The FINANCIAL — A mission from the International Monetary Fund (IMF), led by Mr. James Daniel, Assistant Director of the Asia and Pacific Department, visited Beijing and Lanzhou from June 1 to 14 to conduct discussions on the annual Article IV review of the Chinese economy.
The mission held highly constructive and candid discussions with senior officials from the government, the People’s Bank of China, private sector representatives, and academics to exchange views on economic prospects, reforms progress and challenges, and policy responses.
The IMF’s First Deputy Managing Director, Mr. David Lipton, joined the final policy discussions and met with Vice Premier Ma Kai, People’s Bank of China Governor Zhou Xiaochuan, Director of Central Economic and Financial Reform Leading Group Liu He, Finance Minister Xiao Jie, China Banking Regulatory Commission Chairman Guo Shuqing and China Securities Regulatory Commission Chairman Liu Shiyu, among other senior officials, according to IMF.
At the end of the visit, Mr. Lipton issued the following statement:
“China continues to transition to a more sustainable growth path and reforms have advanced across a wide domain. Our discussions in the past two weeks focused on the policies needed to ensure China’s successful transition, which is vital to its own people and the rest of the world – and the urgency of accelerating pace of reforms.
“Policy support, especially expansionary credit and public investment, has helped China maintain strong growth. Staff now project growth of 6.7 percent in 2017 and average annual growth of 6.4 percent between 2018-20. China has the potential to safely sustain strong growth over the medium term. As has been widely recognized, including in the government’s reform plans, this requires deep reforms to transition from the current growth model that relies on credit-fed investment and debt. It is critical to start now while growth is strong and buffers sufficient to ease the transition.
“The Chinese authorities are fully aware of the challenges and have taken crucial and welcome measures. Important supervisory and regulatory action is being taken against financial sector risks. Corporate debt is growing more slowly, reflecting restructuring initiatives and overcapacity reduction. The house price boom is being gradually contained and excess inventory reduced. Local government borrowing frameworks are being improved and a blueprint for reforming central-local fiscal relations has been published. The creation of new businesses has tripled since the 2014 reform. Data weaknesses have been recognized and actions taken to improve integrity.
“While some near-term risks have receded, reform progress needs to accelerate to secure medium-term stability and address the risk that the current trajectory of the economy could eventually lead to a sharp adjustment. This means switching faster from investment to consumption; increasing the role of market forces; implementing a more sustainable macro policies mix, continuing the regulatory tightening; tackling nonfinancial sector debt; and further improving policy frameworks. Our specific recommendations build on the progress achieved and the government’s existing reform agenda. In particular:
China needs to further boost consumption . Continued increases in public spending on health, pensions, education, and transfers to poor households would reduce excessive precautionary savings and, combined with making the tax system more progressive and greener, would boost growth while reducing China’s high income inequality and pollution.
To increase the role of market forces, the existing reform agenda for state-owned enterprises (SOE) should be accelerated and broadened to include phasing out implicit support and increasing tolerance for default and exit. Building on recent announcements, barriers to entry should be removed, especially in the highly closed service sector. Efforts to reduce overcapacity should have more ambitious targets both in the coal and steel sectors and in other sectors, with greater reliance on market forces.
A more sustainable macro-policy mix would include focusing more on the quality and sustainability of growth and less on quantitative targets, a gradual fiscal consolidation, and less accommodative monetary policy. To reduce nonfinancial sector debt, the focus should be on greater recognition of losses, especially of underperforming SOEs and zombie enterprises. Reducing the flow of new debt and increasing its efficiency requires cutting off-budget public investment and imposing hard budget constraints on SOEs.
The critically important recent focus on tackling financial sector risks should continue, even if it entails some financial tensions and slower growth. We will have more detailed analysis and recommendations on the financial sector in our five-yearly Financial Sector Assessment Program (FSAP) review, which we expect to be completed by the end of the year.
The monetary policy framework should continue to be strengthened over the medium term, including by phasing out monetary targets, resuming progress towards a flexible exchange rate, and improving communications. While China’s external position remains moderately stronger compared to the level consistent with medium-term fundamentals, the renminbi is assessed as broadly in line with fundamentals. Capital flow measures should be applied transparently and consistently. Further capital account liberalization should be carefully sequenced with the necessary supporting reforms, including an effective monetary policy framework, sound financial system, and exchange rate flexibility.
The government’s guidelines on reforming central-local fiscal relations are welcome. We recommend centralizing some expenditure responsibilities, such as social insurance, while local governments should be given more revenue-raising authority, as well as sufficient debt quotas to reduce their incentive to rely on off-budget borrowing and land sales.
China also needs to address remaining data gaps to further improve policy making and meet G20 commitments.
“Given China’s record of successful reforms in the past decades, and the authorities’ strong commitment and determination, we are confident that China will once again find its way through the challenges ahead, and we wish them the best of success in their efforts.
“We would also like to express our sincere appreciation to the Chinese authorities for their hospitality and productive discussions in the last two weeks.”
