Transcript of a Conference Call on China Article IV Staff Report

July 31, 2014

Washington, D.C.
Thursday, July 31, 2014

Markus Rodlauer, Deputy Director, Asia and Pacific Department and Mission Chief for China
Steve Barnett, China Division Chief, Asia and Pacific Department
Dezhi Ma, Senior Communications Officer

MR. MA: Thank you very much. This is Dezhi Ma with the Communication's Department of the IMF. Thank you very much for joining the call. This is an on the record conference call on the IMF's annual review of China's economy, what we commonly refer to at the Article IV Consultation.

This year's Article IV report has been placed under embargo on the IMF Press Center last night. Joining me today we have Markus Rodlauer. He's the Deputy Director of the Asia and Pacific Department at the IMF. He is also the Mission Chief for China. We have also Steve Barnett. He's the China Division Chief at the IMF's Asia and Pacific Department.

Markus will offer some brief opening remarks. We will then take your questions. Markus?

MR. RODLAUER: Thank you. Good evening everybody and thanks for joining. I will give a brief opening statement on our key messages.

First, we welcome and fully support China's reform blueprint issued in November. That is a comprehensive package of reforms and marks a new chapter in China's development. Key principles are to give the market a more decisive role, eliminate distortions, and strengthen governance.

As is to be expected from such a broad, overarching strategy document, it does not have a lot of details nor timetables. So the issue now is implementing it. Successful implementation will move the economy to a more inclusive, environment-friendly, and sustainable growth path.

The blueprint includes the entire gamut of financial, fiscal, external, and social security reforms that are needed to promote the more efficient use of resources, and unleash new sources of growth. So it is becoming increasingly urgent to implement this reform blueprint. Why?

Because the current pattern of growth is unsustainable, resulting in rising vulnerabilities. Although measures have started to be taken to rein in those vulnerabilities with tangible impact, for example, in the shadow banking sector and in local government debts, these vulnerabilities are still rising.

While in the near term, these risks are manageable thanks to the authority's policy buffers and their control over economic developments in China. It is our assessment that timely and steadfast implementation of the reform agenda is critically needed both to prevent a further buildup of risks, and, as I said above, to put the economy on a sustainable growth path.

Successful implementation will also secure a more balanced growth pattern and shifting the economy away from over investment towards consumption. The end result will be higher income in China with even larger gains in consumption and living standards.

My third point is both for China and for the world. Somewhat slower near term growth is safer growth for China in the long run, and is therefore, good for China and good for the world. Demand management should focus on reducing vulnerabilities while also preventing growth from slowing too much.

This is a difficult balance to strike which the authorities will have to accomplish in the coming years. Structural reforms will go a long way toward containing risks, but additional steps are also needed, including reducing off budget fiscal spending, further reining in credit growth, and slowing investment growth.

The result would be somewhat slower growth in the near term. For next year, 2015, we would advise that the authorities focus on implementing the right kind of policies forcefully, and accept a growth outcome somewhere in a range, perhaps not a pinpoint growth target. That range would likely have to be somewhat slower than what has been accomplished this year.

We believe a range of 6.5 to 7 percent for 2015 would be consistent with moving to a safer and more sustainable growth path. Slower growth in the near term, however, would be more than offset by the benefit of much higher income over the medium term.

That, as I said above, would also be good for the world. Global growth would slow slightly in the near term as a result of somewhat slower growth in China, with some variation across countries depending on trade linkages. However, over time the benefits from stronger demand in China will dominate, resulting from higher global output, and underscoring the positive spillovers to the rest of the world.

This concludes my opening statement.

MR. MA: Thank you very much, Markus. Can we move to the questions?

QUESTIONER: Good evening. My question is that you're saying that China should set a 6.5 to 7 percent growth target for next year, but you maintained your official economic forecast at 7.1 percent for 2015. How do you reconcile those two? Are you acknowledging that China is not going to migrate to growth below 7 percent? Thanks.

MR. RODLAUER: I would deemphasize that. Whenever people ask me about decimal points I would like to tell, you know, frankly we don't worry too much whether it's 7.1 or 7.

When we say 6.5, we say in the neighborhood if you tell me 6.5 to a little bit over 7 or a little bit under 6.5, I don't think that is the issue. The point is that this year it's 7.5. It is likely to be 7.5 because of the measurers that have been taken and the government's commitment to do that.

We would consider it more healthy going forward to set a more moderate growth target, but also to set a range, as I have said so that the pinpoint does not become a new floor that needs to be accomplished.

QUESTIONER: In China’s Executive Director Zhang Tao’s response to the Article IV, he talked about your augmented debt estimate and said it risks creating market misconceptions. I was wondering if you'd be able to talk a little bit more about these discussions that you had with the government about estimates of debt?

MR. RODLAUER: Yes. Thank you very much. I will ask Steve to give a bit more details later, but let me just set out the principles of the discussion.

What we were trying to do is give, sort of, an outside estimate. The traditional, conventional numbers that we have reported and that the government has reported, are the lower numbers. The general government numbers, as we know, the debt level is around 20 percent and a deficit of around 2 percent.

We all know this is the lower bound which does not include a number of quasi-fiscal transactions out there. In measuring those quasi-fiscal transactions and operations, a number of assumptions and decisions have to be made. Most importantly, on what to count as a government action and what to count as a private action. Then an estimate of what are the gross liabilities that are out there, contingent liabilities, and what are the kind of liabilities that are likely to come back to the public sector eventually to burden the fiscal.

So because these decisions are difficult to make and require a lot of data, frankly that we don't have, we have decided to put out the augmented data which go out basically and say, well all the debts that the government and quasi-entities have contracted, even if they are quasi-private or for commercial ventures, let's count them as potential government debt and call it the augmented fiscal numbers.

Prompted by that, in part, the government itself, as you know, last year then undertook a very comprehensive audit of their own figures. The National Audit Office came out with its own figures. They, using the same methodology that we did, came up with basically the same figures of overall government debt. Everything included of around 52 percent and we had about 50 percent, so very close.

However, they were very clear in saying that some of those debts that are included there, specifically the so-called contingent debts out there, not all of this will come back to the government. They made an estimate for the year 2012, it was about 20 percent of those contingent debts would come back. As a result of that, their figure that they could count as truly public debt, as they see it, is significantly lower than that.

So we had this technical discussion and we did not disagree. Some of our augmented debts probably are an overestimation. However, we do not have the information to make those decisions. Certainly, we don't have the time series for previous years, and also for 2013, estimate of consistent time series.

So what we have done in the report, and I think we were very transparent about it is that we have put out these two figures, the traditional government debt figures and the augmented debt. Perhaps there's an outside bound of what the government liabilities are out there. We have been transparent about that.

They have clarified what they see as the likely fiscal debt burden in the long run out of that. Steve, do you want to add maybe a few thoughts to that?

MR. BARNETT: Sure. Let me add briefly, I think the real simple story would be if we had the National Audit Office (NAO) definition of government deficit and debt time series, we would use that. However, we just have really two snap shots of government debt using NAO definition.

We have no data whatsoever for the deficit. So until we have such data, the augmented debt and deficit which, as Markus said we know are too big of a definition of government, continue to provide a useful complement to fiscal analysis.

MR. RODLAUER: Is that clear? Do you have a follow-up on this one, David?

QUESTIONER: Yes, if I could just ask. So what is China's objection in terms of market misperceptions? What specific objections did they have? What are they worried about happening or would be worried that your estimates will do in the market?

MR. RODLAUER: Well, I think if you publish a document that has 55 percent of GDP government debt, augmented debt, I suppose their view is that if debt is too high, and if the true number is somewhere in between, around 35 percent or 32 percent, that could significantly alter market perceptions of the government's debt burden.

I think we are quite clear in our assessment. I also think what's important to the market is that we consider that even the augmented debt, as we reported, is very manageable debt figure for China at this point in time. There's no risk of a debt crisis in the near-term.

However, because the underlying trends, in the past five years, have been quite significantly upward, our view remains that the trend has to be flattened and improved. Otherwise going forward whatever measure of debt you take, even on the somewhat more restrained definition of the debt, the slope of the series certainly is significantly upward.

Therefore, in the policy conclusions we fully see eye to eye, and they see eye to eye with us that this very large quasi-fiscal deficit in the local governments has to be addressed.

QUESTIONER: Hi, thanks again. I have a second question. In the report you talk about how if China were to do -- if the economy were to slow and China were to do any stimulus, you say it should be on budget. Yet, you know, in recent months there have been a number of reports, and even some official acknowledgment from the government and the People's Bank of China, that they're using something called relending to channel money possibly to China Development Bank.

Some of the totals mentioned have been 1 trillion RMB. The PBOC has not been completely forthcoming yet in disclosing what exactly it's doing. I'm wondering what you make of these recent developments? What you make of China using the PBOC's money creation abilities to substitute for fiscal policy? Thanks.

MR. RODLAUER: There is a short answer there and a broader one. Let me start with the broader one first, which assesses the recent stimulus that has been implemented.

We were there in May for our mission, and we have had a few further discussions, just after the mission, so this is basically, you know, up to the middle of the year, more or less.

So as foreshadowed in our Staff Report, the pickup in growth in the second quarter reflects a range of so-called targeted measures to support growth which, obviously, confirm the government's commitment to achieve this year's target of around 7.5 percent.

These measures included, as they were reported and as we discussed with them, a number of relatively small measures such as support to small and medium sized enterprises, increased railway investment, more spending to renovate shanty towns, some targeted cuts in reserve requirements, and some targeted easing of loan to deposit ratios.

While individually each of these measures was relatively small and targeted to specific priority areas, therefore, in that they were in line with the government's expressed intention to refrain from the broad, very large indiscriminate stimulus that had been implemented in the past.

So I think in that sense it was consistent with that. But together, of course, they seem to have succeeded now in reversing the declining growth momentum of early 2014. Now, in our assessment, however, a key uncertainty remains in the real estate sector.

Here, as you all know, and we know, some further weakness really could be building. Because of the very large direct and indirect importance of this sector, this really does pose a risk to the near-term outlook.

So it's kind of hard because we don't fully know the underlying growth momentum in the various sectors, particularly in the real estate sector, how big is this threat of growth really going down significantly on that momentum, and therefore, how large does the stimulus measure have to be to prevent too sharp of a decline of GDP growth, which I think is important. We all recognized that. We want to be careful in reflating the economy indiscriminately, but you also have to be very careful, for social and financial stability purpose, not to let growth fall too much.

So given all that our overall assessment is that there is still substantial uncertainty about the growth outlook this year, and is therefore, premature really to judge whether the stimulus that has been applied has been excessive. So we'll see that in the next few months coming forward.

In terms of the specific measure of pledge supplemental lending, which has come out in the last couple of weeks really in terms of a larger envelope, we really don't know the details about that yet. Frankly, it is said to be a trillion Yuan over three years. We don't know is it going just to development banks? Is it going to other banks?

So at this point I think we have to refrain from assessing that as an overall stimulus measure. You know, here I'm speculating, one can see that as it has been interpreted as a medium-term lending instrument that might actually help the central bank in steering interest rates into sort of medium-term bracket going forward, and therefore, be able to help in establishing an interest rate monetary policy.

Other have said that it might also be a step back in terms of, again, you know, giving directed lending to various sectors. We, frankly, have to discuss and find out more about it. So at this point I'm not able to really assess it.

QUESTIONER: My question is you did some measure in the property sector, Did you have any qualitative analysis of how big the drag will be on growth this year and probably next year?
The second question, on the Yuan, you mentioned that the Yuan is now moderately undervalued given the slowdown of the economy and of the potential risks. What's your view? Do you think the Yuan will continue to appreciate or might depreciate? Thank you.

MR. RODLAUER: Thank you. The first one on property and real estate, maybe Steve can take that?

MR. BARNETT: Sure. So the question, how much of a drag on growth will the property sector be? Let me start by saying what our baseline assumes, and basically we assume an orderly adjustment in the real estate market.

To give you some numbers, we assume that, compared to last year, when investment in residential real estate was 10 percent growth, that this year we assume 5 percent growth, and in 2015 we assume 0 percent growth. That's an idea of what we mean by orderly adjustment, and that's consistent with our growth projections of around 7.5 percent growth this year and around 7 percent growth next year.

On that line of argument, we've already built in an orderly adjustment. We do discuss in one of the boxes on real estate, I think it's Box 1, at the very bottom, we did a sensitivity analysis of what happens if there is a sharper slowdown in real estate investment.

Basically the answer there is the drag on the economy would not be that large. Under plausible scenarios for a slowdown in real estate and a critical assumption assuming no offsetting policy adjustments by the government, we'd get a drag on growth of about, three quarters of a percentage point of growth. Again, that assumes no policy response from the government.

MR. RODLAUER: Let me in the meantime outline what our assessment of the exchange rate is trying to do or maybe first what it is not trying to do.

This, I want to be very clear, is not a near-term cyclical assessment of the exchange rate of where the market should be, where the rates should go tomorrow, or in the next few months, or where it will go, frankly, in other countries where we have a fully market determined exchange rate. Our assessment is not designed to project and make recommendations on near-term exchange rate movement.

What it tries to do is, however, to assess the external position from a medium-term perspective in terms of where is the current account likely to go on current policies, and where should it go if all the policies, and not just exchange rate policies, but the entire set of policies are in place. In that context in China it means virtually the entire gamut of reform areas that's in the 3rd plenum. If all these policies succeed, where do we think the current account should go?

Compare this also with countries in a similar stage of development and structural reforms, and make a judgment of where undercurrent policies, current account is likely to be in five years, and where it should be based on the right kind of policies.

That gives us, for China, as you know, a small gap that's still there—after a very large gap in the past—of around between 1 to 3 percent of GDP, and translated that into an exchange rate of assessment, it's between 5 and 10 percent undervalued. But again, this is not an assessment that the exchange rate should be revalued or appreciated in the next few months by 5 to 10 percent.

It means that as China implements all its reforms, including gradually opening of the capital account, widening exchange rate band, reducing intervention, that's the exchange rate part of it, but also changing its fiscal policy, changing its monetary policy. The entire gamut of reforms is shifting towards domestic consumption and boosting domestic demand and incomes.

All of this together will, over time, drive the current account to the desired position, and therefore will result in the real exchange rate appreciation gradually that we think is necessary.

So I think I want to make this very clear. It's important to ask, but it's also very important to the authorities that this is what our EBA framework is trying to do, and is often misunderstood, and therefore, often also resented. I think somewhat unnecessarily by countries because it is meant to be really a medium-term assessment of the entire policy framework.

QUESTIONER: What is the main risk you will see in the second half in China? Also, anti-corruption activities and also with the arrest of Zhou Yongkang, what do you think this (inaudible) can help for the GDP of China will be higher than 7.5 percent? Thank you.

MR. RODLAUER: Thank you. You know, the IMF is an economic institution that deals with financial and economic matters. That is our mandate from the international community. Frankly, I do not feel neither capable nor having the mandate to give you a view on issues of corruption or governance at that level. So I hope you understand that I don't have any comment on that.

On risks, certainly that we do have a mandate, in fact, a very clear mandate that our membership wants us to focus on risk. Frankly, a lot of our energies and time has been spent on identifying the key risks. You see that the report itself looks very carefully at the risks.

Perhaps, this is not news, but perhaps more than last year we see, as I said before, real estate sector as a key risk out there to growth. We don't really know how sharp the correction will be, and therefore, how strong the measures need to be to make sure it's an orderly one.

Clearly, we see the real estate sector as a sector in the economy that has sound medium-term and long-term fundamental because, as we all know, demand for housing will remain strong in China for many years to come because of urbanization and the need for upgrading the housing stock.

However, around that long-term trend is a cyclical fluctuation, the same as everywhere else. We have seen this in the last few years, notwithstanding measures by the government to try to contain it. We have seen a very strong growth of real estate, housing supply, and investment, and building.

Therefore, a number of areas are overbuilt and now the sector is in a cyclical correction. This is an important and necessary development, and it is important to find the right balance to allow this correction to proceed, to allow prices to fall where they have to fall to bring in the demand again, to reduce construction where it's oversupplied.

But then to also make sure that with supporting measures like shifting construction towards social housing, supporting mortgage lending where maybe the housing needs are there, and whether restrictions that have been put in place maybe now can be lifted.

So finding, again, the right balance for an orderly adjustment in the real estate sector is a complex and difficult task for the government going forward. That is the most important near-term risk.

If you look at the report you also see two other risks that we see out there which is (i) the shadow banking, banking sector, and credit growth, and (ii) the local government financing developments, which have begun to be changed. I think we have seen in the last few months over the year an important change in the atmosphere. That's why we see the rates of growth of bank credit come down.

We have seen the investment rates in the local governments change somewhat. But they are still too high. Therefore, there is a continued need to work on that. The authorities are very clear on that.

But again, this is not a near-term risk, maybe for the next six months, as you have said. This is much more a risk that if these things are not addressed in the medium-term they will come to create difficulties. But as I said, we are confident that the 3rd plenum blueprint and the government are working to address that.

MR. MA: Thank you very much. Let me remind you that today's conference call is embargoed until 9:00 p.m. Washington Time which is 9:00 a.m. Beijing Time. The Staff Report and other documents are placed under embargo also until 9:00 p.m. today Washington Time and then 9:00 a.m. Beijing Time. Thank you very much for joining the call.


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