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IMF Executive Board Concludes 2016 Article IV Consultation with the People’s Republic of China
On July 27, 2016, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with China.
China continues its transition to sustainable growth, with progress on many fronts yet also many challenges. Growth slowed to 6.9 percent in 2015 and is projected to moderate to 6.6 percent this year owing to slower private investment and weak external demand. The economy is advancing on many dimensions of rebalancing, particularly switching from industry to services and from investment to consumption. But other aspects are lagging, such as strengthening SOE and financial governance and containing rapid credit growth.
Inflation dipped below 1.5 percent in 2015 and is expected to pick up to around 2 percent this year, reflecting the rebound in commodity prices and the exchange rate depreciation since mid-2015. Infrastructure spending picked up and credit growth accelerated in the second half of 2015. Accommodative macro policies are projected to continue supporting activity over the remainder of 2016.
The current account surplus is projected to decline to 2.5 percent of GDP this year (from 3 percent of GDP in 2015) as imports increase and the services deficit widens with continued outbound tourism. The balance of payments came under pressure in 2015 due to large capital outflows, mainly related to repayment of external debt. The volume of outflows is expected to moderate this year. After appreciating 10 percent in real effective terms through mid-2015, the renminbi has depreciated some 4.5 percent since then and remains broadly in line with fundamentals.
Executive Board Assessment
Executive Directors commended the Chinese authorities for their strong determination to achieve more balanced, sustainable growth. They noted that economic growth continues to moderate and is driven increasingly by services and consumption. Directors welcomed the impressive progress on structural reforms in many areas, notably interest rate liberalization, internationalization of the renminbi, and urbanization. They also welcomed the 13th Five-Year Plan, with its ambitious goals centered on economic rebalancing.
Directors noted that China’s economic transition will continue to be complex, challenging, and potentially bumpy, against the backdrop of heightened downside risks and eroding buffers. They stressed the need for decisive action to tackle rising vulnerabilities; reduce the reliance on credit-financed, state-led investment; and improve governance, risk pricing, and resource allocation in the state-owned enterprise (SOE) and financial sectors. Directors emphasized that consistent, well-coordinated, and clearly-communicated policies are key to a smooth, successful transition, which will eventually benefit the global economy.
Directors highlighted the urgency of addressing the corporate debt problem through a comprehensive approach. They encouraged the authorities to harden budget constraints on SOEs; triage and restructure or liquidate over-indebted firms; and recognize losses and share them among relevant parties, including the government if necessary. Piloting a few SOEs would make a strong start to the process. Directors recommended that the authorities complement these measures with targeted social assistance for displaced workers, and initiatives to facilitate entry of new, dynamic private firms.
Directors concurred that macroeconomic policies should be geared at lowering vulnerabilities, which would likely entail somewhat slower growth in the short term. They welcomed the authorities’ intention to rely on fiscal support if growth falls sharply in the near term. To this end, they saw merit in using on-budget, pro-consumption measures, which would help promote internal and external rebalancing. Measures could include raising pensions; increasing social, education and health spending; providing restructuring funds; and cutting minimum social security contributions. Continued efforts are also needed to ensure full implementation of the new budget law, improve fiscal transparency, and modernize the tax system.
Directors underscored the importance of further enhancing financial stability. Priorities include encouraging banks to proactively recognize loan losses and strengthen capital ratios; enhancing supervisory focus on liquidity risk management and funding stability risks; and addressing vulnerabilities in shadow products. Directors also recommended a major upgrade of the supervisory framework to foster cross-agency information sharing and policy coordination, reduce the scope for regulatory arbitrage, and enhance crisis management capabilities. They looked forward to the forthcoming Financial Sector Assessment Program Update.
Directors noted the staff’s assessment that the renminbi is broadly in line with fundamentals, although the external position in 2015 was moderately stronger than consistent with fundamentals. They welcomed steps toward an effectively floating exchange rate regime and encouraged the authorities to build on this progress while carefully managing the transition, and with the support of a more market-based monetary framework. Directors supported a cautious approach to capital account liberalization that is carefully sequenced with the progress on exchange rate flexibility and financial sector reforms.
Directors encouraged the authorities to continue to improve data quality and policy communications, which would help reduce uncertainty, align expectations, and guard against market turbulence.
People’s Republic Of China – Staff Report For The 2016 Article IV Consultation
Context. China continues its transition to a sustainable growth path. Rebalancing has progressed on many dimensions, particularly switching from industry to services and from investment to consumption, but less on reining in rapid credit growth. Reforms have advanced impressively across a wide domain, but lagged in some critical areas, and the transition to sustainable growth is proving difficult, with sizable economic and financial volatility. Vulnerabilities are still rising on a dangerous trajectory and fiscal and foreign exchange buffers, while still adequate, are eroding. Outlook. The near-term growth outlook has improved due to recent policy support. But the medium-term outlook is clouded by continued resource misallocation, high and rising corporate debt, structural excess capacity, and the increasingly large, opaque, and interconnected financial sector. The apparent challenges in implementing a clear and decisive reform path add to concerns that China may exhaust its still-sizable buffers before the economy changes course sufficiently.
Strategy. While the challenges are still manageable, urgent action is needed to ensure they remain so by reducing vulnerabilities while supporting new, market-based growth. This means slowing credit growth by tackling its root causes—the pursuit of unsustainably-high growth targets, soft budget constraints on SOEs and local governments, the web of implicit and explicit guarantees, and excessive risk taking in parts of the financial sector—while maintaining macro stability. Key elements:
- Tackling the corporate debt problem, with a comprehensive plan and concrete action to harden budget constraints (especially on SOEs), restructure/liquidate weak firms, recognize and allocate losses, improve governance, and facilitate market entry.
- Adjusting macro policies for a moderate slowdown, by allowing growth to settle at a level consistent with sustainable macro policies, substantially slowing credit expansion and switching from off-budget investment to on-budget, pro-reform and pro-consumption fiscal measures.
- Guarding against financial risks, by boosting bank buffers, recognizing losses, improving funding resilience, reining in risks in shadow banks/products, and improving the supervisory framework and crisis preparedness.
- Continuing progress toward an effectively floating exchange rate regime, combining an overarching drive toward progressively greater market-determination and skillful short-term management to avoid excessive volatility.
- Strengthening transparency, especially in communications and data quality.
“The new normal means… a farewell to the unbalanced, uncoordinated and unsustainable growth