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People's Republic of China and the IMF
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IMF Concludes 2001 Article IV Consultation with the People's Republic of China
On July 23, 2001, the International Monetary Fund's (IMF) Executive Board concluded the Article IV consultation with China.1
Over two decades of market-oriented reforms have brought visible success and economic transformation to China. The progress made includes large increases in per capita incomes, significant poverty reduction, a substantial rise in nonstate-sector activity, and growing integration into the global economy. Notwithstanding these achievements, a large reform agenda remains. Most importantly, difficult reforms involving the state-owned enterprises (SOEs) and the financial sector have yet to be accomplished. China's prospective entry into the WTO has increased the urgency of these reforms.
Economic growth gained momentum during 2000, aided by supportive macroeconomic policies and a favorable external environment. As in the previous two years when stimulative policies were adopted to counter the effects of the Asian financial crisis, domestic demand was boosted through increased fiscal spending; in addition, private consumption—proxied by retail sales—staged a recovery buoyed by housing reforms, an increase in civil service salaries, and higher social spending. Export growth accelerated (to 28 percent) as recovery in the region took hold and because of higher VAT rebates. However, imports increased even more quickly (by 35½ percent), partly due to the anti-smuggling campaign—which boosted recorded imports—and higher oil prices. Deflationary pressures gradually receded, with the CPI rising by 0.4 percent in 2000. At the same time, unemployment pressures remained a concern. On the external side, the current account surplus increased slightly in 2000 (to 1.9 percent of GDP, due to an improvement in the services balance), while the surplus in the financial account narrowed by ½ percent of GDP (mainly because of an increase in foreign assets of Chinese banks related to rising foreign currency deposits). Official reserves increased by $10.5 billion, to $170 billion, equivalent to 8 months of imports and over 8 times the level of estimated short-term debt (on a residual-maturity basis).
Growth has remained robust in 2001, despite the weakening global environment. Real GDP rose by 7.9 percent in the first half of the year compared with the same period in 2000, reflecting strong fixed investment and retail sales. Consumer price inflation picked up to 1 percent, as services and housing prices continued to rise. Export growth, while slowing sharply in line with weakening external demand, was still 8¾ percent; import growth also slowed (to 14 percent). The overall balance of payments has strengthened further (mainly reflecting higher capital inflows), with official reserves rising to over $180 billion.
For 2001 as a whole, GDP growth is projected at 7½ percent, reflecting some slowdown in the second half of the year. Consumer prices are projected to increase by around 1 percent, mainly on account of rising services prices. The current account surplus is expected to narrow to about 1 percent of GDP, reflecting a lower trade surplus, while the overall balance of payments is projected to register a surplus of $15-20 billion.
Progress has continued in addressing the intertwined problems in the financial and SOE sectors, although much remains to be done to complete the reform agenda. In the financial sector, efforts have focused on recapitalizing the state commercial banks (SCBs) and transferring their nonperforming loans to asset management companies (AMCs); improving banks' internal operations; and strengthening the prudential and regulatory framework. The recapitalization of the SCBs in 1998—amounting to 3½ percent of GDP—was followed in 1999 and 2000 by the transfer of nonperforming loans—totaling 15½ percent of GDP—to the AMCs. The AMCs have begun to resolve bad debts through asset sales—some with the assistance of foreign expertise—and debt equity swaps. In the SOE sector—where performance improved further in 2000—progress has continued with reducing excess capacity, improving efficiency, and transforming ownership structures (especially for the smaller SOEs). The reform efforts have focused, in particular, on introducing modern enterprise systems, including establishing independent Boards of Directors and Supervisors, separating government functions from enterprise management, and improving incentive and internal control mechanisms.
In February 2001, the Board of Governors of the IMF approved an increase in China's quota to SDR 6,369.2 million (about US$8.1 billion at current exchange rates) from SDR 4,687.2 million (about US$6.0 billion). China now has 3.00 percent of total quota and 2.95 percent of total votes.
Executive Board Assessment
Executive Directors commended the authorities for China's outstanding recent economic performance, with robust growth, easing deflationary pressures, and a strong external position. Directors viewed these developments as reflecting the continued transformation of the Chinese economy, supported by skillful macroeconomic management and structural reforms. Looking ahead, although the external slowdown would likely dampen growth somewhat, they considered that the near-term economic prospects remained favorable.
Notwithstanding these achievements, Directors agreed that China faced major challenges from the unfinished reform agenda. Accordingly, they welcomed the authorities' intention to accelerate reforms to ensure sustained rapid growth and prepare the economy for increased global competition after WTO accession. It was noted that WTO accession, signaling China's further integration into the global economy, would bring not only further economic progress in China but also opportunities for all nations. Directors viewed the authorities' reform efforts as well focused on the intertwined problems of the financial system and the state-owned enterprises (SOEs), while at the same time managing the social costs of the transition and making sure that the benefits of globalization were broadly shared.
Directors supported the present stance of macroeconomic policies. They thought that the continued reduction in the budget deficit envisaged for this year struck a balance between supporting growth and the medium-term constraints. They welcomed the strong revenue performance which testified to successful ongoing efforts to strengthen tax administration. Should revenues continue to exceed budget targets, Directors recommended that the authorities use the bulk of the overrun for deficit reduction or to support medium-term reforms such as social security reform.
Directors pointed to the need to gradually reduce the fiscal deficit further over the medium term. While explicit public debt was relatively low, the fiscal outlook was burdened by the potential losses in the banking system as well as future spending needs for social security, infrastructure, and the environment. Directors therefore encouraged the authorities' plans for additional revenue measures, further strengthening tax administration, and focusing expenditures on development and reform priorities. In addition, Directors observed that managing the fiscal outlook would require dealing decisively with the nonperforming loans (NPLs) problem in the banking system, a key goal of the ongoing SOE and banking reforms. They also advised an early review of the system of fiscal federalism to ensure appropriate levels of transfers to the poorer regions.
Directors viewed the monetary policy stance as appropriate. They encouraged the authorities to continue with the gradual liberalization of interest rates, noting that this needed to be phased carefully together with other reforms. Directors also stressed the need to carefully supervise banks' foreign currency operations, as foreign currency deposits have increased significantly in recent years.
Directors observed that China's exchange rate policy had served both China and the region well in recent years. Looking ahead, they agreed that a gradual move toward greater flexibility would facilitate China's growing integration into the world economy and the major structural changes underway. Noting that the current favorable economic situation in China allowed a move from a position of strength, Directors welcomed the recent greater use of the existing trading band, and encouraged its full use in the period ahead. At an appropriate time, this should be followed by a gradual widening of the band and its linkage to a basket of currencies. Directors supported the authorities' gradual and well-sequenced approach, accompanying the move to greater flexibility with the necessary financial market reforms and taking into account conditions in international financial markets. Some Directors noted that, as China integrates further into the global economy, and as its financial sector and capital markets become more sophisticated and controls more difficult to manage, the economy will derive benefits from a well-sequenced approach to capital account liberalization.
In the financial sector, Directors considered rehabilitating the state commercial banks (SCBs) and creating a strong prudential framework as the priorities. Strong efforts were crucial, in particular, to reduce the flow of new NPLs and to improve further the SCBs' financial position. To this end, Directors stressed the need for further progress in improving banks' credit analysis, risk management and internal controls; retraining commercial bank staff; improving legal and accounting standards; and better monitoring of the quality of new loans. They welcomed the determination and increasing transparency with which the authorities were approaching these issues, and encouraged further upgrading of disclosure standards and increasing use of independent external audits of banks.
Directors urged early adoption of international best practice for loan classification, with a firm timetable for meeting strengthened provisioning and capital requirements. They encouraged the People's Bank of China (PBC) to continue strengthening its supervisory capacity. Directors welcomed the reduction in the business tax on banks, and advised further reform to limit the burden of taxation on banks and to allow tax deductibility of specific loan-loss provisions. They took note of the authorities' plans to implement the new loan classification standards by the end of 2001.
Directors welcomed the start of operations of the asset management companies (AMCs), noting that the AMCs' prime goal should be the efficient and speedy disposal of assets. To that end, Directors stressed, the AMCs needed to be given the necessary authority and legal environment, including the ability to exercise fully their ownership and creditor rights. They urged the authorities to streamline the approval of AMC decisions by relevant government bodies and to remove legal impediments to asset disposal. Directors welcomed the use by some AMCs of foreign expertise, and encouraged wider use of this practice.
Directors encouraged China's early participation in the FSAP, following the authorities' own self-assessment, so as to take stock of the impact of ongoing reforms and identify vulnerabilities and priorities for future development.
Directors supported the wide range of SOE reforms underway and encouraged their further acceleration as intended by the authorities. Noting that the financial condition of the SOE sector remained weak, Directors underscored, in particular, the importance of tightening the budget constraint on enterprises—and hence that of commercializing SCBs' lending decisions. Directors welcomed the efforts to establish modern enterprise management systems, and the progress made with transforming ownership in small- and medium-sized enterprises. They welcomed the authorities' plans to further develop the non-state sector and noted that this sector could play an important role as an engine of growth and job creation.
Directors commended the ongoing efforts to improve transparency and market fundamentals in the securities markets. In particular, they noted the authorities' commitment to strengthen the regulatory and supervisory framework, increase the transparency and quality of listed companies, and raise accounting and auditing standards. Looking forward, Directors pointed to the need to further open up China's vast pool of savings to effective intermediation and to strengthen insolvency legislation.
Directors agreed that strengthening the social safety net was a key element of successful reforms. They welcomed the ongoing efforts to divest SOEs of their social responsibilities, and supported the plans for pooling the main social risks at the provincial level and for moving toward a partially funded pension system. Since lack of resources was a constraint in many poor localities, Directors observed that well-targeted central budgetary support may be warranted to allow those reforms to go forward. At the same time, they pointed out that, in addition to institutional changes, pension reform would have to encompass cost-containing measures to ensure the long-term viability of the system. It was also noted that maintaining public support for reforms would depend on successful efforts to improve governance and fight corruption.
Directors shared the authorities' concern over the widening regional income disparities, particularly the lagging growth of rural incomes. Directors therefore supported the authorities' efforts at fostering the development of agriculture and small- and medium-sized enterprises in rural areas. They also considered that the efforts to "Develop the West," through investments in infrastructure, training, and education, should help narrow the income gap between inland and coastal provinces.
While welcoming the progress that had been made in strengthening the quality and coverage of economic data, Directors stressed the need for substantial further improvements to facilitate analysis and IMF surveillance. They encouraged continued efforts at addressing the weaknesses in the data, which would be facilitated by further technical assistance. Directors also noted that—notwithstanding some strengthening in data provision to the IMF—there remained considerable scope for improvement in a number of areas of key importance to IMF surveillance under Article IV. Directors looked forward to China's participation in the General Data Dissemination System.
Directors commended the authorities for their African Initiative for debt relief.
|People's Republic of China: Selected Economic and Financial Indicators 1/|
|(Change in percent)|
|Consumer prices (period average)||2.8||-0.8||-1.4||0.4||1.0|
|(In billions of U.S. dollars)|
|Current account balance||37.0||31.5||15.7||20.5||12.4|
|Capital and financial account balance 2/||21.1||-6.3||7.6||1.9||10.0|
|Gross official reserves 3/||143.4||149.8||158.3||168.9||186.3|
|Current account balance (in percent of GDP)||4.1||3.3||1.6||1.9||1.1|
|Public finance 4/|
|Overall budgetary balance||-1.8||-3.0||-4.0||-3.6||-3.2|
|(Change in percent)|
|Money and interest rates|
|Broad money (M2) 5/||17.3||15.3||14.7||12.3||...|
|Interest rate 6/||5.7||3.8||2.3||2.3||...|
|Sources: Chinese authorities; and IMF staff estimates.
|1/ As of July 23, 2001.|
|2/ Excluding errors and omissions.|
|3/ Includes gold, SDR holdings, and reserve position in the Fund.|
|4/ Central and local governments. Data include all expenditure financed by official external borrowing, interest payments on government debt, and unbudgeted expenditures in 1998-2000 related to the fiscal stimulus program.|
|5/ Banking survey.|
|6/ One-year time deposits, year-end.|
1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. This PIN summarizes the views of the Executive Board as expressed during the July, 23, 2001 Executive Board discussion based on the staff report.
IMF EXTERNAL RELATIONS DEPARTMENT