## PEOPLE'S REPUBLIC OF CHINA — STAFF REPORT (cr17247)

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### Executive Board assessment and strategic priorities
- Directors acknowledged China’s continued strong growth as critical support to global demand.
- Key assessments and recommendations:
  - Commended ongoing rebalancing toward services and consumption and urged accelerating reforms to improve quality and sustainability of growth.
  - Emphasized reducing national savings to prevent domestic and external imbalances; recommended greater social spending and making the tax system more progressive.
  - Urged further SOE reform: harden budget constraints, accelerate restructuring of underperforming debt, and allow exit of non-viable firms.
  - Called for broader investment-climate reforms: reduce barriers to entry, ensure a level playing field, and reduce trade barriers.
  - Supported efforts to reduce overcapacity, with greater reliance on market forces.
  - Welcomed strengthening of regulatory and supervisory efforts on financial stability and looked forward to the Financial Sector Assessment Program (FSAP) findings.
  - Supported a gradual tightening of monetary policy if core inflation continues to pick up.
  - Fiscal immediate priority: adjust budget composition to support rebalancing and ease transition costs while retaining some fiscal space.
  - Stressed monitoring debt, reforming central-local fiscal relations, and improving statistical coverage and quality.
- External and exchange rate view:
  - Staff assessed the renminbi remains broadly in line with fundamentals; the external position in 2016 was moderately stronger than implied by fundamentals.
  - Directors stressed progress toward greater exchange rate flexibility and deeper market-based reforms.
- Capital flows:
  - Noted recent tightening of capital flow measures broadly consistent with the Fund’s Institutional View but urged consistent, transparent implementation and careful sequencing to support liberalization.

### Outlook, projections, and key statistics
- Near-term and medium-term outlook:
  - Staff projection for 2017 growth: 6.7 percent (up from 6.2 percent in last Article IV).
  - Staff revised up average GDP growth over 2018-20 to 6.4 percent, from 6.0 percent in the last Article IV.
  - Momentum likely to decline over the year due to regulatory tightening and declining credit impulse; Q1 2017 real output rose 6.9 percent (yoy).
- Selected key statistics (as reported):
  - Real GDP (base=2015): 2016 = 6.7 percent; 2017 projection = 6.7 percent; 2018 projection = 6.4 percent.
  - Current account balance: 2016 = 1.7 percent of GDP; projections: 2017 = 1.4 percent, 2018 = 1.3 percent.
  - Gross official reserves (bn US$): 2016 = 3,098; 2017 projection = 2,934.
  - Total domestic nonfinancial sector debt (percent of GDP): 2016 = 236.4.
  - Household debt (percent of GDP): 2016 = 44.2.
  - Total capital formation (percent of GDP): 2016 = 44.2.
  - Gross national saving (percent of GDP): 2016 = 45.9.
  - General government net lending/borrowing (percent of GDP): 2016 = -3.7; projected 2017 = -3.7.
  - Augmented deficit (percent of GDP): reached an estimated 12¼ percent (augmented fiscal data).
  - Total non-financial sector debt: about 235 percent of GDP in 2016 and projected to rise further to over 290 percent of GDP by 2022.
  - Renminbi depreciation: 5 percent in real effective terms in 2016; depreciated some 2¾ percent since then.
  - Benchmark lending rate reduction between September 2014 and December 2015: 165 basis points.

### Tightening measures, financial conditions, and near-term impacts
- Macroprudential and regulatory actions:
  - Second half of 2016: tightening macro-prudential measures for real estate, reversing prior easing.
  - Early 2017: PBC increased 7-day repo twice by 10bps and extended MPA coverage to include Wealth Management Products (WMPs).
  - CBRC published documents for stricter enforcement and reduced regulatory arbitrage.
- Key financial-condition effects:
  - Interbank and market rates have risen sharply since mid-2016:
    - three-month Shibor has risen 124 basis points
    - one-year government bond yield has risen 107 basis points
    - AAA corporate bond yields have risen 124 basis points
  - Bank claims on NBFIs and off-balance sheet WMPs largely stopped growing month-to-month after prior booms.
  - Total credit to the non-financial private sector has started to moderate at the margin but has been relatively less affected to date.
- Exchange rate management and CFMs:
  - Late 2015/early 2016 RMB depreciated by 8 percent in effective terms (CFETS basket); since mid-2016 RMB traded within a narrow range.
  - Enforcement of existing CFMs tightened substantially from late 2016; tighter enforcement, stronger near-term growth outlook, and a weaker U.S. dollar reduced net capital outflows.
  - May 2017: CFETS guidance introduced a “counter-cyclical adjustment factor”; RMB appreciated almost 100 basis points relative to CFETS basket and roughly 90 basis points against the U.S. dollar in the first week after introduction.

### Downside risks, shock simulations, and proactive reform scenario
- Key downside risks:
  - Funding shocks in short-term interbank wholesale markets and runs on short-term asset management products issued by NBFIs (WMPs).
  - Retreat from cross-border integration: IMF GIMF simulation indicates a 10-percent U.S. tariff on Chinese exports, with China allowing real exchange rate adjustment, would lower Chinese real GDP by about 1 percentage point in the first year; retaliatory tariffs by China would contract GDP further.
  - Capital outflows could resume with faster U.S. rate normalization, weaker China growth, or confidence shocks, potentially causing renewed reserve loss and disruptive depreciation (risk judged small in short run given tightened CFMs and ample reserves).
- Proactive reform scenario:
  - Structural reforms resolving weak firms and converging to cross-country efficiency frontier could raise productivity contribution to growth by about 1 percentage point over the long term, enabling a 1 percentage point reduction in investment’s contribution while keeping headline GDP growth broadly unchanged.
  - Short-term costs: staff estimate short-term growth in a proactive reform scenario could fall to about 5½ percent absent policy response.
  - With fiscal smoothing targeted on social safety nets, total debt would still increase by 35 percentage points of GDP over the medium term and stabilize at 270 percent of GDP (compared to 293 percent in the baseline).
  - The scenario’s outcomes depend on depth, pace, sequence of reforms, cyclical fluctuations, and external conditions.

### Consumption, national savings, demographics, and fiscal reforms
- Findings on savings and consumption:
  - National savings estimated at 46 percent of GDP, which is 26 percentage points higher than the global average.
  - Excess savings largely driven by households and linked to weak social safety net.
  - Low consumption reduces current welfare and can lead to inefficient large domestic investment.
- Demographics:
  - Elderly-to-working-age ratio projected to rise from 15 percent in 2015 to 50 percent in 2050.
  - Aging projected to lower the 2030 household savings rate by about 6 percentage points of GDP.
- Recommended structural fiscal reforms to boost consumption:
  - Make tax system more progressive: reduce PIT basic exemption (about 80 percent of urban workers not paying PIT) and remove imputed minimum earnings for social contributions.
  - Increase social transfers to poor households and public spending on health, pensions, and education.
  - Intensify hukou reform and improve access to social services in less-developed areas.
  - Increase SOE dividend payments to the budget (current share of SOE profits paid to budget estimated well below the government’s 30-percent target by 2020).

### State-Owned Enterprises, overcapacity, and market reforms
- SOE performance and risks:
  - SOE productivity about a quarter lower on average than non-SOEs when controlling for sector.
  - SOEs receive implicit support estimated at about 3 percent of GDP (excluding other benefits).
  - In industry, SOEs account for more than half of corporate debt and 40 percent of industrial assets but less than 20 percent of industrial value added.
  - SOE assets reported to be over 200 percent of GDP.
  - After the global financial crisis, SOEs started growing and accounted for three-quarters (60 percentage points) of the rise in corporate debt/GDP since then.
  - Resolution of zombie debt incomplete: 20 percent of identified “zombie” central SOEs reportedly resolved; SOEs continue to account for 50 percent of zombie debt outstanding.
- Policy recommendations on SOEs and competition:
  - Move SOEs’ social functions to the budget; raise share classified as “commercial-competitive”; open protected sectors to private and foreign competition; speed up restructuring of underperforming SOE debt; harden budget constraints and phase out implicit subsidies.
  - Improve investment climate: reduce barriers to entry (services—financial, IT, transportation, logistics highly closed), ensure equal access to resources and treatment, reduce trade barriers including tariffs.
- Overcapacity:
  - At least ten sectors with overcapacity (coal, steel, cement, plated glass, aluminum, chemicals, paper, solar power, ship building, coal-fueled power).
  - 2016 targets for coal and steel over-achieved; total employment in two sectors reported 25-30 percent (around 2 million) below 2013 levels.
  - Policy guidance: broaden sectoral targets, rely more on market forces, avoid excessive administrative measures, and address root causes (high growth targets, soft budget constraints, environmental underpricing).

### Banking sector, private debt, and deleveraging priorities
- Banking sector size and leverage:
  - Banking sector at 310 percent of GDP (advanced economies average: 283; emerging markets average: 95).
  - Nonfinancial private sector lending rose 16 percent in 2016, twice nominal GDP growth.
  - Private credit % of GDP: 158 172 169 (table figures).
  - Since 2008, private sector debt relative to GDP rose by 80 percentage points to about 175 percent.
  - Credit gap about 25 percent of GDP.
- Deleveraging policy priorities:
  - Stock: greater recognition and removal of bad assets; reduce implicit subsidies (especially for SOEs); focus on zombie firms, overcapacity companies, and underperforming SOEs.
  - Flow: ensure credit grows more slowly than GDP; improve quality and efficiency of new credit; impose hard budget constraints on SOEs; tighten micro- and macro-prudential regulations and require additional buffers.
- Intra-financial sector credit channels and risks:
  - Channels: large banks lending to small banks and NBFIs; banks/NBFIs investing in other banks’ WMPs and NCDs; investment in shadow products by NBFIs.
  - Risks: capital mis-weighting, liquidity strain due to short-term products without PBC access, and opacity due to multiple stages of leverage.
- Regulatory tightening approach:
  - Continue tightening even if some financial tension and slower growth result.
  - Safeguards: effective coordination, equal access for solvent banks to PBC standing lending facilities with required collateral, allow insolvent financial institutions to exit.
  - FSAP will provide comprehensive assessment.

### Fiscal stance, “augmented” debt, and debt sustainability
- Official general government net borrowing and debt (2016): 3¾ and 37 percent of GDP, respectively.
- “Augmented” debt (including LGFV and similar entities): estimated 62 percent of GDP in 2016, projected to rise to 92 percent in 2022.
- Box 1 DSA highlights:
  - Nominal gross public debt (narrow coverage) 2016 = 36.6 (percent of GDP).
  - Nominal gross public debt (broad/augmented) 2016 = 56.6 (percent of GDP).
  - Under narrow coverage: maintaining 2016 GG deficit would stabilize debt at around 82 percent of GDP.
  - Under augmented coverage: maintaining 2016 augmented deficit would stabilize debt at 320 percent of GDP.
  - Baseline narrow-coverage primary balance projections (percent of GDP): 2017 = -4.8; 2018 = -4.4; 2019 = -4.3; 2020 = -4.3; 2021 = -4.2; 2022 = -4.1.
  - Baseline broad-coverage primary balance projections (percent of GDP): 2017 = -9.6; 2018 = -9.3; 2019 = -9.2; 2020 = -8.8; 2021 = -8.2; 2022 = -7.5.
- Policy guidance:
  - Recalibrate spending toward health, education, social security; reduce infrastructure investment.
  - Re-calibrate revenues away from land sales and social security contributions toward higher personal, property, and environmental taxes and higher SOE dividends.
  - Gradual “augmented”-deficit reduction: tightening of some ½ percent of GDP per year could balance sustainability while limiting growth drag.
  - Use fiscal space to ease transition costs, ideally via enhanced social safety net for affected workers.

### Monetary stance, exchange rate, and reserves
- Monetary stance and instruments:
  - Staff: stance described as still accommodative; benchmark lending rate 4.35 percent; PBC’s 7-day repo rate 2.45 percent; core inflation risen from 1½ to 2 percent in the last year.
  - Staff guidance: gradual removal of accommodation justified if core inflation ticks up; PBC should increase 7-day repo gradually.
  - Authorities view: see stance as neutral after recent adjustments; prefer no bias on future moves.
- Exchange rate and reserves:
  - Steps since 2015: reference to CFETS basket, reduced dollar link, move toward market focus; staff assesses real effective exchange rate broadly consistent with fundamentals.
  - Concerns: increased administrative control over FX flows and the exchange rate in the past year (tighter CFMs and counter-cyclical factor) reduces market role.
  - Reserves: China’s foreign currency reserves are US$ 3 trillion; staff notes composite metric suggests precautionary level between thresholds for floating with controls and fixed-open regimes.

### External rebalancing indicators (selected table figures)
- Contribution of net exports to GDP growth %: -0.1 -0.5 -0.5
- Current account balance % of GDP: 2.7 1.7 2.4
- FX reserve coverage months of imports: 18.2 18.6 18.7
- National saving rate 1/ % of GDP: 47.5 45.9 46.3
- Share of private consumption (Nominal) % of GDP: 38.0 39.2 39.1
- Share of investment (Nominal) % of GDP: 44.7 44.2 43.9
- Private credit % of GDP: 158 172 169
- Energy intensity of output per unit of output: 92 92 89

### Data gaps, statistical issues, and capacity development
- Data adequacy: "broadly adequate for surveillance, they are only barely so." Important gaps remain in national accounts and government finance statistics.
- National accounts weaknesses: volume measures techniques need improvement; annual GDP by expenditure compiled at constant prices but not published; expenditure components not available quarterly.
- Government finance statistics: serious shortcomings; data on social security and extra-budgetary funds only annual with long lag; expenditure classification needs improvement.
- Monetary and financial statistics: PBC reporting issues (central government deposits not separately reported since April 2005); recommended acceleration of compiling IMF SRFs.
- External statistics: historic BOP series from 2005; need stronger external debt monitoring.
- Capacity development: extensive IMF CD/TA across tax reform, public financial management, statistics, monetary policy, bank supervision, AML/CFT; ongoing cooperation and technical assistance programs noted.
- Recent data (IMF staff statement, July 28, 2017):
  - Q2 GDP growth 6.9 percent (y/y); real retail sales growth 10.0 percent (y/y); industrial value added growth 7.6 percent (y/y); FX reserves US$3,057 billion; headline CPI 1.5 percent (y/y); core CPI 2.2 percent (y/y); PPI 5.5 percent (y/y).

### Risk Assessment Matrix — key upside and downside scenarios
- Upside:
  - Faster-than-anticipated implementation of reforms (Medium/High likelihood).
  - Stronger-than-anticipated recent stimulus (Medium/Medium likelihood).
- Downside (High likelihood items):
  - Retreat from cross-border integration and protectionism.
  - Significant further strengthening of the US dollar and/or higher rates leading to capital outflows and reserve loss.
  - Structurally weak growth in key advanced and emerging economies.
- Financial sector scenarios:
  - Short-term: funding shocks and runs on WMPs (Medium likelihood).
  - Medium-term: slow reform progress and unsustainable credit growth leading to permanently lower growth (Medium likelihood).
- Policy recommendations and contingency measures:
  - Support multilateralism and WTO rules; guard against financial risks; use on-budget, pro-consumption fiscal stimulus if growth threatens to fall; move flexibly to an effective float while intervening to mitigate disorderly conditions; accelerate reforms to shift growth from investment/state to consumption/private sector.

### IMF–World Bank discussions and division of labor (June 2017)
- Agreed reform focus: shift to balanced sustainable growth per 13th Five-Year Plan; prevent buildup of credit, intra-financial claims, and quasi-fiscal spending; make growth more inclusive and green; give markets a more decisive role.
- Macro-critical reform areas:
  - Financial sector: harden budget constraints, debt restructuring, supervisory tightening, phase out regulatory arbitrage.
  - Fiscal: implement new budget law, strengthen local government finances, modernize tax system to be more progressive.
  - Social security: strengthen pensions and health insurance, improve portability, develop financing strategy.
  - SOE reform: advance debt restructuring, phase out implicit guarantees, open services sector to competition.
  - Green growth and infrastructure: price externalities (e.g., carbon tax), mobilize private capital, improve infrastructure approval for high social return.
- Planned cooperation:
  - Joint FSAP — Nov 2017.
  - Ongoing TA and project work by both Bank and Fund on fiscal, financial, social, and environmental reforms.

*Source: People's Republic of China — Staff Report for the 2017 Article IV Consultation; IMF staff report (cr17247).*

### 1.4 percent of GDP this year, due primarily to robust domestic demand and a deterioration in

### PEOPLE'S REPUBLIC OF CHINA — STAFF REPORT FOR THE 2017 ARTICLE IV CONSULTATION

### Executive Board Assessment
- Directors acknowledged that China’s continued strong growth has provided critical support to global demand.
- Commended authorities’ ongoing progress in rebalancing the economy toward services and consumption.
- Saw recently firmer economic activity as an opportunity to accelerate reforms and focus on the quality and sustainability of growth.
- Emphasized the importance of reducing national savings to help prevent domestic and external imbalances; recommended greater social spending and making the tax system more progressive.
- Welcomed improvements in state-owned enterprises and urged further reforms, including hardening budget constraints, accelerating restructuring of underperforming debt, and allowing exit of non-viable firms.
- Highlighted the need for a broader improvement in the investment climate: reducing barriers to entry, ensuring a level playing field, and reducing trade barriers.
- Welcomed efforts to reduce overcapacity and urged broadening such efforts with greater reliance on market forces.
- Commended increased focus on reducing financial stability risks and urged continued strengthening of regulatory and supervisory efforts; looked forward to findings of the ongoing Financial Sector Assessment Program.
- Supported a gradual tightening of monetary policy if core inflation continues to pick up.
- Agreed that immediate fiscal priority is adjusting budget composition to support rebalancing and ease transition costs from an investment- and credit-led model; noted value of having some fiscal space to balance growth and sustainability concerns.
- Underscored importance of monitoring debt and reforming central-local fiscal relations to reduce off-budget spending risks.
- Took note that staff assessed the renminbi remains broadly in line with fundamentals, while the external position in 2016 was moderately stronger than implied by fundamentals; stressed continued progress toward greater exchange rate flexibility and commitment to deepen reforms and rely more on market forces for exchange rate determination.
- Noted recent steps to tighten enforcement of capital flow measures were broadly consistent with the Fund’s Institutional View but emphasized need for consistent and transparent implementation and carefully sequenced reforms to support ongoing capital account liberalization.
- Supported further improvements in policy frameworks: fiscal framework to increase local government autonomy and reduce off-budget spending; transition to a modern price-based monetary policy framework; continued improvement in coverage and quality of official statistics.

### Outlook and Risks
- Outlook revised up reflecting strong momentum, a commitment to growth targets, and a recovering global economy, but at the cost of further large and continuous increases in private and public debt and rising medium-term downside risks.
- China has potential to sustain strong growth over the medium term if reforms accelerate to rebalance toward less credit-intensive growth while using buffers to smooth the transition.
- Key elements of the staff strategy:
  - Further boosting consumption by increasing social spending and making the tax code more progressive.
  - Increasing the role of market forces by reducing implicit subsidies to SOEs and opening key sectors to private investment.
  - Deleveraging the private sector with continued regulatory/supervisory tightening, greater recognition of bad assets, and more market-based credit allocation.
  - Ensuring macro sustainability by gradual fiscal consolidation and eventually less monetary accommodation; focus more on quality and sustainability of growth and less on quantitative targets.
  - Improving policy frameworks for center-local fiscal relations, financial stability (to be covered in the forthcoming FSAP), monetary policy, and data.

### Context and Recent Developments
- Domestic demand and supply-side reforms have helped maintain strong growth; tighter enforcement of capital flow management measures (CFMs) has reduced exchange rate pressure.
- Regulators have recently focused on addressing financial sector risks, resulting in tightening financial conditions.
- The five-yearly Communist Party Congress is scheduled for the fall.

Key developments and assessments:
- Renminbi movements:
  - After depreciating 5 percent in real effective terms in 2016, the renminbi has depreciated some 2¾ percent since then and remains broadly in line with fundamentals.
- Growth and demand:
  - GDP growth in 2016 reached 6.7 percent, down from 6.9 percent in 2015 and in line with the authorities’ target of 6.5-7 percent.
  - Momentum stabilized in the second half of 2016 and accelerated into Q1 2017 when real output rose 6.9 percent (yoy).
  - Consumption accounted for nearly two-thirds of total growth in 2016, the highest share since 2000.
  - Investment remained strong, supported by fast growth in public infrastructure and the first acceleration in real estate investment in five years.
- External sector:
  - Current account surplus fell by almost 1 percentage point to 1.7 percent of GDP in 2016.
  - Staff assesses the 2016 current account was ½-2½ percent of GDP stronger than the level implied by medium-term fundamentals and desirable policies (versus 1–3 percent of GDP in 2015); tourism imports may be overstated by roughly ½ percent of GDP since 2014 due to data limitations.
- Policy easing and supply-side reforms:
  - Between September 2014 and December 2015, the benchmark lending rate was reduced by 165 basis points.
  - Authorities eased real-estate macro-prudential policies in 2015 and early 2016 (e.g., lower down-payment requirements and higher discounts on mortgage rates).
  - General government net borrowing widened by 2¾ percent of GDP between 2014 and 2016, driving a similar increase in the “augmented” deficit which reached an estimated 12¼ percent.
  - Supply-side measures reduced overcapacity in coal and steel, restructured some weak SOEs, and tightened environmental regulations; a 2014 reform to facilitate business registration increased new businesses from 6,000 before the reform to 15,000 per day in 2016.

### Policy Recommendations and Priorities
- Fiscal policy:
  - Adjust budget composition to support faster rebalancing and ease transition costs from an investment- and credit-led model.
  - Use available fiscal space to balance growth and sustainability; pursue gradual fiscal consolidation over time.
  - Reform central-local fiscal relations to increase local government autonomy, reduce scope for off-budget spending, and centralize some expenditure responsibilities.
- Monetary policy:
  - Complete transition to a modern price-based monetary policy framework.
  - Support gradual tightening of monetary policy if core inflation continues to pick up.
- Financial sector and macroprudential:
  - Continue strengthening regulatory and supervisory frameworks; accelerate recognition and resolution of bad assets.
  - Sequence capital account liberalization reforms carefully and ensure consistent, transparent implementation of CFMs.
  - Rely more on market-based credit allocation and reduce implicit subsidies to SOEs.
- Structural and market reforms:
  - Broaden efforts to reduce overcapacity with greater reliance on market forces.
  - Improve the investment climate by reducing barriers to entry and leveling the playing field between public and private firms.
  - Increase social spending and make the tax system more progressive to boost consumption.
- Data and governance:
  - Improve the coverage and quality of officially provided statistics to inform policymaking and investment decisions.

### Selected Key Statistics (as reported)
- Real GDP (base=2015): 2016 = 6.7 percent; 2017 projection = 6.7 percent; 2018 projection = 6.4 percent.
- Current account balance: 2016 = 1.7 percent of GDP; projections: 2017 = 1.4 percent, 2018 = 1.3 percent.
- Gross official reserves (bn US$): 2016 = 3,098; 2017 projection = 2,934.
- Total domestic nonfinancial sector debt (percent of GDP): 2016 = 236.4.
- Household debt (percent of GDP): 2016 = 44.2.
- Total capital formation (percent of GDP): 2016 = 44.2.
- Gross national saving (percent of GDP): 2016 = 45.9.
- General government net lending/borrowing (percent of GDP): 2016 = -3.7; projected 2017 = -3.7.
- Augmented deficit (percent of GDP): reached an estimated 12¼ percent (augmented fiscal data).
- Benchmark lending rate reduction between September 2014 and December 2015: 165 basis points.
- Renminbi depreciation: 5 percent in real effective terms in 2016; depreciated some 2¾ percent since then.

*Source: People's Republic of China — Staff Report for the 2017 Article IV Consultation (IMF staff report, July 13, 2017).*

### 5.       Amid strong growth, the authorities have pivoted toward tightening measures,

### cr17247 - 5.       Amid strong growth, the authorities have pivoted toward tightening measures,

### Tightening measures and immediate financial impacts
- Macroprudential and regulatory actions:
  - In the second half of 2016, the authorities started tightening macro-prudential measures for the real estate sector, reversing much of the previous easing.
  - In early 2017, the PBC increased its 7-day repo rate twice by 10bps and clarified that the policy stance was now neutral.
  - In early 2017, the PBC extended the coverage of its “Macro-Prudential Assessment (MPA)” to off-balance sheet activity for the first time by including Wealth Management Products (WMPs).
  - The CBRC published several new documents aimed at stricter enforcement of existing regulations and reducing regulatory arbitrage across financial products.
- Key financial-condition effects:
  - Interbank and market rates have risen sharply since mid-2016:
    - three-month Shibor has risen 124 basis points
    - one-year government bond yield has risen 107 basis points
    - AAA corporate bond yields have risen 124 basis points
  - Bank claims on non-bank financial institutions (NBFIs) and off-balance sheet WMPs have largely stopped growing month-to-month after booming in recent years.
  - Total credit to the non-financial private sector has started to moderate at the margin but has been relatively less affected to date.

### Exchange rate management and capital flow measures
- FX intervention and exchange rate behavior:
  - In late 2015 and early 2016, the RMB depreciated by 8 percent in effective terms (using the CFETS basket).
  - Since mid-2016, the RMB traded within a narrow range against the CFETS basket; stabilizing the RMB effective rate required considerable sales of foreign exchange when the U.S. dollar strengthened in H2 2016, but FX reserves stabilized once capital outflows moderated.
- Tightening of capital flow measures (CFMs):
  - Enforcement of existing CFMs was tightened substantially from late 2016, including measures on overseas direct investment and offshore RMB lending and other measures (e.g., overseas RMB withdrawals by payment cards).
  - Tighter enforcement, together with a stronger near-term growth outlook and a weaker U.S. dollar, helped reduce net capital outflows substantially.
- Change to central parity fixing:
  - In May 2017, CFETS revised guidance to banks for calculating quotes for the daily opening exchange rate by requesting inclusion of a “counter-cyclical adjustment factor” to reduce “irrational” depreciation expectations and “pro-cyclical” herding behavior.
  - In the first week after the new factor was introduced, the RMB appreciated by almost 100 basis points relative to the CFETS basket and roughly 90 basis points against the U.S. dollar.

### Near-term outlook and projections (staff baseline)
- Growth:
  - Government 2017 growth target: around 6½ percent (with “or higher if possible in practice”).
  - Staff projection for 2017: 6.7 percent (up from 6.2 percent in the last Article IV).
  - Momentum likely to decline over the year due to recent regulatory measures tightening financial conditions and a declining credit impulse; high-frequency indicators from Q2 suggest activity likely peaked in Q1.
- Inflation and external balances:
  - Core inflation expected to remain broadly stable around 2 percent.
  - Current account surplus projected to fall by 0.3 percentage points to 1.4 percent of GDP, driven primarily by robust domestic demand and a projected 5-percent deterioration in terms of trade; moderation in capital outflows will more than offset this fall.
- Medium-term baseline revisions and debt:
  - Staff revised up average GDP growth over 2018-20 to 6.4 percent, from 6.0 percent in the last Article IV.
  - Staff assume authorities will broadly maintain current levels of public investment and not substantially consolidate the “augmented” deficit; as a result, “augmented” debt reaches 92 percent of GDP in 2022 on a rising path.
  - Total non-financial sector debt: about 235 percent of GDP in 2016 and projected to rise further to over 290 percent of GDP by 2022.

### Downside risks, shock scenarios, and alternative (proactive) scenario
- Key downside risks:
  - Funding shock risks in short-term interbank wholesale markets and loss of confidence/run on short-term asset management products issued by NBFIs (WMPs).
  - Retreat from cross-border integration: IMF GIMF simulation indicates a 10-percent U.S. tariff on Chinese exports, with China allowing real exchange rate adjustment, would lower Chinese real GDP by about 1 percentage point in the first year; retaliatory tariffs by China would contract GDP further.
  - Capital outflows could resume with faster-than-expected U.S. rate normalization, much weaker growth in China, or other confidence shocks, potentially causing renewed large reserve loss and disruptive exchange rate depreciation (risk judged small in short run given tightened CFMs, state-owned banks’ prominence in FX market, and ample reserves).
- Proactive reform scenario:
  - Structural reforms to resolve weak firms and converge to cross-country efficiency frontier could raise productivity contribution to growth by about 1 percentage point over the long term, enabling a 1 percentage point reduction in investment’s contribution to growth while keeping headline GDP growth broadly unchanged.
  - Changing fiscal composition toward consumption could support rebalancing, financing faster consumption with a drawdown in household savings rather than higher debt.
  - Short-term costs: staff estimate short-term growth in a proactive reform scenario could fall to about 5½ percent absent a policy response.
  - With fiscal smoothing on-budget targeted at social safety nets, total debt would still increase by 35 percentage points of GDP over the medium term and stabilize at 270 percent of GDP (compared to 293 percent in the baseline).
  - The proactive scenario’s growth path is uncertain and depends on depth, pace, sequence of reforms, cyclical fluctuations, and external conditions.

### Global spillovers and policy message
- Near-term spillovers of the revised baseline (higher growth, slower rebalancing, tighter capital account):
  - Ongoing support for global commodity exporters reliant on public investment, real estate, and heavy industry (e.g., Brazil, Australia).
  - Fewer global mergers and acquisitions and Chinese-financed real estate purchases due to more limited residents’ access to foreign exchange (e.g., Canada, U.K., Australia).
  - Continued Chinese gains in upstream share of Asian supply chains (e.g., Japan, Korea, Malaysia) but at a slower pace absent better domestic private-sector investment climate and FDI.
- Major medium-term risk:
  - High growth with high debt accumulation raises probability of a disruptive adjustment that would sharply contract Chinese imports and impart a contractionary impulse to the global economy.
- Policy imperative:
  - Decisive implementation of reforms to: (1) switch faster from investment to consumption so growth is less reliant on debt, (2) increase the role of market forces to improve resource allocation, and (3) further build modern policy “soft infrastructure” to enhance policymakers’ ability to manage the modern Chinese economy.
  - China has buffers to boost growth if needed, but these should be used to support accelerated reforms; replacing precise numerical growth targets with a commitment to reforms that achieve the fastest sustainable growth path is emphasized.

*Source: IMF staff — Chapter: “Amid strong growth, the authorities have pivoted toward tightening measures” (cr17247).*

### 15.      Low consumption and high national savings translate into lower welfare for Chinese

### Low consumption and high national savings translate into lower welfare for Chinese

### High national savings and low consumption: findings
- China’s national savings are estimated at 46 percent of GDP, which is 26 percentage points higher than the global average.
- Excessive savings are driven largely by the household sector (SIP) and are linked to structural characteristics and policy factors, notably a comparatively weak social safety net.
- Macroeconomic and welfare implications of high savings:
  - Allocating a low share of income to consumption reduces current welfare (e.g., via a lower standard of living).
  - Given home bias, capital account restrictions, and high growth targets, high savings translate into large amounts of domestic investment that are unlikely to be absorbed efficiently; returns from such high investment may not sufficiently support future growth and debt service obligations.
  - If investment were curtailed amid such high savings, the current account surplus would widen, worsening global imbalances, reducing China’s contribution to global demand, and undermining the multilateral trade system.

### Demographics and the need for structural fiscal reforms
- Demographic projection: the ratio of elderly to working-age population is expected to rise from 15 percent in 2015 to 50 percent in 2050.
- Model simulation: aging is projected to lower the 2030 household savings rate by about 6 percentage points of GDP.
- Because demographic change will be gradual and insufficient alone to normalize savings or reduce inequality, prioritized reforms include:
  - Make the tax system more progressive:
    - Reduce the personal income tax (PIT) basic exemption (which results in about 80 percent of urban workers not paying the PIT).
    - Remove imputed minimum earnings for social contributions, which result in prohibitively high effective tax rates for the working poor.
  - Further increase social transfers to poor households:
    - Lower-income households in China have a savings rate of plus 20–30 percent compared to minus 20 percent in many peers; a key driver is China’s lower public transfers.
    - Moving toward international norms on social assistance would lower excessive precautionary savings and reduce income inequality.
  - Continue to increase public spending on health, pensions, and education:
    - Higher health and pension spending will increase government consumption directly and private consumption indirectly by reducing precautionary savings.
    - Intensified hukou (residency) reform and improved access to social services, particularly in less-developed areas, are needed to ensure an adequate safety net for all citizens.
  - Increase SOE dividend payments to the budget:
    - The share of aggregate SOE profits currently paid to the budget is estimated to be well below the government’s 30-percent target by 2020; addressing this can help impose budget constraints on weaker SOEs, reduce wasteful investment, and finance needed social spending.

### State-Owned Enterprises (SOEs): performance, risks, and reform priorities
- SOE performance and implicit support:
  - SOEs have been structurally less efficient than the private sector; SOE productivity is about a quarter lower on average than non-SOEs when controlling for sector and is partly driven by significant social responsibilities and weak corporate governance.
  - SOEs receive substantial implicit support (e.g., credit, land) estimated at about 3 percent of GDP (excluding other benefits such as operating in protected markets).
  - In the industrial sector, SOEs account for more than half of corporate debt and 40 percent of industrial assets but less than 20 percent of industrial value added.
  - SOE assets are reported to be over 200 percent of GDP.
- Recent trends and outstanding concerns:
  - After many years of downsizing, SOEs started growing after the global financial crisis, accounting for three-quarters, or 60 percentage points, of the rise in corporate debt/GDP since then.
  - “Mixed-ownership” reforms are at initial stages with limited increases in private participation; political influence remains institutionalized; restructuring often focuses on mergers rather than operational change.
  - Resolution of unviable debt is incomplete: while 20 percent of identified “zombie” central SOEs were reportedly resolved, SOEs continue to account for 50 percent of zombie debt outstanding.
  - The share of aggregate SOE profits transferred to the fiscal budget has been low historically, with a government target to transfer 30 percent by 2020.
- Policy recommendations on SOEs and competition:
  - Expedite implementation of existing reform initiatives to foster competitive neutrality:
    - Move SOEs’ social functions to the budget to allow firms to focus on commercial objectives.
    - Raise the share of SOEs classified as “commercial-competitive.”
    - Open additional protected sectors to greater competition from private and foreign investment.
    - Speed up restructuring of underperforming SOE debt.
  - Harden budget constraints on SOEs by phasing out implicit subsidies on factor inputs and forcing non-viable firms to default and exit when warranted, with fiscal support for affected workers.
  - Complement state-ownership reforms by transferring more state-owned assets to private ownership where appropriate.
  - Improve the investment climate and trade openness:
    - Reduce barriers to entry—services (financial, IT, transportation, logistics) are highly closed relative to the OECD and other emerging markets, with SOEs dominant in services.
    - Ensure private sector (including foreign firms) equal access to resources (land, natural resources, credit, government subsidies) and equal treatment in regulations, taxation, government procurement, and administrative approvals.
    - Follow through on plans to expand private and foreign market access and local governments’ fair-competition reviews.
    - Reduce trade barriers, including tariffs which remain considerably higher than those of China’s main trading partners, to help reduce trade tensions and demonstrate commitment to an open rules-based trading system.

### Overcapacity: scope, progress, and next steps
- Scope and impact:
  - Overcapacity spans at least ten sectors including coal, steel, cement, plated glass, aluminum, chemicals, paper, solar power, ship building, and coal-fueled power.
  - Overcapacity is associated with low capacity utilization rates and a large share of firms incurring losses, contributing to downward pressure on global prices, rising market share for Chinese firms, and tensions with trading partners.
  - Overcapacity damages China’s medium-term growth, the environment, and financial stability.
- Recent progress and limitations:
  - Authorities set capacity and employment reduction targets for the coal and steel sectors for 2016-2020; official data indicate capacity targets were over-achieved in 2016 and are on track for 2017, aided by tighter enforcement of environmental and regulatory standards.
  - Total employment in the two sectors is reported to be 25-30 percent (around 2 million) below 2013 levels.
  - Concerns remain that capacity reductions included closure of already-idle plants and there is limited restructuring of overcapacity firms’ outstanding debt.
- Policy guidance to reduce overcapacity sustainably:
  - Broaden and deepen reform efforts with greater reliance on market forces:
    - Set more ambitious net targets within coal and steel and broaden targets to other sectors.
    - Avoid excessive reliance on administrative measures such as cuts in work days, mergers, and window guidance on prices.
    - Address root causes: high GDP growth targets met through state-directed investment, soft budget constraints that keep loss-making firms in business, and underpricing of long-term environmental damage.
  - Encourage multilateral cooperation (e.g., participation in the OECD Global Forum on Steel Excess Capacity) to strengthen collective efforts in reducing overcapacity.

### Authorities’ views (summary)
- On savings and consumption: Authorities agreed national savings remained high and noted demographics would help reduce savings; they emphasized recent rises in social spending but cautioned that further discretionary increases must be balanced against spending pressures from aging.
- On SOEs and overcapacity: Authorities argued SOE productivity continued to improve due to supply-side and mixed-ownership reforms, noted SOE profits had risen 10 percent year-over-year while leverage had declined, disputed staff estimates of material state support (including the 3 percent of GDP estimate), and emphasized completed classification of central SOEs and accelerated mixed-ownership reforms.
- On opening to private and foreign sectors: Authorities underscored commitment to reducing barriers to entry (e.g., in oil refining, electricity, natural gas, telecommunications, civil aviation, and certain financial services), reducing the negative list for foreign investment, improving the business environment for foreign firms, promoting global trade and investment liberalization, and seeking cooperative solutions to trade tensions.

*Source: IMF staff report chapter on the People’s Republic of China.*

### 27.      China now has one of the largest

### 27.      China now has one of the largest banking sectors in the world.

### Banking sector size and systemic risk
- China’s banking sector is at 310 percent of GDP.
- Advanced economies average: 283 (percent of GDP).
- Emerging markets average: 95 (percent of GDP).
- The sharp growth reflects both a rise in credit to the real economy and intra-financial sector claims.
- The increase in size, complexity and interconnectedness of these exposures have resulted in sharply rising risks.

### Nonfinancial private sector debt: recent evolution and risks
- Lending to the private sector rose 16 percent in 2016, twice nominal GDP growth.
- The credit gap is about 25 percent of GDP.
- Since 2008, private sector debt relative to GDP has risen by 80 percentage points to about 175 percent.
- Staff estimates: had credit growth been kept to a sustainable rate, ceteris paribus, real GDP growth would have been around 5½ percent between 2012 and 2016, rather than 7¼ percent (SIP).
- Large increases in private sector debt have internationally been associated with sharp growth slowdowns and often financial crises.

### Deleveraging: stock and flow priorities (policy recommendations)
- Stock (recognition and removal of bad assets)
  - Focus on greater recognition of the underlying stock of bad assets.
  - Requires a reduction in implicit subsidies, especially for SOEs, and more decisive action by supervisors.
  - Immediate focus could be the debt of zombie firms, overcapacity companies, and underperforming SOEs.
- Flow (slow credit growth relative to GDP)
  - Private sector deleveraging will require credit to grow more slowly than GDP.
  - Overarching priority: focus more on the quality and sustainability of growth and less on quantitative targets.
  - To reduce drag on growth from slowing credit expansion, new credit needs to become more efficient.
  - Credit demand side measures: impose hard budget constraints on SOEs and use macro-prudential measures to contain mortgages and broader risks to the real estate sector.
  - Credit supply side measures: tighten micro- and macro-prudential regulations further by requiring additional buffers for the financial system and continuing efforts to eliminate regulatory arbitrage.

### The size and complexity of intra-financial sector credit (channels and risks)
- Key channels of intra-financial sector credit:
  1. Large banks lending to small banks and NBFIs in the largely short-term and collateralized wholesale market.
  2. Banks or NBFIs investing in other banks’ WMPs and negotiable certificates of deposit (NCDs).
  3. Banks and NBFIs investing in shadow products issued by other NBFIs.
- Risks posed:
  - Capital: risk-weighting of investment products may be lower than regular loans even when underlying assets are loan-like; losses on WMPs may ultimately be absorbed by issuing banks given perceived guarantees.
  - Liquidity: products often short-term and collateralized but may prove hard to redeem; NBFIs do not have access to PBC funding; underlying asset prices could gap lower in large-scale liquidity stress, amplifying shock.
  - Complexity: multiple stages of leverage make “seeing-through” to the underlying asset more difficult for banks, regulators and investors.

### Regulatory tightening: approach and safeguards
- Recent regulatory/supervisory tightening is critically important and should continue, even if it means some financial tension and slower growth.
- To prevent tightening from derailing reform and causing a “stop-go” cycle, regulators should:
  1. Coordinate effectively to ensure that financial conditions do not tighten excessively.
  2. Ensure that all solvent banks have equal access to the PBC’s standing lending facilities provided they have the required collateral.
  3. Allow insolvent financial institutions to exit.
- The ongoing Financial Sector Assessment Program (FSAP) will provide a comprehensive assessment; current analysis and recommendations are preliminary while FSAP work is ongoing.

### Authorities’ views on banking risks and deleveraging
- Authorities disagreed that the stock of bad assets was underestimated.
  - Argued weak firms were facing harder budget constraints due to pressure on financial institutions to reduce financing to overcapacity and real estate sectors.
  - Viewed a more gradual pace of deleveraging than staff recommended as desirable and sustainable.
  - Pointed out lending to firms was already slowing and would stabilize as a share of GDP over the medium term.
- On financial sector size and complexity, authorities recognized increased risks but argued the problem was manageable.
  - Pointed to intensification of supervision and slowdown in financial sector leverage as evidence of commitment.
  - Recognized increase in market interest rates could create tension, but emphasized stepped up policy coordination and that the PBC would maintain sufficient liquidity to avoid disorderly adjustment and systemic risks.
  - Emphasized all banks had access to the PBC’s standing facility against required collateral, but disagreed with staff’s recommendation not to use penalty rates for banks with low MPA ratings.
  - Looked forward to finalized FSAP recommendations.

### Fiscal stance, “augmented” debt, and policy guidance
- Official general government net borrowing and debt were 3¾ and 37 percent of GDP, respectively, in 2016.
- Including debt of Local Government Financing Vehicles (LGFVs) and entities such as government-guided funds, “augmented” debt is estimated at 62 percent of GDP in 2016 and projected to rise to 92 percent in 2022.
- Two-thirds of LGFV debt (22 percent of GDP) was recognized as government obligations in 2014; the large jump in 2014 reflects official recognition of 22 percent of GDP in LGFV debt.
- Staff view: “augmented” concept may better capture obligations that financed spending mostly non-market based with uncertain returns and entities largely government-controlled.
- Further firm-level analysis is needed to assess whether LGFVs operate on a fully commercial basis with sound earnings and debt outlook.
- Fiscal policy recommendations:
  - Fiscal reform for faster rebalancing:
    - Increase spending on health, education, and social security; reduce infrastructure investment.
    - Re-calibrate revenues away from land sales and social security contributions toward higher personal, property, and environmental taxes and higher SOE dividends.
    - Substantially raise taxes on fossil fuel and pollution (e.g., a carbon/coal tax) to raise revenue, curtail emissions, improve energy efficiency, and prevent almost 4 million premature deaths by 2030 (WP/16/148).
  - Gradual “augmented”-deficit reduction:
    - The “augmented” deficit should gradually fall to its debt stabilizing level.
    - A tightening of some ½ percent of GDP per year could balance sustainability needs while limiting drag on growth.
    - On-budget deficits can be maintained and even expanded if combined with faster off-budget consolidation.
  - Easing transition costs in the short to medium term:
    - If accelerated reform weighs on growth, China has some fiscal space which could be used to limit transition cost, ideally via an enhanced social safety net for affected workers.
    - Consolidation could be slowed or temporarily reversed if necessary.

### Authorities’ views on augmented debt and deficits
- Authorities disagreed with staff use of “augmented” debt and deficit concepts.
  - Argued the 2014 budget law and subsequent regulations clarified LGFVs were standard firms and new borrowing was not part of the government sector.
  - Argued all obligations of local governments had been explicitly recognized within official public debt statistics and local governments would not assume legal repayment responsibility for financing vehicles, government guided funds, or special construction funds.
  - Argued many LGFV projects were commercial and backed by real assets.
  - Maintained staff should use general budget deficit and official debt numbers of roughly 3 and 37 percent of GDP (as of end-2016), respectively.

### Monetary stance
- Current stance described by staff as still accommodative.
  - Benchmark lending rate: 4.35 percent (at its historical low).
  - PBC’s 7-day repo rate: 2.45 percent (a key policy instrument for the new interest rate corridor), described as barely positive in real terms.
  - Core inflation has risen from 1½ to 2 percent in the last year.
  - Current rates are well below Taylor Rule-suggested levels (Taylor rule assumes an inflation target of 3% and a neutral benchmark lending rate of 6%).
- Staff guidance:
  - A gradual removal of monetary accommodation would be justified if core inflation continued to tick up.
  - The PBC should expect to increase gradually the 7-day repo rate, with pace data dependent and focused on near-term developments in core inflation and activity.
  - Moderately higher interest rates could help reduce excessive leverage and limit pressure on the exchange rate, but interest rates should not be the primary tool for tackling financial stability concerns or stabilizing the exchange rate (SIP).
- Authorities’ views:
  - Disagreed that monetary stance was accommodative; after recent adjustments they saw it as neutral.
  - Preferred no bias regarding future interest rate moves.
  - Noted headline inflation had fallen sharply recently due to food prices but saw underlying inflation dynamics as broadly consistent with desired range of 2-3 percent.
  - Viewed current stance as appropriate for exchange rate and financial sector stability objectives.

### Exchange rate management and reserves
- Steps taken since 2015 to prepare for increased exchange rate flexibility:
  - Established reference to a basket (CFETS basket), reducing the dollar link and increasing market focus on the nominal effective exchange rate.
  - Reduced intervention: tighter enforcement of CFMs, a better growth outlook, and a weaker U.S. dollar helped reduce FX intervention and near-term risk of large outflows.
  - Staff assesses the real effective exchange rate to be broadly consistent with fundamentals (unchanged from 2015 assessment).
  - Authorities helped stabilize depreciation expectations by countering market views that they sought depreciation to boost growth and competitiveness.
- Concerns and recommendations:
  - Administrative control over FX flows and the exchange rate increased over the past year (e.g., tighter CFMs and a “counter-cyclical” factor to guide banks’ fixing quotes), which reduces the role of market forces and appears a step back toward a closer link to the U.S. dollar.
  - Progress toward a more market-determined, flexible exchange rate should resume; changes could have been better explained.
  - Recommended framework: maintain an implicit and widening band around an equilibrium effective rate within which the spot rate could fluctuate with market forces; adjust the center of the band if the equilibrium rate is assessed to have changed; implement via FX intervention and public communication.
- Reserves:
  - China’s foreign currency reserves are US$ 3 trillion.
  - The IMF composite metric considerations:
    - For a floating exchange rate with capital controls the implied threshold of US$ 1 trillion is too low for China; for a fixed but open regime US$ 2.9 trillion is too high.
    - On balance, the appropriate precautionary level lies between those values.
    - The composite metric guides the appropriate level of reserves to acquire in normal periods so they can serve as a buffer if a capital account crisis materializes; it is not meant to be a minimum to maintain at all stages of capital outflow pressure.

_Source: IMF staff report (chapter content provided)._

### 45.      Further capital account opening, while desirable over the medium term, should be

### 45.      Further capital account opening, while desirable over the medium term, should be

### Capital account opening and capital flow management measures (CFMs)
- Recent tightening in CFMs was broadly consistent with the IMF’s institutional view on capital flows: the necessary supporting reforms (effective monetary policy framework, sound financial system, and exchange rate flexibility) had not kept pace with the de facto liberalization of capital flows (SIP).
- Concerns about tighter enforcement of CFMs:
  - Weighing on the business climate due to less-than-transparent implementation and uneven enforcement over time and across provinces.
  - Risk that CFMs allow delay in supporting reforms and increase the risk of domestic asset bubbles.
  - Effectiveness likely to erode as investors find loopholes and portfolio flows increase.
- Two key priorities:
  - Accelerate progress on necessary supporting reforms to support ongoing liberalization. In the near term, only carefully targeted liberalization—e.g. more FDI in services or reducing the reserve requirement for onshore hedging—should be considered.
  - Ensure existing CFMs are consistently and transparently enforced and do not restrict current international payments and transfers, in line with China’s IMF obligations.

### Belt and Road Initiative (BRI)
- BRI could foster multinational cooperation in trade, investment and finance and bring infrastructure and connectivity to the region.
- Fully reaping benefits requires strong governance of projects to ensure financial viability and sufficient institutional and macroeconomic capacity in recipient countries.

### Authorities’ views on exchange rate, FX policy, and CFMs
- Authorities believed capital flow pressures had become more balanced since early 2017 but saw persistent irrational and self-reinforcing market dynamics.
- Example: Authorities viewed the RMB’s stability against the dollar in Q1 2017 (a period of depreciation in the global dollar index, little official foreign exchange intervention, and improving fundamentals in China) as evidence of persistent irrational market behavior; in their view, the RMB should have strengthened during that period.
- To break such expectations, authorities considered policy steps to generate two-way expectations, including intervention (selling FX to move the exchange rate against market expectations); they were confident that the current level of FX reserves was adequate.
- Regarding the daily fixing, authorities introduced a “counter-cyclical factor” to reflect better macroeconomic fundamentals and underlying market forces, motivated by concerns that the previous mechanism had at times led to self-fulfilling market expectations.
- Authorities noted tighter enforcement of existing regulations had helped reduce excessive capital outflows; they emphasized that legitimate transactions should not be delayed and intended to increase administrative capacity to ensure smooth processing.
- They stressed commitment to not restricting current international payments and transfers, and remained committed to further gradual capital account liberalization, arguing opening could support reforms. They described the BRI as an open and inclusive regional economic cooperation framework.

### Fiscal framework: ongoing reforms and considerations
- Reforms underway: new Guidelines for Local Government Debt and a blueprint for reforming inter-governmental fiscal relations (SIP).
- Issues to consider:
  - Targeted amount of revenues and spending:
    - China’s tax revenue is relatively low at 20 percent of GDP (versus OECD average of 34 percent) due primarily to low PIT and property receipts.
    - Tax structure is regressive; China lags major emerging markets in public spending on education, health and other social assistance.
    - One of the highest levels of income inequality in the world, which, while easing slightly recently, is projected to increase without policy action.
  - Allocation of responsibilities:
    - Assign tax and spending responsibilities to the level of government that can most efficiently execute them.
    - Example: centralize social insurance functions (e.g. pensions and employment insurance) to take advantage of economies of scale, remove barriers to mobility and ensure equalized benefits across regions.
    - Currently, local governments in China have the highest share of national spending responsibility in the world yet very limited revenue autonomy.
    - Introducing a recurrent property tax with rates set by local governments within a centrally-approved band is one option to address this imbalance.
  - Intra-governmental transfers:
    - Reduce vertical imbalance via central government transfers (i.e. non-revenue sharing) that are rules-based to improve predictability and reduce pro-cyclicality of local government funding.
    - Increase size of equalization grants and rationalize/simplify targeted transfers with stronger emphasis on outputs/quality of services.
  - Financing:
    - Adequate debt authorization reduces pressure for off-budget borrowing or reliance on land sales.
    - Developing comprehensive medium-term budgets and stronger coordination with the NDRC on investment projects supports the Ministry of Finance’s focus on eliminating potential government liabilities from LGFV borrowing, currently included in staff’s “augmented” debt/deficit concepts—staff will continue to review the size, coverage and appropriateness of this concept as these efforts gain traction.
- Authorities’ views:
  - Broad agreement that direct taxes (including on personal income and property) should increase but that the process should be gradual and consistent with broader tax reform strategy.
  - Agreed more centralization of social insurance spending could be appropriate.
  - Differed with staff on whether recent measures (new budget law, steps to remove government guarantees, increased reliance on PPPs, existing local government borrowing quotas) were adequate to prevent off-budget fiscal spending.
  - Did not see a need for further increasing pollution tax rates or expanding the base (notably by adopting a carbon tax).
  - Favored tax sharing to finance local government spending rather than giving more revenue autonomy via property tax and personal income tax surcharge.

### Monetary policy framework: modernization needs and instruments
- Staff recommendations to modernize monetary policy:
  - Identify price stability formally as PBC’s primary objective; assign clear accountability (such as a medium-term inflation target set by the government) and necessary operational independence.
  - Strengthen interest rate-based framework centered on the 7-day interbank reverse repo rate by:
    1. Formally acknowledging the framework.
    2. Dropping monetary aggregate targets and the publication of benchmark lending rates.
    3. Gradually reducing distortionary high reserve requirements (offset as needed by open-market operations).
    4. Basing pricing and access to PBC’s lending facilities on clearly defined collateral rules and not supervisory criteria.
    5. Aligning lending instruments more closely to PBC’s monetary policy objectives.
  - Improve communications by clarifying objectives and instrument linkages, communicating transparently with financial institutions, and publishing policy communications simultaneously in English.
- Authorities’ views:
  - PBC articulated price stability was the primary, but not the only, objective; per the PBC Law, aim is to maintain the stability of the value of the currency and promote economic growth.
  - As a transition economy, price stability has highest weight but other objectives (employment, balance of payments, financial sector stability) must be considered.
  - Agreed progress had been made toward a market-based system but felt premature to drop monetary aggregate targets.
  - Did not consider current levels of reserve requirements as distortionary and feared lowering them would signal looser policy.
  - Felt premature to refer explicitly to the 7-day repo as the policy rate and saw continued need for benchmark rates to guide market pricing.

### Data frameworks: gaps and priorities
- Major data gaps remain, undermining policy making, credibility, IMF surveillance, and G20 commitments.
- Key gaps and needs:
  - Coverage: missing full breakdown of real GDP by expenditure (e.g. quarterly levels of consumption, investment, exports, and imports) and by supply (e.g. decomposition of “other services” and “industry”).
  - Integrity: steps taken (e.g. regulation on implementing the Statistics Law) but continued follow-through is critical.
  - Quasi-fiscal: closer monitoring of all types of public investment (e.g. LGFVs, PPPs, government-guided funds) is necessary to avoid sudden increases in public debt and to assess impact on aggregate demand.
  - Communication: more detailed communication alongside data releases would improve transparency and credibility.
- Authorities’ views:
  - Agreed with need to broaden publication of macroeconomic data but considered further technical work necessary and did not see imminent publication as realistic.
  - Argued increased monitoring of new debt incurred by LGFVs was not necessary given recent reforms had largely eliminated the risk that such debt could migrate to the government balance sheet.
  - Emphasized steps taken to improve data integrity, including more frequent provincial inspection visits and greater penalties for falsification.

### Staff appraisal: growth, risks, and policy priorities
- Progress and risks:
  - Reforms have advanced across a wide domain; supervisory and regulatory action taken to contain financial sector risks; corporate debt growth slowing; local government borrowing frameworks improving.
  - Near-term growth outlook has firmed but at the cost of higher medium-term risks.
  - Policy support, recovering external demand, and reform progress have helped keep growth strong; staff have increased medium-term baseline growth projections amid strong momentum and expectations authorities will achieve medium-term growth target.
  - Risks around this baseline have increased—main cost is further large increases in public and private debt; such increases have internationally been associated with sharp growth slowdowns and often financial crises.
  - Staff recommends replacing precise numerical growth targets with a commitment to reforms that deliver the fastest sustainable growth path.
- Policy recommendations:
  - Accelerate deep reforms to transition from credit-fed investment and debt toward a sustainable growth model while growth is strong and buffers sufficient.
  - Boost consumption via continued increases in public spending on health, pensions, education, and transfers to poor households; make the tax system more progressive and greener to reduce precautionary savings, boost growth, reduce income inequality and pollution.
  - Increase role of market forces by accelerating and broadening SOE reform, removing implicit state support (forcing default and exit where warranted), removing barriers to entry (especially in the closed service sector), and setting more ambitious overcapacity reduction targets with greater reliance on market forces and attention to underperforming debt.
  - Improve macro-policy mix: focus more on quality and sustainability of growth and less on quantitative targets; gradually tighten fiscal stance and reduce monetary accommodation.
  - Reduce nonfinancial sector debt by recognizing losses (especially of underperforming SOEs and zombie enterprises), cutting off-budget public investment, and imposing hard budget constraints on SOEs.
  - Continue focus on tackling financial sector risks even if it entails some financial tensions and slower growth; ongoing FSAP will provide comprehensive assessment.
  - Strengthen monetary policy framework: phase out monetary targets, resume progress towards a flexible exchange rate, improve communications; apply CFMs transparently and consistently; sequence further capital account liberalization with supporting reforms (effective monetary policy framework, sound financial system, exchange rate flexibility).
  - Centralize some expenditure responsibilities (e.g. social insurance) and give local governments more revenue-raising authority and sufficient debt quotas to reduce incentives for off-budget borrowing and land sales.
  - Address remaining data gaps to improve policy making and meet G20 commitments.
- Institutional recommendation:
  - It is proposed that the next Article IV consultation with China take place on the standard 12-month cycle.

*People’s Republic of China — IMF staff report excerpt*

### 1. External rebalancing

### 1. External rebalancing

### External rebalancing: key indicators
- Contribution of net exports to GDP growth %: -0.1 -0.5 -0.5
- Current account balance % of GDP: 2.7 1.7 2.4
- FX reserve coverage months of imports: 18.2 18.6 18.7
- National saving rate 1/ % of GDP: 47.5 45.9 46.3

### Internal rebalancing

#### Demand side
- Growth contribution of consumption vs investment %: 1.4 1.5 1.3
- Share of private consumption (Nominal) % of GDP: 38.0 39.2 39.1
- Share of investment (Nominal) % of GDP: 44.7 44.2 43.9

#### Supply side
- Real growth rate of Tertiary vs Secondary sector %: 1.3 1.3 1.3
- Share of Tertiary sector in GDP (Nominal) % of GDP: 50.2 51.6 51.9
- Share of Tertiary sector in total employment %: 42.4 43.5 44.1

#### Credit side
- Private credit % of GDP: 158 172 169
- Credit intensity: 3.7 4.0 4.1
- SOE share in credit stock %: 57.6 ......
- Difference in return on asset %: ......

### Environmental rebalancing
- Energy intensity of output per unit of output: 92 92 89
- Carbon emission intensity kg CO2 per output: .........
- PM 2.5 mcg per cubic metre: 55.0 53.1 ...

*Source: cr17247 - 1. External rebalancing*

### 4. Income distribution

### 4. Income distribution

### Key statistics (2016)
- Gini index: number0.46......
- Household disposable income: 2/% of GDP.........
- Urban/rural income gap (income ratio): 2.92.9...

### Notes and data flags
- Note: Green indicates substantial progress, yellow indicates some progress, and red means lack of progress. For more details on the color coding, see IMF working paper 16/183.
- 1/ IMF staff estimates.
- 2/ Based on flow of funds data, available up to 2014.

*Source: PEOPLE’S REPUBLIC OF CHINA — IMF staff estimates and figures (2016).*

### 2015. The decrease of the CA surplus was

### 2015. The decrease of the CA surplus was

### Current account (CA) — developments and assessment
- 2015: The decrease of the CA surplus was mainly due to shrinking trade balance (driven by high import volume growth), notwithstanding REER depreciation.
- Longer perspective: The CA surplus has fallen substantially relative to its peak of about 10 percent of GDP in 2007, reflecting strong investment growth, REER appreciation, weak demand in major advanced economies, and, more recently, a trend widening of the services deficit.
- EBA-estimated CA gap:
  - Narrowed to about 1.5 percent of GDP in 2016 from 2.4 percent in 2015, primarily due to the declining actual CA surplus.
  - The remaining total gap is mostly accounted for by the residual, reflecting factors other than policy gaps identified in the EBA model, including distortions that encourage excessive savings.
- Contribution of identified policy gaps: On net mutually offsetting, with:
  - Loose fiscal policy and excessive credit growth contributing to narrowing the CA gap.
  - Inadequate health spending and capital controls widening the CA gap.
- Uncertainties and caveats:
  - Large uncertainty about China’s cyclical position and possible underestimation of the CA (outbound tourism figures may be somewhat overstated).
  - Given ongoing rebalancing away from investment and high and sticky savings in the short term, the downward trend of the CA could be reversed.
- Staff overall assessment: The CA remains ½ to 2½ percent of GDP stronger than implied by medium-term fundamentals and desirable policies.

### Real exchange rate (REER) — background and assessment
- Background:
  - In 2016, the average REER depreciated by about 5.1 percent relative to 2015, driven by the depreciation in the NEER (6.5 percent), and reflecting in part the strengthening of the US dollar.
  - As of May 2017, the REER is 2.8 percent weaker relative to the average 2016 level.
- EBA REER index regression results:
  - Estimates China’s REER to be 2.7 percent weaker than levels warranted by fundamentals and desirable policies in 2016, compared to 3.9 percent stronger in 2015.
  - The EBA REER Level model estimates a total REER gap of 6.3 percent, with identified policy gaps of 3.4 percent. However, the model fit of the EBA REER Level model is very poor for China.
- Assessment:
  - The move to a marginally negative gap reflects the depreciation of the REER in 2016.
  - Assessment is subject to large uncertainties related to the outlook and shifts in portfolio allocation preferences.
  - Overall, staff assesses the REER to be broadly consistent with fundamentals and desirable policies, with the gap being in the range of -10 to +10 percent.

### Capital and financial accounts — flows and policy measures
- Background:
  - After a long period of net capital inflows, the financial account recorded a net outflow of US$647.4 billion in 2015 and US$639.7 billion in 2016.
  - Net direct investment inflows shrank, as FDI inflows slowed and Overseas Direct Investment surged in 2016.
  - Substantially negative errors and omissions (2.0 percent of GDP) are included as capital outflows as they are likely to be unrecorded capital rather than CA transactions.
  - Notwithstanding some new inflow liberalization measures in 2016, China’s capital account remains relatively closed in a de jure sense and the authorities have materially increased the enforcement of existing measures to help reduce outflow pressure.
  - Following measures taken in 2016Q4, outflows have moderated in recent months.
- Assessment and policy implications:
  - Over the medium term, the sequence of capital control loosening, consistent with exchange rate flexibility, should carefully take into account domestic financial stability.
  - Further opening of the capital account is likely to lead to sizable gross flows in both directions; the adjustment path is hard to predict.
  - Equilibrating balance sheet adjustments and shifts in market sentiment argues for prioritizing the move to an effective float (while using foreign reserves to a limited degree to smooth excessive volatility) and strengthening domestic financial stability, over substantial further liberalization of the capital account.
  - Efforts should be stepped up to encourage inward FDI, which would generate positive growth spillovers from the import of foreign technology and improving corporate governance standards.

### FX intervention and reserves level
- Background:
  - After a long period of reserve accumulation, FX reserves declined in 2015 and 2016 by US$513 billion and US$320 billion, respectively, of which intervention accounted for about US$342 billion and US$448 billion.
- Reserves adequacy metrics:
  - Reserves stood at 105 percent of the IMF’s composite metric unadjusted for capital controls at end-2016 (down from 118 in 2015).
  - Relative to the metric adjusted for capital controls, reserves stood at 171 percent (down from 190 in 2015).
  - The decline of the ratio is driven not only by lower reserves but also by higher broad money (M2) growth which is driving up the metric.
  - Given that the progress made in capital account liberalization over time was partly reversed by the recent capital account tightening measures, the capital account is considered partially open. Consequently, reserves would be considered adequate in the range indicated by the adjusted and unadjusted metrics.
- Assessment:
  - Overall, staff assesses the current level of reserves to be adequate.
  - Continuing the move toward a more market-based and transparent monetary policy framework is a key element in ensuring an orderly transition to an effective float, which may also require use of foreign exchange reserves to smooth excessive volatility.

### Debt Sustainability Analysis (DSA) — framework, scenarios, and risks
- Coverage and scenarios:
  - Because of uncertainty about the perimeter of general government, the DSA assesses government debt under narrow and broad definitions.
  - Two definitions of debt are used:
    - Narrow coverage: includes central government debt and “on-budget” local government debt identified by the authorities. For 2004–13, general government debt includes central government debt and local government bonds (issued by the central government). From 2014, general government debt includes central government debt and explicit local government debt (which consists of local government bonds and other recognized off-budget liabilities incurred by end-2014).
    - “Augmented” debt (broad coverage): adds other types of local government borrowing, including off-budget liabilities borrowed by Local Government Financing Vehicles (LGFVs) via bank loans, bonds, trust loans and other funding sources, estimated by staff; also covers debt of government-guided funds and special construction funds.
  - Note: The stock of approved PPP projects in end-2016 is 3.2 trillion or 4.3 percent of GDP. PPPs are not currently included in the “Augmented” estimate due to data gaps.
- Macroeconomic and fiscal assumptions:
  - The projection reflects a gradual slowdown of real GDP growth to 5¾ percent y/y by 2022 and GDP deflator of about 2¼ percent.
  - Fiscal assumptions differ by scenario:
    - Narrow coverage fiscal balance:
      - Assumes all spending is done within the confines of the budget and that the new budget law is strictly implemented and off-budget public investment is sharply reduced.
      - Primary fiscal deficits are assumed to decline from 5 percent of GDP in 2016 to 4 percent of GDP in 2022.
    - Broad coverage fiscal balance:
      - Off-budget local government spending is assumed to remain elevated and decline only marginally.
      - Augmented primary deficit is projected to decline from around 9½ percent of GDP in 2016 to around 7½ percent of GDP by 2022.
      - Interest bill increases from around 3 to 4¼ percent of GDP reflecting the rapid buildup of augmented debt.
  - Local government financing: DSA assumes future financing needs will be increasingly met by bond issuance, in line with authorities’ plan to replace all local government debt with bonds within three years.
  - Interest rate assumptions:
    - Interest rates for central government and local government bonds: about 3–4 percent.
    - Interest rates of off-budget borrowing (augmented scenario): about 6–7 percent.
  - Amortization: Staff assume all maturing debt will be rolled over, noting strong front loading of refinancing due to ongoing swap of legacy LGFV loans for LG bonds.
- Baseline and scenario outcomes:
  - Narrow coverage:
    - General government debt at 37 percent of GDP in end-2016 is increasing gradually.
    - Would only stabilize at 82 percent of GDP in the very long-run if the 2016 primary balance is maintained.
  - Broad coverage (augmented):
    - Augmented debt rises rapidly to about 92 percent of GDP in 2022 from around 62 percent of GDP in 2016.
    - Debt would only stabilize at a very high level (above 300 percent of GDP) if the 2016 primary balance is maintained.
- Risks and stress tests:
  - China faces relatively low risks to debt sustainability, but is vulnerable to contingent liability shocks.
  - In the narrow coverage scenario, general government debt remains relatively low and stabilizes in all standard stress tests except for the scenario with contingent liability shocks.
  - A contingent liability shock in 2018 will result in a sharp increase from about 37 percent of GDP in 2016 to about 67 percent of GDP in 2019.
    - Mechanically, the standard contingent liability shock in the IMF’s DSA toolkit assumes that 10 percent of non-government banking system assets would turn into government liabilities. Non-government banking system assets were about 220 percent of GDP in 2016. It also assumes that the real GDP growth in 2018 and 2019 would be 2–2.5 percent lower (a one standard deviation shock).
  - Without any extra fiscal consolidation, the debt-to-GDP ratio would stay around 70 percent of GDP over the medium term under the contingent liability shock.
- Policy implications:
  - China’s debt profile will largely depend on the implementation of the new budget law and, more fundamentally, on the willingness to reduce public investment.
  - If the new budget law is strictly implemented and future LGFV borrowing will be completely on a commercial basis, debt-to-GDP will rise only gradually and stabilize around 82 percent of GDP in the very long-run without a need for consolidation.
  - If local governments continue to incur off-budget liabilities, the debt profile will move closer to the broad coverage scenario and the debt-to-GDP ratio will continue to rise in the medium term and only stabilize at very high levels, underpinning the need for consolidation under that scenario.

*People’s Republic of China — Appendix I and Appendix II, External Sector Report and Debt Sustainability Analysis (excerpts).*

### Box 1. How much fiscal space does China have?

### Box 1. How much fiscal space does China have?

### Definitions and measured debt levels
- Depending on the definition of government, China’s debt in 2016 is between 37 percent and 62 percent of GDP.
  - The lower-end (37 percent) is narrowly-defined general government debt that includes only explicit debt recognized by the MOF.
  - The upper-end (62 percent) includes off-budget debt (“Augmented” debt).
- Nominal gross public debt (narrow coverage) shown in the staff DSA: 2016 = 36.6 (percent of GDP).
- Nominal gross public debt (broad/augmented coverage) shown in the staff DSA: 2016 = 56.6 (percent of GDP).

### Fiscal space — narrow vs. augmented coverage
- Under the narrow definition of government:
  - There is some fiscal space.
  - Despite a favorable growth–interest rate differential, China’s primary balance is still too large to stabilize debt at low levels.
  - If the 2016 general government (GG) deficit is maintained indefinitely, debt stabilizes at around 82 percent of GDP (Point A).
  - If the GG deficit were to widen by 0.9 percentage points of GDP from its 2016 level, debt would stabilize at the 75th percentile of advanced economies (around 100 percent of GDP) (Point B).
  - Point C: the projected primary balance in 2022 is still 4 percentage points of GDP away from stabilizing debt.
  - Staff note reasons China could tolerate higher debt than most EMs: very high savings rate, strong external position, capital controls, limited alternative domestic assets, strong state control and confidence.
  - 2016 primary deficit (narrow coverage) = 4.1 (percent of GDP).
- Under the “augmented” (broad) definition:
  - Fiscal space is more limited.
  - Augmented debt is projected to be larger than the EM 75th percentile in 2017.
  - The mild consolidation assumed in staff’s baseline projections of around 2 p.p. of GDP is insufficient to stabilize debt; consolidation would have to be maintained well beyond 2022.
  - If the 2016 augmented deficit is maintained indefinitely, debt stabilizes at 320 percent of GDP (Point D).
  - Under augmented coverage, there is limited room for permanent fiscal expansions and the window for temporary expansions is closing.
  - Staff emphasize demographic spending pressures as an additional constraint.
  - 2016 primary deficit (broad coverage, labelled “Primary deficit” in the broad table) = 7.5 (percent of GDP) in the baseline path for 2016? (Note: baseline primary deficits shown in augmented DSA table: Primary deficit 2015=6.4, 2016=7.5.)

### Debt dynamics and stabilization mechanics (chart explanation)
- The chart plots combinations of debt (x-axis) and primary deficit (y-axis).
- Blue and red bubbles: projections of general government and augmented debt and deficits respectively.
- Blue and red solid lines: debt-stabilizing primary deficit for each level of government.
- Key labeled points:
  - Point A: 2016 GG deficit maintained indefinitely → debt stabilizes at 82 percent of GDP.
  - Point B: GG deficit widened by 0.9 percent of GDP → debt stabilizes at the 75th percentile of advanced economies.
  - Point C: projected primary balance in 2022 is 4 percentage points of GDP away from stabilizing debt.
  - Point D: 2016 augmented deficit maintained indefinitely → debt stabilizes at 320 percent of GDP.

### Projections and scenario assumptions (selected staff assumptions from DSA)
- Baseline narrow-coverage underlying assumptions (selected):
  - Real GDP growth: 2017 = 6.7; 2018 = 6.4; 2019 = 6.4; 2020 = 6.3; 2021 = 6.0; 2022 = 5.8 (in percent).
  - Inflation (GDP deflator): 2017 = 2.2; 2018 = 2.1; 2019 = 2.0; 2020 = 2.1; 2021 = 2.1; 2022 = 2.0 (in percent).
  - Primary Balance (baseline, narrow coverage): 2017 = -4.8; 2018 = -4.4; 2019 = -4.3; 2020 = -4.3; 2021 = -4.2; 2022 = -4.1 (percent of GDP).
  - Effective interest rate (narrow coverage): 2017 = 3.5; 2018 = 3.3; 2019 = 3.1; 2020 = 3.1; 2021 = 3.1; 2022 = 3.1 (in percent).
- Baseline broad-coverage (augmented) assumptions (selected):
  - Primary Balance (baseline, broad coverage): 2017 = -9.6; 2018 = -9.3; 2019 = -9.2; 2020 = -8.8; 2021 = -8.2; 2022 = -7.5 (percent of GDP).
  - Effective interest rate (broad coverage): 2017 = 5.2; 2018 = 5.1; 2019 = 5.2; 2020 = 5.3; 2021 = 5.3; 2022 = 5.3 (in percent).

### Stress tests and risk assessment (narrow and broad DSAs)
- Stress tests conducted include:
  - Primary Balance Shock, Real GDP Growth Shock, Real Interest Rate Shock, Real Exchange Rate Shock, Combined Shock, Contingent Liability Shock.
- Narrow-coverage stress test outcomes (high-level):
  - Combined shocks and contingent liability shocks materially raise gross nominal public debt trajectories relative to baseline.
  - Example outcomes from chart annotations:
    - Under narrow coverage, debt-stabilizing paths show vulnerability if primary balances worsen or growth slows; baseline projections remain below some stress scenarios but with reduced margins.
- Broad-coverage stress test outcomes (high-level):
  - Under augmented coverage, stress scenarios produce much larger debt outcomes (e.g., debt measured in percent of GDP reaches materially higher levels under shocks).
  - Contingent liability shock in augmented DSA includes assumption that 10 percent of banking assets would turn into government liabilities (footnote).
- Risk-assessment heat map indicators and benchmarks (as used by staff):
  - Benchmarks referenced: bond spreads 200 and 600 basis points; external financing requirement 5 and 15 percent of GDP; annual change in share of short-term debt 0.5 and 1 percent; public debt held by non-residents 15 and 45 percent; share of foreign-currency denominated debt 20 and 60 percent.
  - Market perception indicators shown: EMBIG (bp) = 107; 5Y CDS (bp) = 89 (as of the data in tables).

### Policy implications and recommendations (as stated)
- Temporary fiscal support should be reserved for supporting the reform process or smoothing large shocks, and not geared towards achieving growth targets.
- Given limited fiscal headroom under augmented coverage and demographic spending pressures, staff imply:
  - Permanent fiscal expansions are constrained under augmented debt metrics.
  - The window for temporary fiscal expansions is closing if the augmented debt path and pressures persist.
- Staff assume a mild consolidation of around 2 p.p. of GDP in the baseline projections, but note this is insufficient to stabilize augmented debt without further consolidation beyond 2022.

*Source: IMF staff — Box 1, “How much fiscal space does China have?” (DSA charts and accompanying text, as of March 16, 2017).*

### Appendix III. Risk Assessment Matrix 1/

### Appendix III. Risk Assessment Matrix 1/

### Upside scenarios
- Medium / High likelihood
  1. Faster-than-anticipated implementation of reforms.
     - Faster implementation of reforms, especially on more opening up of the service industries to private and foreign sectors, corporate debt restructuring, SOE governance and eliminating implicit guarantees, can help address vulnerabilities, increase productivity, and rebalance the economy toward more sustainable growth.
- Medium / Medium likelihood
  2. Stronger-than-anticipated recent stimulus.
     - The recent stimulus measures may either have a larger and longer impact on the economy, for example, robust growth in real estate investment. It would increase near-term growth prospects (though likely reduce medium-term growth prospects and increase vulnerabilities).

### Downside scenarios
- High / High / High/Medium likelihood (aggregate across items)
  1. Retreat from cross-border integration.
     - A fraying consensus about the benefits of globalization could lead to protectionism and economic isolationism, leading to reduced global and regional policy collaboration with negative consequences for trade, capital and labor flows, sentiment, and growth. The retreat from cross-border integration is likely to be a drag on China’s export growth.
  2. Significant further strengthening of the US dollar and/or higher rates.
     - As investors reassess policy fundamentals, as term premia decompress, or if there is a more rapid Fed normalization, leveraged firms, lower-rated sovereigns and those with un-hedged dollar exposures could come under stress. It could result in capital outflow pressure in China, leading to sustained large reserve loss which eventually leads to a disorderly exchange rate depreciation.
  3. Structurally weak growth in key advanced and emerging economies.
     - Low productivity growth, a failure to fully address crisis legacies and undertake structural reforms, and persistently low inflation undermine medium-term growth in advanced economies. Resource misallocation and policy missteps, including insufficient reforms, exacerbate declining productivity growth in emerging markets. The weak growth in key advanced economies and emerging economies is likely to be a drag on China’s export growth.

### Financial sector and credit risk scenarios
- Medium likelihood
  1. Short-term risks:
     - Defaults in the wake of a sudden tightening in liquidity or a sharp fall in investor confidence could result in a funding shock in the wholesale market in which small banks and NBFIs borrow to expand their balance sheets or a run on the short-term asset management products issued by NBFIs (or a run on the WMPs which fund them). These could be amplified by renewed capital outflows and exchange rate pressure.
  2. Medium-term risks:
     - Slow progress on reform and continued reliance on policy stimulus and unsustainable credit growth, would add to vulnerabilities, worsen resource misallocation, and lead to permanently lower growth.

### Policy recommendations and contingency measures (as presented)
- Support multilateralism and ensure WTO trade rules enforced
- Guard against financial risks, enhance crisis preparedness, sustainable macro policies (especially credit). Use on-budget, pro-consumption fiscal stimulus if growth threatens to fall excessively.
- Move, flexibly, to effectively floating exchange rate regime, but intervene to mitigate disorderly market conditions.
- Enhance reforms to switch growth engines from investment/state to consumption/private sector.

### RAM definitions, likelihoods, and timing
- The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff).
- The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline:
  - “low” is meant to indicate a probability below 10 percent,
  - “medium” a probability between 10 and 30 percent,
  - “high” a probability between 30 and 50 percent.
- The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities.
- Non-mutually exclusive risks may interact and materialize jointly.
- “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

*Source: Appendix III. Risk Assessment Matrix 1/*

### 1.      The IMF China Resident Representatives held discussions with the World Bank team in

### IMF–World Bank discussions on China (June 2017)

### Meeting overview
- The IMF China Resident Representatives held discussions with the World Bank team in June 2017 to exchange views on key areas of reform to ensure sustainable medium-term growth in China, minimize risks, and improve the inclusiveness of growth.
- The teams discussed their agendas for 2017-2018. The last such meeting was held during June 2017 in Beijing.

### Agreed focus of reform
- Shift growth to a more balanced and sustainable path, along the line of the 13th Five-Year Plan and Third-plenum Reform Blueprint.
- Prevent further buildup of risks from rapid credit growth, complex intra-financial sector claims, and quasi-fiscal spending.
- Move the economy to a more inclusive, environment-friendly, and sustainable growth path by giving the market a more decisive role, eliminating distortions, and modernizing policy frameworks.

### Macro-critical reform areas (findings and key measures)
- Financial sector reforms
  - Further progress in financial sector reform is central to containing risks and boosting growth by facilitating better allocation of resources.
  - Widespread implicit guarantees distort pricing of risk, resulting in misallocation of credit and inefficient investment.
  - Intra-financial sector credits have become large and complex, posing risks to financial stability.
  - Key measures: hardening budget constraint; enhanced debt restructuring to facility the resolution of underperforming loans; stepped-up supervision and regulation of the financial system.
  - Continue cautious supervisory tightening on the shadow banking sector to phase out regulatory arbitrage opportunities.
  - Upgrade the regulatory structure to ensure adequate supervisory cooperation and coordination.

- Fiscal reforms
  - Off-budget spending by local government-owned entities has led to a significant buildup of debt.
  - The new budget law aims to bring these projects on-budget and strengthen control over public financial management; implementation is key.
  - Central government needs to provide consistent signals on budget reform implementation to moderate growth in public investment financed at the local level.
  - Priority medium-term improvements: strengthen budget processes, data transparency, local government finances, and medium-term budget planning.
  - Tax reforms should continue to modernize the current tax system and make it more progressive (e.g., relying more on direct taxes).
  - Align central and local government finances—matching local government revenues to spending responsibilities.

- Reform of the social security system
  - Strengthen pension and health insurance systems, improve adequacy and expand coverage to reduce precautionary household savings, while ensuring fiscal sustainability.
  - Improve benefit portability within and across provinces and economic sectors.
  - Possible measures: parametric changes (such as increasing retirement age, indexation, and so on) and structural reforms (such as introducing the NDC approach, deepening alignment of civil service and PSU pension schemes with the urban worker scheme, upgrading the pooling level).
  - Develop medium and long term financing strategy, including for financing legacy costs outside the pension system.
  - Strengthen budget processes and administration for social security funds.

- SOE reform
  - Advance debt restructuring given the central role of SOEs in corporate debt vulnerabilities and in overcapacity sectors.
  - Hardening budget constraints to properly price finance and other factor inputs; facilitate adequate dividend payments to the budget and phase out social functions of SOEs.
  - Open the service sector to full and fair competition for activities currently reserved to SOEs to generate productivity gains.

- Governance and regulatory reforms
  - Align coordination and incentives of governing and regulatory bodies to empower markets: entry/exit of firms, competition policy, resolution of insolvencies, intellectual property rights (IPR), and adjustments in public sector cadre evaluation systems.

- Green growth
  - Address air pollution, water quality and supply, soil contamination, desertification, degradation of grasslands, and dependence on coal and energy intensive options.
  - Underpricing of energy and inadequate consequences for pollution have worsened these effects and contributed to dependence on industry.
  - Raise factor costs to capture externalities (such as introducing a carbon tax) and invest in green development including renewable energy.
  - Mobilize private capital and utilize capital markets to support green investments.

- Infrastructure
  - Investment in infrastructure has been a key driver but rapid pace has in some cases left communities behind or produced excessive investment with low social or financial returns.
  - Fill gaps in social project investment to make growth more inclusive and improve social and financial efficiency of infrastructure investment.
  - Improve the process of approving new infrastructure projects to ensure investments focus on areas of highest social return.

### Division of labor (Bank, Fund, joint activities)
- Financial sector reforms
  - The Bank and the Fund are jointly conducting the 2017 FSAP; assess financial sector risks and provide recommendations on needed reforms.
  - The Fund will continue to provide technical assistance to the Chinese authorities as needed.

- Fiscal reforms
  - The Bank will continue to work with the Ministry of Finance (MOF) in implementing public finance reforms in the context of an ongoing fiscal technical assistance investment project.
  - The Fund will continue technical cooperation on the fiscal framework and budgetary preparation: strengthen medium-term macro and fiscal framework, enhance local government borrowing monitoring, and modernize accounting and treasury management.
  - The Fund will continue to discuss fiscal space in China and policy choices, and implications for global spillovers.

- Social security system
  - The Bank will work with authorities to improve equity, sustainability, and portability of the social security system, including helping provincial governments develop more integrated social security information systems.
  - The Bank will work with MOF on pooling and financing strategies and optimize fiscal risk management associated with social security liabilities.
  - The Fund will assess how different social insurance schemes fit into the medium-term fiscal and macroeconomic policy framework and review the balance between benefits and financing from different revenue sources.
  - Both institutions will encourage regular and robust actuarial modeling of social insurance liabilities.

- Green growth
  - The Bank focuses on climate change, renewable energy, pollution reduction and prevention, cutting-edge green technologies, energy conservation and efficiency, green transport and green building policies, and development of green finance including carbon markets.
  - The Fund will discuss fiscal policy options to capture externalities (such as excise calibration and introducing a carbon tax) and provide assistance on pricing and taxation of energy and discuss growth and fiscal implications.

- New drivers of growth
  - The Bank is cooperating with the Development Research Center (DRC) of the State Council on a flagship report identifying new sources of growth to sustain China’s development into high income status, focusing on removing distortions, accelerating diffusion, and fostering discovery and innovation (the three ‘D’s).

### Information requests and coordination
- The Fund team requests to be kept informed of progress in the above macroeconomic structural reform areas, as milestones are reached and at least on a semiannual basis.
- The Bank team requests to be kept informed of the Fund’s assessments of macroeconomic policies and prospects in the context of the Article IV consultation and staff visits, and at least semiannually.

### Planned work programs and expected deliveries (June 2017–June 2018)
- Bank work program (selected items)
  - Building a Modern Fiscal System Technical Assistance Project to support implementation of central government’s public finance reforms — Ongoing
  - China Economic Reform Implementation Project (umbrella TA project, including various subprojects with MOF, PBC, and provincial finance bureaus) — Ongoing
  - New Drivers of Growth Report — Ongoing
  - China Economic Update — Ongoing
  - “Just-in-time” Policy Notes for MOF — Delivered on demand
  - Subnational Intergovernmental Fiscal Relationship — Ongoing
  - Municipal Financing and Local Debt Management — Ongoing
  - Inclusive Finance — Ongoing
  - Financial Consumer Protection and Consumer Literacy — Ongoing
  - Deepening health reform in China-building high quality and value-based service delivery — Ongoing
  - Strengthening China’s social protection and labor systems — Ongoing
  - Analytical work and projects on pollution control and innovative green financing in several provinces — Ongoing
  - Projects and work on food safety — Ongoing

- Fund work program (selected items)
  - 2017 Article IV Consultation — May / June 2017
  - January Staff Visit — Jan 2018
  - Cooperation Program for Fiscal Reforms (FAD) — Ongoing
  - Cooperation Program for Financial Reforms (MCM) — Ongoing

- Joint work program
  - Financial Sector Assessment Program — Nov 2017

### Relations with the Asian Development Bank (AsDB) — summary findings and figures
- PRC membership and borrowing
  - The PRC became a member of AsDB in March 1986.
  - By the end of 2016, the PRC’s cumulative borrowing from AsDB reached $32 billion with 238 loans for public sector projects.

- Sectoral allocation of public sector loans (end-2016)
  - Transport and ICT: 52.6 percent
  - Energy: 15.1 percent
  - Water and other municipal infrastructure services: 12.8 percent
  - Agriculture and natural resources: 12.8 percent
  - Industry and trade: 2.4 percent
  - Finance: 1.8 percent
  - Multisector: 1.6 percent
  - Education: 0.9 percent
  - Health: 0.2 percent

- Private sector financing by AsDB (cumulative, end-2016)
  - Total: $3.3 billion
  - Direct loans: $2.8 billion
  - Equity investments: $404 million
  - Partial credit guarantee facility: $107 million

- Technical assistance by AsDB (end-2016)
  - Total: $483.6 million for 831 technical assistance projects
  - $152.9 million for preparing projects
  - $330.7 million for policy advice and capacity development

- Projected public sector lending (2016–2018) — total about $4.56 billion with sectoral shares
  - Agriculture, natural resources, and rural development: 30 percent
  - Education: 6 percent
  - Energy: 8 percent
  - Health: 5 percent
  - Transport: 29 percent
  - Water and other urban infrastructure and services: 22 percent
  - Over 90 percent of projects located in the western, central and north-eastern regions.

*Source: IMF China Resident Representatives and World Bank team discussions, June 2017 (cr17247).*

### 6.      AsDB’s technical assistance will complement the lending program to improve the

### 6.      AsDB’s technical assistance will complement the lending program to improve the sector policy environment, support governance and capacity development, and strengthen the knowledge base and innovative features of lending operations.

### Statistical issues — assessment of data adequacy for surveillance
- General: Data are "broadly adequate for surveillance, they are only barely so." China subscribed to the SDDS in October 2015, but important gaps remain, mainly in national accounts and government finance statistics.
- National Accounts:
  - NBS compiles and disseminates annual GDP by activity and by expenditure in current prices, by activity at constant prices (2010), and quarterly estimates of GDP by activity.
  - Transition underway from 1993 SNA to 2008 SNA; 2008 SNA applied to some industries (e.g., FISIM and capitalizing R&D).
  - "The techniques for deriving volume measures of GDP are not sound and need to be improved."
  - Annual GDP by expenditure is compiled at constant prices but is not published; expenditure components are not available quarterly.
  - Improvements made to exhaustiveness of GDP by activity; further improvements intended but "no target dates have been set."
  - Monthly industrial production, retail sales, and fixed investment indices are disseminated as year-on-year ratios; no chain-linked indices are produced.
  - Data revisions tend to be made without publishing the entire revised series.
  - Decentralized statistical system restricts ability to change data collection systems.
- Price Statistics:
  - CPI covers approximately 500 areas (around 200 counties and around 300 cities).
  - Current CPI is a chained Laspeyres price index compiled and disseminated since 2001.
  - Weights derived from urban and rural household surveys every five years; current weights are for 2008-2010; weights from the base period are price-updated every month.
  - PPI survey covers 40 percent of total industry turnover, including 60,000 enterprises in 31 provinces and over 430 cities; prices cover 1702 product groups (basic sub-categories); current base year is 2010.
  - PPI definitions are consistent with PPI manual (2010); PPI is not seasonally adjusted.
- Government Finance Statistics:
  - "Serious data shortcomings continue to hamper fiscal analysis."
  - Data on social security and extra budgetary funds are only provided annually and with a long lag.
  - Expenditure classification needs improvement; data by economic type are not published.
  - Authorities intend to begin collecting these data and to develop accrual-based measures over the medium term while strengthening cash-based GFS.
  - China committed under the G20 Data Gaps Initiative to develop quarterly general government data, but "no specific timeframe has been communicated."
- Monetary and Financial Statistics:
  - Improvements made recently, but surveys lack sufficient detail on bank claims on the government, hampering estimation of fiscal deficit from financing side.
  - Reported net foreign assets position of PBC does not include exchange rate valuation effects and interest earnings on foreign reserves.
  - PBC ceased reporting separate data on central government deposits in its balance sheet since April 2005, causing breaks in monetary base and monetary aggregates series.
  - March 2015 missions recommended accelerating PBC implementation of IMF SRFs; PBC technically capable of compiling SRFs for central bank and other depository corporations, but reporting not begun pending internal review and approval.
- Financial Sector Surveillance:
  - China reports FSIs to the Fund; in early 2015 authorities added two encouraged FSIs for deposit takers and increased periodicity from annual to semi-annual in May 2015.
- External Sector Statistics:
  - Historic BOP series start with 2005, IIP with 2004; compiled largely in accordance with BPM6 and disseminated in the IFS.
  - Recommendations include regular training for provincial SAFE staff due to reliance on the International Transactions Reporting System.
  - Improvements made: participation in CDIS in 2011 (only inward DIs currently recorded); initiated CPIS reporting end-2015; reporting to COFER since 2015; compiling and disseminating International Reserves and Foreign Currency Liquidity Template starting September 2015.
  - Need to strengthen external debt monitoring and compilation; since 2010 China submits total and public external debt data for QEDS.

### Data standards and quality
- China began subscription to the Special Data Dissemination Standard in October 2015.
- "No data ROSC has been conducted."

### Key data-frequency observations (as of June 26, 2017)
- Exchange rates: Latest observation 02/17; Date received 03/17; Frequency D; Frequency of Reporting M; Frequency of Publication D.
- International reserve assets and reserve liabilities of the monetary authorities: Latest observation 05/17; Date received 06/17; Frequency M; Frequency of Reporting M; Frequency of Publication M.
- Reserve/base money and Consolidated balance sheet of the banking system: Latest observation 05/17; Date received 06/17; Frequencies Q, M (reserve/base money) and M (reporting/publication) as indicated.
- Broad money and Central bank balance sheet: Latest observation 05/17; Date received 06/17; Frequency M; Frequency of Reporting M; Frequency of Publication M.
- Consumer price index: Latest observation 05/17; Date received 06/17; Frequency M; Frequency of Reporting M; Frequency of Publication M.
- External current account balance: Latest observation Q4/16; Date received 05/17; Frequency Q; Frequency of Reporting A, Q; Frequency of Publication A, Q.
- International investment position: Latest observation Q4/16; Date received 05/17; Frequency A, Q; Frequency of Reporting A, Q; Frequency of Publication A, Q.
- Notes from table: For real GDP, level data are available only on an annual basis (growth rates available on a quarterly, cumulative basis); goods trade data monthly; services trade with current account statistics; interest rates change only infrequently and are publicly announced.

### Capacity development and technical assistance (2011–17) — summary themes
- Wide-ranging IMF CD and TA across Tax System Reform, Tax Administration Reform, Public Financial Management, Statistics, Monetary Policy, Bank Supervision, AML/CFT, and Training.
- Examples of topics and missions include:
  - Tax gap analysis (September 2011), Reforming the Personal Income Tax (October 2015), The Future Design of Value-added Tax (September 2016).
  - Medium-Term Expenditure Frameworks seminars and missions (2011–2017) and multiple missions on treasury and accounting modernization.
  - STA missions and workshops on SDDS, Government Finance Statistics, Quarterly National Accounts, Monetary and Financial Statistics, TSF indicators, Balance of Payments Statistics, Debt Securities Statistics.
  - Training courses at CTP and ICD on BOP/IIP, Monetary and Financial Statistics, FSI, macroeconomic forecasting, DSGE modeling, financial sector surveillance.
- The Institute for Capacity Development (ICD) formed May 1, 2012 from merger of INS and OTM.

### Recent data updates and near-term outlook (IMF staff statement, July 28, 2017)
- Q2 GDP growth was 6.9 percent (y/y), as in Q1; consumption contributed most, investment contribution rose, net exports remained positive.
- High-frequency indicators for June:
  - Real retail sales growth: 10.0 percent (y/y).
  - Industrial value added growth: 7.6 percent (y/y).
  - Services and manufacturing PMIs both rose.
- Trade and reserves:
  - Trade surplus widened marginally in June compared to May; export growth (USD terms) accelerated to 9.1 percent (y/y).
  - FX reserves increased by US$3 billion, to US$3,057 billion.
- Credit and bank assets:
  - Total social financing growth: 12.9 percent (y/y) in June.
  - Adjusting for the local government bond swap, total social financing moderated to 14.5 percent (y/y) in June.
  - Bank asset growth moderated to 10.8 percent (y/y) in June.
- Prices:
  - Headline CPI inflation: 1.5 percent (y/y) in June.
  - Core CPI: 2.2 percent (y/y) in June.
  - PPI inflation: 5.5 percent (y/y) in June.
- IMF staff view: Recent releases "suggest some upside risk to full-year 2017 GDP growth."

*Statement by the IMF Staff Representative, July 28, 2017.*

### 3. The 5-yearly National Finance Work Conference was held July 14-15. At this

### 3. The 5-yearly National Finance Work Conference was held July 14-15. At this

### Conference decisions and institutional changes
- President Xi announced the establishment of a “Financial Stability and Development Committee” under the State Council.
- Responsibilities of the PBC for macro-prudential management and systemic risk prevention would be strengthened.
- The Committee will set up its coordination office in the central bank.
- The Conference highlighted:
  - prevention and mitigation of systemic financial risks,
  - enhancing financial safety net,
  - developing contingent plans of risk resolutions,
  - strengthened accountability of regulatory authorities,
  - professional, unified, and cross-cutting supervision to cover all financial activities,
  - stronger function regulation and more behavior regulation to identify and mitigate risks timely.

### Economic performance — first half of 2017
- Growth picked up since late 2016, reaching 6.9 percent for the first half of 2017.
- Inflation was 1.4 percent.
- 7.35 million new jobs added.
- Consumption contributed 63.4 percent of GDP growth in the first half of 2017.
- Service industry accounted for 54.1 percent of GDP and continued to outpace manufacturing.
- Capacity utilization in the industrial sector rose by 3.4 percentage points to 76.4 percent.
- Liability/asset ratio of the industrial sector declined by 0.7 percentage points to 56.1 percent (y-o-y).
- Housing inventory dropped by 9.6 percent (y-o-y).
- Industrial enterprises registered a 22.7 percent growth of profitability in the first five months of 2017, 16.3 percentage points higher than the same period of last year.
- Foreign trade registered a growth of 19.6 percent in the first half of 2017 (y-o-y), with imports growing 10 percentage points higher than exports.

### Growth outlook and risk assessment
- Authorities emphasize quality and sustainability of growth over a single GDP target; pursue innovation-driven, harmonized, green, open, and inclusive development.
- Stronger performance since 2017 attributed to rebalancing, structural adjustment, and a rebound in the business cycle amid a stronger global recovery—not merely policy stimulus.
- The staff’s scenario of an abrupt slowdown is characterized as “highly unlikely.”
- Authorities’ ongoing efforts expected to mitigate downside risks.
- Specific mitigation measures noted:
  - Reform of the regulatory system announced by the Financial Conference to address vulnerabilities in interbank funding and wealth management activities.
  - Strengthened central bank with adequate facilities and policy buffers to ease liquidity shocks.
  - More active embrace of free and open trade (including the “Belt and Road” initiative) to offset risks from inward-looking policies of some trading partners.
  - Greater exchange rate flexibility in line with market fundamentals, with a reference to a basket of currencies rather than a single currency, supported by prudent capital account management and CFMs, when necessary.

### Deleveraging
- Notable progress in corporate sector deleveraging; staff recommendations on mitigating financial risks and deleveraging align with authorities’ policy objectives.
- Growth of overall leverage in 2016 slowed by 7 percentage points compared with the same period of the previous year.
- Growth of leverage in the corporate sector slowed by 9.2 percentage points.
- Leverage in the corporate sector declined in Q3 of 2016 (the first time since 2011) and stabilized in Q4.
- 80 percent of China’s financing need is covered by banks—relatively high leverage viewed as structural.
- Leverage in the household sector and the public sector remains much lower than the global average.
- Further scrutiny warranted on the structure of leverage despite countercyclical nature of recent leverage increases.

### Monetary policy
- Monetary policy described as sound and tilted to a more neutral stance, balancing boosting growth, facilitating structural adjustment, and managing aggregate social finance.
- By end-June, M2 growth slowed by 2.4 percentage points to single digit, 9.4 percent.
- M1 growth plunged by 9.6 percentage points to 15 percent, compared with last June.
- China will deepen market-oriented exchange rate reform and rely more on market forces to determine the exchange rate.

### Government debt and “augmented” debt concept
- Adoption and implementation of the new budget law, nationwide clean-up of implicit local government debt through Local Government Financing Vehicles (LGFVs), and standardizing and capping local government financing have:
  - quantified the size of public debt,
  - strengthened local public debt management,
  - hardened budget constraints of local governments.
- The Financial Conference announced a “lifetime” accountability for decision makers of local government borrowing.
- Authorities disagree with staff’s “augmented” debt concept that defines government debt based on purpose of borrowing and presumed government backup rather than actual and legal repayment liabilities.
- Staff’s approach useful for vigilance, but ignoring country-specific institutional setup could exaggerate fiscal vulnerabilities and underestimate long-term growth.
- Points noted in defense of China’s debt profile:
  - Local government debts mostly finance infrastructure construction, transforming into tangible assets and returns—productive and self-sustainable compared with debt for current spending in many other countries.
  - Local governments promote infrastructure investments with cross-regional high economic returns and positive externalities in the medium and long term.
  - Using national savings to meet aging population challenges is a rational choice to boost domestic demand and achieve external rebalancing.
  - Taking account of China’s large public asset, net public debt is much smaller than nominal debt.
  - Partial interpretation of productive debt could bias or err in assessing the economy.

### Financial regulation and supervision (continued)
- Financial regulation will be tightened and enhanced holistically.
- Goals include better serving the real economy, preventing financial risks, and deepening financial reforms.
- The central bank’s role in macroprudential management to mitigate systemic risks has been significantly strengthened.
- Given high savings ratio, large foreign reserves, and adequate capital, required reserves and provisioning in the banking sector, supported by the recently established deposit insurance scheme, authorities express confidence that financial risks are manageable.

### SOE reform and role in the economy
- SOE reform is a high priority.
- Over 80 percent of central SOEs in China are listed holding companies and subject to commercial principles.
- Banks make lending decisions to SOEs based on independent and commercial judgment.
- Significant progress achieved in strengthening corporate governance of SOEs and enhancing their efficiencies.
- SOEs have been growing at the same pace as the economy and play a significant role in underpinning growth and development.
- SOEs under the central budget have registered double-digit growth of revenues and profits since 2003.
- Fifty SOEs are listed in the “Fortune 500” and three SOEs are among the top 5.
- The private sector provides over 80 percent of employment, 60 percent of GDP, 50 percent of tax revenue, and 89 percent of export.
- SOEs’ value should not be assessed only by financial returns; they assume social and policy responsibilities, contribute to tax revenue, and support social stability.
- Going forward, authorities will focus on:
  - containing excessive leverage of some SOEs,
  - preventing and reducing inappropriate monopoly,
  - deleveraging SOEs and eliminating Zombie firms as top priorities,
  - accelerating SOE reform to continuously enhance overall economic efficiency.

*Statement by Jin Zhongxia, Executive Director for China, Ping Sun, Alternate Executive Director for China, and Jing Chen, Senior Advisor to Executive Director — July 28, 2017*

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_Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17247.pdf_