Press Release No. 13/192

Press Release: IMF Mission Completes the 2013 Article IV Consultation Discussions with China

July 20, 2013

A mission from the International Monetary Fund (IMF), led by Mr. Markus Rodlauer, Deputy Director of the Asia and Pacific Department, visited Beijing, Shanghai, Guiyang, and Anshun from May 15 to 29 to conduct discussions on the annual Article IV review of the Chinese economy. The mission held wide-ranging discussions with senior officials from the government, the People’s Bank of China, private sector representatives, and academics to exchange views on prospects for the economy and the challenges ahead. 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, Finance Minister Lou Jiwei, and National Development and Reform Commission Vice Chairman Liu He. The discussions also covered the effects of China’s policies on the rest of the world, and vice versa, in the context of the IMF’s analysis of policy spillovers from the top five systemic economies.

At the conclusion of the visit, the mission issued the following statement:

“Despite weak and uncertain global conditions, the Chinese economy is expected to grow at around 7¾ percent this year. The pace of the economy should pick up moderately in the second half of the year, as the recent credit expansion gains traction and in line with a projected mild pick-up in the global economy. Inflation is forecast to end the year at around 3 percent, and the external current account surplus is projected to remain broadly unchanged at around 2½ percent of GDP.

“Notwithstanding this relatively favorable near-term outlook, China’s economy faces important challenges. In particular, the rapid growth in total social financing—a broad measure of credit—raises concerns about the quality of investment and its impact on repayment capacity, especially since a fast-growing share of credit is flowing through less-well supervised parts of the financial system. While good progress has been made with external rebalancing, growth has become too dependent on the continued expansion of investment, much of it by the property sector and local governments whose financial position is being affected as a result. High income inequality and environmental problems are further signs that the current growth model needs to change.

“The Chinese authorities recognize these challenges, and the new government that took office in March has announced a set of reforms for 2013 to start addressing them. In our discussions with the authorities, they emphasized their intention to embark on a comprehensive reform agenda that will ensure more balanced, inclusive and environmentally friendly growth going forward. While China still has significant policy space and financial capacity to maintain stability even in the face of adverse shocks, the margins of safety are narrowing and a decisive impetus to reforms is needed to contain vulnerabilities and move the economy to a more sustainable growth path.

“Our dialogue with the authorities has highlighted three broad challenges for the reform agenda: (1) embedding strong governance in lower-level state or state-related economic institutions, especially the banks, state-owned enterprises, and local governments; (2) continued liberalization and reduced government involvement, allowing a greater role of market forces; and (3) a decisive push for rebalancing toward higher household incomes and consumption. Overall success will depend on effective implementation of all three of these goals; for example, further liberalization of financial markets will not achieve the desired efficiency gains—and may even be counterproductive—in the absence of strengthened financial discipline and accountability.

“In terms of the main policy areas of the agenda, the mission was reassured by the authorities’ focus on the financial sector, fiscal reforms, and other measures to strengthen price signals and the framework for well-functioning markets. Reining in total social financing growth is a priority and will require further tightening of prudential oversight as well as, critically, improved investor accountability for their investment decisions (rather than the widespread perception of guaranteed returns on interest-bearing assets). These policies may slow activity in the short-term, but would do so in a way that supports the transition to a more sustainable growth path. If growth were to slow sharply below this year’s target, then on-budget fiscal stimulus should be used, focusing on measures that support household incomes and consumption, such as reductions in social contributions, subsidies to consumption, or targeted social safety net spending.

“Continued progress with interest rate liberalization and greater exchange rate flexibility will support rebalancing, and can be accompanied by a gradual and careful further opening of China’s capital account. The staff’s assessment of China’s external position is broadly unchanged from last year’s, with the renminbi considered to be moderately undervalued relative to a basket of currencies.

“Fiscal reforms are an integral part of the agenda to support rebalancing, improve governance, and raise the efficiency of investment. Including local government financing vehicles, an estimate of ‘augmented’ general government debt has risen to nearly 50 percent of GDP, with the corresponding estimate of an ‘augmented’ fiscal deficit on the order of 10 percent of GDP in 2012. While part of this deficit is financed through land sales, and augmented debt is still at a well-manageable level, it is important to gradually reduce the deficit over the medium term to ensure a robust and sustainable debt profile. Continuing tax reform and a comprehensive re-ordering of local government finances, realigning resources with spending needs and revamping the framework for local government investment and borrowing, will be key elements of this effort. Shifting part of the very high social security contributions to other taxation would also contribute to rebalancing and reduce the burden on low-wage earners.

“A broad range of other structural reforms will support the transition to more balanced and inclusive growth. Many of these, such as improved pricing of energy, land and water, are already proposed by the authorities. Allowing more competition in sectors currently considered strategic will boost growth and household income, and higher dividends from state-owned enterprises will improve financial discipline and provide additional fiscal revenue.

Taken together, these measures represent a challenging reform agenda that will require strong determination and administrative capacity to implement. The authorities repeatedly emphasized that they are fully aware of those challenges, as they are of the need for a decisive new round of reforms to shift the economy onto a more balanced and sustainable growth path. Their success will benefit both China and the rest of the world, reflecting the growing importance of China and its integration with the global economy.”