to the domestic price mechanism in food prices at the end of 1993 and in mid-1994 should largely have been digested by the third quarter this year. Under the consumer price index weightings, food prices contributed about 75 per cent of the increase in consumer prices. Should food price gains remain about 15 per cent in 1995 then the overall rate of inflation could recede. 'Even if other factors like high wages, strong money supply and higher import prices push up other prices, it will need to double the increase of non-food prices to keep overall inflation at the current level,' Mr Kwan said. Mr Kwan predicted the problems related to the huge burden imposed by state owned enterprises, triangular debt and unemployment, might work themselves out slowly. Rapid deposit growth was the prime factor preventing the triangular debt from hurting the economy. Mr Kwan said a number of solutions were being considered to reduce the burden of losses by state-owned enterprises on the economy. Bankruptcy, however, remained an essential final option. 'Bankruptcy should not be taken as the only or primary means to transform the state sector, but without this exit option, reforms will never be complete,' he said. He said the sector monopolised more than 90 per cent of the state budget and swallowed 80 per cent of China's bank loans. It took up 60 per cent of the country's fixed-asset investment. Triangular debt was put at 650 billion yuan (about HK$596 billion) by the government, while unofficial estimates put the total at two or three times the official estimate. The government was hindered from pumping huge amounts of yuan into the system to disentangle the problem because of the inflation this might tend to unleash. 'Fortunately, enough new deposits are being mobilised by banks to roll over the debt debacle,' Mr Kwan said.