Public Information Notice No. 09/87

Public Information Notice: IMF Executive Board Concludes 2009 Article IV Consultation with the People's Republic of China

July 22, 2009

On July 8, 2009, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the People's Republic of China.¹

Background

China has been hit hard by the global economic crisis, a slowdown in the real estate market, and the overhang caused by excess capacity in various industries. Exports have fallen dramatically and growth is now at its lowest point in more than a decade.

The government has responded with decisive monetary and fiscal policies, offsetting the drag from declining world demand and falling private investment. While the recovery has yet to be firmly established, recent data are encouraging and there are signs an economic turnaround is taking hold. Consumption indicators are relatively strong, industrial production appears to have bottomed out, and labor markets appear to be absorbing those workers laid off from export industries.

A long track record of fiscal discipline has driven down public debt, affording China the space needed to significantly expand fiscal support. Public infrastructure has been deployed quickly—including major infrastructure projects and efforts to rebuild following the Sichuan earthquake—and the tax burden has been reduced.

Monetary policy has also been loosened. Interest rates and reserve requirements were lowered in the latter part of 2008 and limits on credit growth were removed. This has led to an extraordinary expansion in bank lending in the first quarter, although the pace of credit growth has slowed somewhat in recent months.

Strategic plans have been devised to support individual industries, retooling factories, improving energy efficiency, encouraging innovation and R&D spending, and consolidating those industries with excess capacity.

Banks have increased capital and the bulk of the banking system meets the minimum capital adequacy requirement. Progress has also been made in recapitalizing and restructuring Agricultural Bank of China. Most banks have a sizable capital base, low nonperforming loans and high profits. Loan loss reserves have also been increased. Bank profits are, however, being squeezed by falling loan rates and higher provisioning costs.

Since the middle of 2008, nominal exchange rate appreciation against the U.S. dollar has stopped although the nominal effective exchange rate has appreciated 5 percent. Real appreciation in the 12 months to May was 5 percent.

Executive Board Assessment

Executive Directors recognized that the global crisis has severely affected China, and congratulated the authorities on a rapid and vigorous policy response in both the fiscal and monetary policy areas. This response has served to mitigate the economic downturn and facilitate an economic recovery during the course of this year and into 2010 and has contributed to broader global stability. Directors highlighted, in particular, the important role of China’s stability-oriented economic policies as a bedrock of regional stability.

Nevertheless, Directors recognized that the uncertain pace and timing of the global recovery would make it much harder for global demand to absorb increased production capacity from China. They, therefore, supported the steps that China is taking to bolster private consumption as part of a comprehensive, well-sequenced strategy aimed at rebalancing China’s growth model, and saw further room for policies to reduce China’s dependence on exports and high levels of investment. This, alongside efforts by other countries, would also help reduce global current account imbalances.

Directors welcomed China’s already substantial fiscal support. Given the low level of public debt, they generally saw further room for a targeted, additional stimulus aimed at increasing private consumption through near-term fiscal measures to raise household income. Directors were of the view that fiscal support should be maintained in 2010.

Directors highlighted that additional reforms to improve healthcare, education and pensions would help lessen the motivation behind high precautionary savings. They welcomed the recent bold efforts to reform the provision and financing of health care, raise the public funding for education, expand pension coverage for rural residents, and increase the portability of pensions. They encouraged the authorities to further deepen reform efforts in these areas. Directors also encouraged the government to increase the size of dividends paid to the government by state-owned enterprises and to ensure that such dividends are brought fully onto the budget as general revenues.

Directors supported the recent loosening of monetary policy. While China’s financial sector has shown its resilience to the global turmoil, they called for continued vigilant monitoring of possible risks to credit quality, especially from lending to infrastructure projects or from a further build up of excess capacity in tradable industries. Directors agreed that the monetary expansion would need to begin to be unwound once the economic recovery is firmly established.

To lessen the reliance on investment and increase employment, Directors supported an increase in the cost of capital through a cautious liberalization of domestic deposit and loan rates, when conditions permit, to be accompanied by appropriate adjustments to financial supervision. They generally agreed that measures to promote capital market development would play a useful complementary role in raising household income, lowering the savings rate, boosting consumption, and improving the allocation of capital in the economy. They welcomed the authorities’ intention to participate in an FSAP (Financial Sector Assessment Program) to help identify priorities for further financial sector reform. Directors also recommended allowing the costs of other factors of production, such as energy, water and land, to increase further in order to support the government’s intentions to improve energy efficiency and protect the environment.

Directors welcomed the important progress made in the past few years in increasing the market’s role in determining the exchange rate, as well as the consequent substantial real appreciation that has been achieved since the exchange rate reform in 2005. Some Directors nevertheless supported the view that the renminbi remains substantially undervalued. Looking ahead, many Directors considered that a further strengthening of the renminbi would be part of a comprehensive strategy to rebalance the economy by increasing the purchasing power of households and the labor share of income, and reorienting investment toward non-tradable sectors. Exchange rate flexibility would also allow monetary policy to focus more clearly on price stability. A number of other Directors pointed to the methodological difficulties of making exchange rate assessments. These Directors generally considered that exchange rate appreciation would only play a supplementary role in supporting reforms to reorient the Chinese economy and should be pursued in a gradual manner, as and when conditions permit.

Directors recognized that, over the near term, rebalancing the economy could raise unemployment as jobs are shed in export-oriented sectors. At the same time, they considered that the authorities could employ policies to provide income support, retraining, and social programs for laid-off workers. Some Directors indicated that any moves towards trade protectionism should be avoided. Directors believed that, over a longer horizon, the employment gains from rebalancing towards domestic consumption and an increase in service sector employment should outweigh short-term losses. Over time, there would also be important and wide-ranging spillovers from rebalancing, with Chinese consumption becoming a key factor in driving global growth.