Transcript of a Conference Call on China Article IV Review
July 17, 2013Washington, D.C.
Wednesday, July 17, 2013
MR. Dezhi MA: Good morning -- and good evening to those of you who are calling from Asia and China. And I'm Dezhi Ma, with the Communications Department of the IMF. I would like to welcome you all to this on-the-record conference call on the release of the Article IV consultation with China.
With me today are Markus Rodlauer, Deputy Director at the IMF’s Asia and Pacific Department, and mission chief for China. We also have Steve Barnett; he's the China division chief at the IMF's Asia and Pacific Department.
Markus will start with some short opening remarks to frame the discussion on the Article IV report, and we will then take your questions. And when you ask your questions, please do identify yourself, and also your media affiliations.
And let me also remind you that the publication of the staff report, which has been posted online last night, is embargoed until 9:00 a.m. Washington time.
MR. RODLAUER: Yes, good morning. Thank you all for joining us. It's a pleasure to be here.
Before we start, let's put a bit of context around the Article IV. In looking at China's economy, it's always helpful to gain some perspective by looking at China's recent history. And, of course, we all know China's economic performance over the past three decades has been remarkable -- growth averaged around 10 percent a year and some 500 million people were lifted out of poverty.
This success did reflect the government's ability to implement reforms, often very difficult ones. And, although, as the saying goes, past performance is not a guarantee for future success, it does provide confidence that China has the ability to tackle its current economic challenges, even if they are formidable.
So, what is the main challenge, looking forward?
As we have explained in the report, the overarching priority is to secure a more balanced and sustainable growth path, while maintaining domestic stability -- and all this, in a global environment that will likely remain difficult for some time. This really puts the onus on policy-making in China to put in place a strong package of reforms covering the financial sector, fiscal policy, and structural policies that, if successfully implemented, will help China transition to a more consumer-based, more inclusive, and more environmentally friendly growth path.
This could very well entail somewhat slower growth in the short run. But it is a tradeoff worth making for much higher income in the long run. Not only would success be good for China, it would also provide substantial benefits to the world economy, as we have further laid out in our IMF Spillover Report for 2013, that will also shortly be published.
China's leadership has clearly stated their intention to re-energize the reform effort. And their announced plans are congruent with the above agenda. The key now will be to turn these plans into specific and decisive actions.
A few words about the growth outlook. With the numbers for the second quarter of this year just announced earlier this week, there has been a lot of attention to the near-term growth outlook. The key question, in our view, however, is not whether growth will be 7.8, or 7.7 or 7.6, or 7.5 percent this year but is there a significant risk of a sharp slowdown, of a hard landing, as some would like to call it.
Well, our view is clearly "no." The latest data confirm that growth is on track, more or less towards the authorities' growth target, and probably even slightly higher than that. The growth target, as you know, is 7.5 percent for this year.
So our projection in the report, as you have seen, is 7.75percent. And while there are some downside risks to this outlook, we are quite confident that that growth is on a solid, reasonable path.
What does this mean for policy advice? In a nutshell, it means that the latest data do not change our recommendation detailed in the report. In particular, we think that another stimulus would be warranted only if growth were to slow considerably more.
So, to be clear, while there has been a moderate slowdown recently, the current data, in our view, do not suggest that a further stimulus is needed at this juncture. I would add, however, if a stimulus was needed, then it should rely on on-budget fiscal measures that support the needed rebalancing towards more consumer-based growth.
This takes me to the last point I would like to make in my opening remarks, on financial sector reforms. Since 2008, China has maintained robust growth by relying heavily on expanding credit and investment. China's growth has, as a result, remained high through the global financial crisis and provided a welcome lift to global demand. However, this heavy reliance on investment and credit is not sustainable.
‘Total social financing’ -- a broad measure of credit that includes traditional bank lending and new forms of financial intermediation -- has increased from about 130 percent of GDP in 2008, to nearly 200 percent of GDP now. This is a development that underscores the importance of transitioning to a new pattern of growth, as argued above. Financial sector reforms -- the details of which are outlined in the report, and which we would be happy to discuss if you have more questions -- will be critical for two things: one, safeguarding financial stability in the banking and non-bank financial sector; and also fostering the transition to a more balanced and more sustainable growth path.
With better financial intermediation, this will help channel funds to high-yielding investment projects that will drive growth and help boost household income and, therefore, also consumption. Both of these are critical for the transition to a more sustainable and consumer-based growth model.
These were my opening remarks. We are now ready to take questions.
Questioner: Hi, all. Good morning.
So, two things, if I could -- first off, I just want to make sure I'm looking at this issue of, you know, larger than advertised government debt of 45 percent of GDP, compared to the general government debt listed in the table, of around 22 percent. So that's like double.
And I want to know, is this the first time -- a, is this the first time that the IMF has tried to make this calculation about all the stuff that the central government's really responsible for? And, second, how comfortable are you on data -- as a corollary to that, does the government even know what they really owe?
MR. RODLAUER: We just lost you in the middle of your question. Would you mind repeating it?
MR. SCHNEIDER: Yes, I just want to make sure I'm interpreting this correctly, that you're saying that the central government's obligations are 45 percent of GDP, once you include everything in, as opposed to the 22, roughly 22.5percent listed in the table -- and, A, if that's correct, B, how comfortable are you with your estimates. Is this the first time you've made such an estimate? And do you feel that the central government there even really knows what it's obligated for?
MR. RODLAUER: Two points -- one is, to be very clear, the traditional and official data are for central government operations, as well as local government operations that are on-budget.
This is the conventional Government Finance Statistics (GFS) data that result in, as you have mentioned, a 22 percent of GDP "general government debt" and a fiscal deficit of around 2 percent.
Now, in addition to presenting this conventional measure of general government debt and deficits (which follows the accounting conventions of GFS), we have augmented these data with our own estimates of local government operations outside the official budgets. Those are mainly the investments through the local government financing vehicles and the various corporations that local governments have created to finance their spending plans. Such spending, if it is mainly fiscal in nature, is not normally excluded from the on-budget fiscal accounts, in contrast to commercial operations like a state-owned enterprise or bank. Since most of the off-budget local government spending has been mainly fiscal in nature, we are quite confident to include that in an augmented measure of the government deficit and debt.
So it's not just central government, it's central government on-budget, local government on-budget, plus local government off-budget fiscal spending. That, together, is the combined augmented debt we have estimated, as a combined measure of the obligations of the central government and local governments. As to the question of who will be, in the end, responsible for that debt, we are not answering that question.
This is the first point, on coverage and definitions.
Then, the second point, are we reasonably confident about our estimates? I think we are, as an order of magnitude. We are confident that we have hit the right order of magnitude, based on that definition.
Of course, as you see in the Annex, there are a number of assumptions that have to be made. So there is a margin of error around it because of the various assumptions, especially as we go backward to try to reconstruct past levels of deficits.
But, on the order of magnitude, given what we know about central government and local government operations, we are quite confident.
We would also, however, note that we have excluded two important points from these estimates. One is, it includes only what we consider "quasi-fiscal operations" – such as those financed by the local government financing vehicles. It does not include other corporations, or other entities out there that are also public-sector in nature -- like, for example, state-owned enterprises and their liabilities, or the railway ministry, which has corporatized its operations, and therefore is not included in this measure, or the asset management companies which, again, are corporatized, and are therefore not included. So, these liabilities are excluded.
But also, second point, very importantly, all of the state’s assets are excluded. So this is a measure of gross debt. As you know, in a country like China, which has large amounts of financial reserves, central bank, international official reserves, but also state assets, I think in assessing the 45 – 50 percent of GDP government debt, you also need to keep in mind that this economy has very large government resources, as well as, probably, an above-average government capacity to move these assets around to address any shocks that might come to the system.
And that leads us to the conclusion that, overall, still, despite this augmented debt -- which, as you notice, is double what the official data for general government is --
the so-called "fiscal space" to address any shocks or problems is still there and quite large.
QUESTIONER: Thanks for taking my question.
I was wondering if you could just speak a bit more about the Chinese labor market -- specifically, two questions.
Chinese officials say the labor market is stable. And I was wondering if you agree with that.
And also is this idea that the services sector is going to take up any losses in manufacturing jobs. Do you see that happening in China? Or what do you think is going to replace that?
MR. STEVE BARNETT: Okay, thank you. This is Steve Barnett. I'll take that.
I think movement of labor to the service sector, or the tertiary sector, indeed we think that's going to be an important transition in China. Generally speaking employment in firms in a service sector, more of the money goes to labor in the form of wages. So it's one way to boost household share of income -- that is how much money households get out of total GDP. This would be very important for moving to a more consumer-based economy. So we see that as a very important shift that should take place over time.
We have seen, already, that the share of labor in the service sector has been increasing. There is a chart in the report that shows that.
If you look -- you have to go back to previous reports -- it is true, at this juncture, for its income level relative to other countries, China's employment in the service sector is still a little bit lower than what we've seen in other economies. This underscores the scope to move to a more service oriented economy.
On the first question, about the labor market, we probably agree that labor conditions have been stable. If you look at the official statistics, the unemployment rate has been fairly steady. Wage growth seems reasonable, given the total growth in the economy.
Let me stop there, on the labor market.
MR. RODLAUER: As we've pointed out in the report, for the shift of labor to the service sector, and for the increase in the labor share to happen, that precisely needs the reforms that we are advocating, such as opening up the service sectors to new private initiative, and in the financial sector to allow these new enterprises to be financed.
QUESTIONER: Hi, thank you. Thank you for taking my questions. I have three questions.
The first one is on the shadow banking. So, the report wrote that wealth-management products, and trust products could, over time, involve a systemic threat to financial stability. So, does the IMF have some estimates for the size of shadow banking in China? And how concerned are you about this risk? And what should Chinese authorities do to guard against the potential system risk?
And my second question is on the capital account liberalization. The report suggested that capital account opening in China would prompt sizeable portfolio stock adjustment, which initially would result in net capital outflows. So I'm wondering, do Chinese authorities agree with this assessment?
And my third question is about something more related to the U.S. QE. So, we know that Chinese authorities are concerned about the spillover effects of the UMP, and also now the unwinding of the UMP.
So, do you expect the tapering, and eventual ending, of the QE to be a potential trigger of systemic crisis in emerging markets, especially in China?
MR. RODLAUER: Okay, these are very good questions. Thank you so much.
Let me take the shadow banking questions. Steve will talk about capital account opening.
MR. BARNETT: Okay.
MR. RODLAUER: And then we can briefly address spillovers, but more from China's perspective rather than U.S. perspective.
On shadow banking, you have a chart in the paper that indicates what the approximate size of that is. Altogether, we know that all the assets that are called “shadow banking” – personally, I don't like this expression "shadow banking", we prefer to call it "non-traditional financing," because much of it, as you know, doesn't happen in the shadows. Only some small parts I would really call "shadow banking." Most of it is really innovative new forms of financial intermediation which have their good sides, but also have their risks, as you point out.
Overall, if you count everything all together, the available estimates put the nontraditional financial intermediation on the order of close to 50 percent of GDP. This is on the asset side (nontraditional lending, so to speak). Only part of that is funded by the banking system, through the various wealth-management products that the banks put together – and that part is still relatively small, on the order of 10-15 percent of deposits in the banking system. So that is still quite manageable, from the banking side, in terms of their share of overall bank liabilities.
Let me first note the positive aspects of this development, which is a very rapid expansion of market-based lending and borrowing. This is a key shift in the Chinese economy over the past few years -- probably nobody would have foreseen just five years ago that in 2013, approximately half of all financial intermediation is truly market based. That's really remarkable.
At the same time, it is a development that has been growing very fast. The speed of growth is nothing short of impressive. And, in many other countries we have seen that, when you have such rapid growth, it carries risks. It carries risks because bank supervisors can't really keep up with the new instruments and the fast growth. It creates questions of credit quality, liquidity management. So, just the simple speed of the growth is something that is of potential concern.
Second, you have to recognize that this is market-based lending, but it is also what we call "regulatory arbitrage." It tries to get around various regulations and interest rate restrictions that are in place for the traditional saving and lending. So, to the extent that this is an effort to circumvent regulations, it's an aspect that is not that welcome, because it migrates activity to less well supervised parts of the financial system.
So these two concerns – very rapid growth and regulatory arbitrage -- are things that need to be watched, and need to be reined in. I think the authorities themselves agree very much with our assessment that this very rapid growth of nontraditional lending needs to be reined in and better supervised.
The authorities have taken significant steps in recent years, and especially in recent months, to do that, both on the supervisory and prudential side, but also through the inter-bank market to contain some of the more risky forms of financing.
So, are we very concerned about it? We are concerned in terms of, as I say, the rapid growth. We are not really concerned, yet, that it would be a systemic problem already that creates the risk of a systemic crisis. We are not there -- neither in size, nor in any sort of loss of control of the overall system.
So I want to be very clear on the record that we don't think that this has, at this point, reached any sort of crisis proportions.
What can be done about it? For one, continued strength of supervision, regulation -- exactly what they are doing. But also, more fundamentally, one needs to remove these strong incentives for what I have called "regulatory arbitrage." One needs to remove the wedge between the traditional and nontraditional lending, which is precisely the plan of the authorities, to gradually move forward with liberalizing and opening up the traditional sectors, which will then remove the incentives for investors and savers to get around that.
So, that's about nontraditional lending.
Let's turn to the capital account.
MR. BARNETT: I'll take the capital account question.
What we did is we wanted to look at the situation: Suppose that China completely opened its capital account. And we looked at international experience, and we asked what would the portfolio look like? And, based on the portfolio, how much foreign assets China would hold, how much foreigners would invest in China?
It's clear that there would be significant adjustments, both gross outflows from China, and gross inflows from China. This is also consistent with international experience: When economies open their capital account, we saw significant gross flows in both directions.
The key finding of this research, though, is that in China, because the domestic financial markets are very big, that this sort of portfolio reallocation of China's residents wanting to hold assets abroad, that impact is actually quite large. So that, on a net basis, we would expect, initially, that there would be net outflows from China.
And this gets to your question of what was the authorities' view. Of course, it's always best to ask them. But I would note what they emphasized to us is that they would open the capital account at a measured pace consistent with fostering domestic stability and avoiding disruptions to external market.
So, remember, our exercise asked the hypothetical, what if it was completely open? In reality, it's going to be opened gradually. And they've assured us that it would be opened in a way consistent with stability.
I should remind you, we also have posted on the internet an e-book which summarizes the conference that we jointly hosted with the central bank back in March, that is all about international experience with capital account liberalization. It includes the experience of a lot of different economies -- from South America, to Europe, to the Middle East.
I'll put it back to Markus.
MR. RODLAUER: Yes, thank you.
On your last question, on QE, and the spillovers to China and emerging markets -- two things I would like to say about QE, and then about the impact on emerging markets and China.
When we talk about QE, we talk about, of course, what we also like to call "UMP," unconventional monetary policy. And, in a nutshell, that is just simply very loose, very easy, very expansionary monetary policy in the advanced economies. We have four main implementers of that: the U.S., U.K., Japan, and the euro area, each of them in a different form.
Now, again, when we talk about UMP with a broad brush, we also need to recognize that these are quite different animals in the four countries/areas, and at very different stages. But let's call it the UMP, very easy monetary policy in advanced economies.
Two points on that. First, why was it done? Let's not forget that this was a change in the monetary policy paradigm for advanced economies that was totally necessary in order to address either a financial crisis, or very weak cyclical demand conditions in the advanced economies.
And therefore, as it was critical for them to overcome this weakness in their own economies, it was, of course, also key for the global economy and for the world. In that sense, the spillovers and the impact on the global economy were eminently positive and necessary.
Now, there were and are, of course, side effects. And we know that these side effects tend to increase over time. But that's another question we can come back to when we talk about impact.
Second point, about tapering or removing UMP -- also, we need to remember that the point of removing is to take the foot off the monetary policy pedal when, and only when, the recovery in the advanced economy takes hold, and one must not lose sight of that: the underlying favorable reason for tapering – the recovery of growth in the respective advanced economy.
One implication of that is that tapering, and ending UMP will be at very different stages for the various economies. And therefore, one cannot just only simply talk about it in one sentence.
How about the impact on China? Again, as I have said before, very few people argue that monetary policy should have been tighter early on in the financial crisis, or when advanced economies were very, very weak. The counterfactual of significantly tighter monetary policy – no UMP in the U.S., in the U.K., in the euro, and in Japan -- is not something that is desired by anybody. And neither was it by China.
Regarding tapering and removing UMP -- two additional points. I think going forward, as this will happen, it will likely be a somewhat bumpy road, because the expectations and market reactions often cannot be precisely predicted and calibrated.
That being said, we also see that the impact of tampering on the various emerging markets differs. And one pattern we have seen emerge a little bit already is that it differs depending on the kind of policies those emerging markets themselves have pursued, the kind of buffers and safety margins they themselves have -- in terms of reserves, in terms of their own monetary policy stance, in terms of their fiscal policies. Those that are more vulnerable have experienced larger swings in their financial markets, and a bigger reaction as a result of the initial announcements of tapering. Whereas countries that are better prepared, that have bigger buffers -- and, in the case of China, that have capital controls, for example -- they will be less affected by the tapering. And I clearly put China here into the camp of those who are well prepared, who have significant financial margins, who do not rely extensively on external savings and capital inflows, who have -- in the case of China -- also these capital controls which do help, in such a case, to shield.
So I don't see a major impact, frankly, of tapering on China, at least at this point.
QUESTIONER: Hi. Thanks. I was going to ask about WMP, but I think you've addressed that.
I did, however, want to ask this -- in talking with the authorities there, I'm wondering if you were able to glean any information about the sort of direction and pace of reforms that they're intending. And, you know, for example, when they talk about the assumptions that the Fund is using about exchange rate policy or whatever, they obviously might be using a different set of assumptions, because they have an insight into what's going to happen.
And I'm wondering if they shared anything along those lines with you, or whether or not you were able to sort of glean any understanding of their plans going forward as a result of the difference in assumptions that they may have brought to the table in discussing the various models and outcomes?
MR. RODLAUER: Are you specifically asking about the exchange rate, or the whole range of financial reforms?
QUESTIONER: Well, in general. I thought exchange rate might be one where, you know, if you're assuming a band here, and they know it's going to be widened in six months, they might, you know, have a different outcome from their model because they know that your assumption is wrong.
MR. RODLAUER: Right. Well, of course we don't discuss with them -- and neither could I do it here today if we had – specific near-term, say, month-by-month plans -- on specific financial steps and the exchange rate. That's not what we do.But I can say this. Our sense was that the authorities' own analysis of the risks that have been building, their own analysis of what is needed to shift the economy to a different growth path, is very congruent with the analysis that we have made. So, there might be details here and there in the numbers, in the assumptions, where we differ, but there is not a significant difference in our view, in terms of the basic analysis, and in terms of the basic direction of policies and overall objectives, the strategy toward a greater role for market forces, removal of government intervention, strengthening the governance and incentives for financial discipline at the level of enterprises, individuals, and financial institutions -- so, this is the overall strategy.
But also, on the policy areas -- capital account opening, exchange rate flexibility, financial market reforms, interest rate liberalization and deposit insurance, monetary framework, opening up the services sectors -- all these policy areas, plans are in the right direction, and I don't see a significant difference between us and them.
As we talk about exchange rate policy, we also don't talk about near-term specific policy steps or expected exchange rate developments. But we understand that -- and it's been announced by the authorities repeatedly -- there is a clear intention to move towards greater flexibility of the renminbi, continued increase in the flexibility of managing the exchange rate. And, over time -- I think there is also a view that, over time, as reforms in China are successful, this will lead to a continuing increase in the dollar-wage for the Chinese people which, in the end, means an increase of the real purchasing power in China, that is real effective appreciation, over time, in a gradual way.
QUESTIONER: Okay. And just quickly -- on the government debt, that issue again, is this the first -- Fund has made this sort of overall, you know, general estimate of government debt for China?
MR. RODLAUER: Yes, for China, I think it's the first time that we have looked at it in that detail, and that we have put it into a report like this.
MR. BARNETT: On that question, for some context -- way back, I think it's page 55, we have a chart comparing our estimates of the augmented debt stock with a host of academics' and market estimates. And we're all broadly in the same range.
And most of the differences -- can be pinned to differences in coverage, maybe a different year. Do you include asset management companies, do you include the ministry of railways?
(Inaudible) sort of conformity of estimates around 50 percent of GDP.
MR. BARNETT: But it is the first time we've published that.
MR. RODLAUER: Well, thank you all for calling in, and for your interest. And we hope to meet each of you at some point, personally.
MR. MA: Thank you very much.