The economy still faces downward pressure and domestic and external situations are "grim" as industrial output posted its slowest growth in nearly three years, the Ministry of Industry and Information Technology warned on Wednesday.

Difficulties faced by companies and the consequences of sustained "sluggish" external demand should not be underestimated, Zhu Hongren, the ministry’s chief engineer, said.

Related readings:  Senior CPC official stresses stable economy  Economy may rebound in Q2 on stimulative policies  China's economy to avoid hard landing  More policy easing on way to boost economy

Industrial output grew by 11.6 percent year-on-year in the first quarter of 2012, the slowest growth since July 2009, according to figures released by the National Bureau of Statistics.

The figure hit 20 percent a year ago.

China’s economy expanded 8.1 percent in the first three months from a year earlier, the smallest expansion in almost three years and the fifth straight quarterly deceleration.

Data this week showed manufacturing may shrink for a sixth month in April and a leading index rose in March at a slower pace, adding to evidence growth is moderating.

Chinese companies are facing increasing operational difficulties, the ministry said. Higher electricity and fuel prices are pushing up costs and average wages across the nation this year may increase by 20 percent, it said.

The ministry said in December it would set an industrial output growth target of about 11 percent for this year, the same goal as 2011 when production actually expanded 13.9 percent.

The lower target will ease environmental pressure which was caused by rapid economic growth and induce industries to produce higher quality products, Zhu told a news conference organized by the State Council Information Office.

"We need to pay more attention to the possibility that the economy might weaken further," Zhu said.

To propel the growth of small and medium-sized enterprises (SMEs), the State Council introduced a package of supportive measures in February.

However, rising costs and difficulty in securing finance are still causing problems for firms. Increasing labor costs will further squeeze margins as "the average salary is predicted to rise 20 percent this year", Zhu said.

China has more than 10 million SMEs, accounting for more than 95 percent of the country’s companies.

They are responsible for about 80 percent of national employment and 60 percent of GDP, according to data from the All-China Federation of Industry and Commerce.

The end of last month saw loans extended to the industrial sector, with a maturity of more than one year, increase by 7.3 percent year-on-year. But this increase was 2 percentage points lower than three months earlier, according to data released by the People’s Bank of China on Wednesday.

New lending to SMEs, in the first three months of 2012, hit 153.2 billion yuan ($24 billion), 69.7 billion yuan less than a year earlier.

Growth in outstanding middle and long-term loans to heavy industries declined by 3.3 percentage points from the end of 2011.

Zhao Xijun, deputy head of the School of Finance at Renmin University of China, said liquidity demand from enterprises remained weak, and the government should strengthen efforts to guide capital flow to the right sectors instead of injecting more liquidity into the overall market.

Despite sluggish growth, Zhu said industrial output growth is showing signs of acceleration.

"Production is picking up in the second quarter from the first quarter," he stressed.

"The fundamentals of our industrial sector development remain good. We still have sustainable growth potential and the downward pressure is under control," he added.

Zhu also mentioned that external demand continued to weaken and domestic demand remained basically stable.

Wu Yiyao in Shanghai contributed to this story.