## cr18240 ## Source details **Canonical URL:** [cr18240](https://www.imf.org/-/media/files/publications/cr/2018/cr18240.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr18240.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr18240.pdf.json) --- ### Context and strategic priorities - 2018 marks the 40th anniversary of China’s “reform and opening-up” policy; four decades transformed China into the second largest economy accounting for one-third of global growth. - Two key policy packages: (1) “Supply-Side Structural Reforms” (overcapacity, excess housing inventory, high leverage); and (2) the “Three Critical Battles” — addressing financial risks (goal of stabilizing the debt/GDP ratio in three years), eliminating absolute poverty, and tackling pollution. - Institutional restructuring: formation of Party “central committees” in key areas; Financial Stability and Development Committee (FSDC) established; banking and insurance regulators merged; expanded responsibility of environment protection ministry; new agencies for international aid and market regulation (including antitrust and intellectual property rights protection). ### Recent macroeconomic developments - GDP growth: in the range of 6.7-6.9 percent for eleven consecutive quarters; GDP growth reached 6.9 percent in 2017. - Inflation: headline CPI around 2 percent; PPI grew 6.3 percent in 2017 after prolonged deflation; CPI expected to pick up to around 2½ percent in 2018. - Labor and corporate profits: unemployment (survey-based) has fallen; corporate profits rose with nominal GDP growth. - Financial conditions: China to date not significantly affected by recent EM tightening. ### External sector and capital flows - Reserves and FX: foreign currency reserves US$3.1 trillion; IMF reserve adequacy metrics suggest reserves ranged between 100 percent and 260 percent at end-2017. - RMB: broadly stable against CFETS basket in 2017; appreciated by about 2 percent in real effective terms in H1 2018; staff estimates minor net positive intervention since last Article IV (subject to margin of error). - Current account: surplus continued to decline; current account surplus 1.4 percent of GDP in 2017 (cyclically adjusted); staff assesses external position for 2017 as moderately stronger than level consistent with fundamentals and desirable policies. - Capital flow management: CFMs generally eased and made more transparent since last consultation (RRR for offshore RMB deposits and FX derivatives lowered to zero; ODI restrictions eased); new macroprudential framework for capital flows introduced with a formula-based approach and a “macroprudential parameter” for ceilings on entities’ cross-border financing. ### Trade tensions and policy response - Authorities announced responses to U.S. tariffs while also announcing opening-up measures (lowering entry barriers in financial services and autos; reducing import tariffs for consumer goods and autos; shortened negative list; faster progress toward WTO Government Procurement Agreement). - Direct macro impact of tariffs announced to date appears limited but risks of amplification via financial and investment channels and further retaliation remain. ### Financial sector de-risking and regulatory tightening - Measures to tackle excessive expansion of riskier financial parts: limits on WMP growth and reliance on NCDs; stricter enforcement of “look-through” principle; adjustments to loan provisioning to encourage NPL recognition and disposal. - Result: reduced shadow banking size and bank–nonbank interconnections. - Banking sector: banking sector assets grew by 8 percent in 2017 (half the rate in 2016); total bank assets fell as a ratio to GDP for the first time since 2011. - Funding and market: funding costs rose somewhat; increased defaults in corporate bond markets though still relatively low; PBC maintained sufficient wholesale liquidity. - Migration of lending: some activity moved to money market funds and trust loans; these sectors expected to be affected as reforms phase in. ### Asset management sector and guidelines - Asset management business described as "large (120 percent of GDP) asset management business." - Rapid sector growth due to regulatory gaps and arbitrage through multi-layered intermediation producing maturity and liquidity mismatches. - New guidelines aim to harmonize regulation across all asset management products: product classification, investor suitability, conduct rules, risk management, disclosure, valuation and reporting. - Size of asset management industry more than doubled since 2014 (insurance AM plans excluded at 2.5 trillion RMB at end 2017). ### Credit efficiency: recent development and outlook - 2017 credit growth (TSF adjusted for local government bond swaps) slowed to 13 percent, down 3.1 percentage points from 2016. - Credit intensity: - Staff baseline: credit intensity improves from 3.1 (trillion of credit needed to generate 1 trillion of nominal GDP) in 2017 to 2.6 in 2023; this improvement would not be enough to stabilize the credit-to-GDP ratio. - Scenario A: credit efficiency would need to improve by at least 5 percent per annum to stabilize the credit-to-GDP ratio; requires SOE reforms and market-based credit allocation. - Scenario B: improving credit efficiency of the worst-performing industrial sector by 10 percent per annum could allow the debt ratio to stabilize around 2020 and fall thereafter without jeopardizing growth. - Scenarios on PPI: - Scenario 1: substituting an average post-Global Financial Crisis investment deflator of 1.6 percent lowers 2017 nominal GDP growth by 1.4 percentage points; credit efficiency still improves relative to 2016 but by less than baseline. - Scenario 2: real credit intensity (credit deflated by investment deflator) deteriorated more between 2011 and 2016 than nominal measures suggested; improved in 2017 but remains high vs post-GFC levels. - SOE metrics: share of loss-making SOEs declined from 28 percent to 24 percent since 2015; SOE liabilities-to-profits improved; SOE ROA improved. ### Rebalancing: progress, tensions, and regional divergence - 2017: rebalancing continued but slowed in several dimensions; growth became less dependent on credit; investment moderated; current account surplus declined; environmental clean-up improved air quality and energy efficiency. - Consumption: contribution of consumption to GDP declined for the first time since 2013. - Income inequality: one of the highest in the world, stopped falling. - Diverging provinces: defined as provinces with per capita GDP and per capita GDP growth both below or both above national averages; social spending relatively low (social spending percent of GDP referenced). - Policy tradeoffs and advice: - Support regions severely hit by restructuring with targeted social safety nets; Hukou reform and centralizing social welfare spending recommended. - Strengthen intra-government transfers rule-based and targeted for environmental and restructuring impacts. - Boost consumption, further opening-up, and more flexible exchange rate to offset exports effect from internal rebalancing. - Ensure appropriate on-budget funding for environmental investment needs. ### Policies: resolving tensions to deliver high-quality growth - Two policy imperatives: - Strengthen underlying drivers for sustainable growth. - Stay the course on reforms even amid growth slowdown. - Key recommendations: - Continue to rein in credit growth and accelerate rebalancing. - Increase role of market forces; foster openness; modernize policy frameworks. - Improve transparency and data on nonfinancial debt: produce official series on debt by borrower/creditor types, channels, and debt-servicing capacities. - Fiscal consolidation (staff “augmented” view): consolidate the augmented deficit on average by ½-1 percent of GDP a year to bring primary balance toward debt-stabilizing level by lowering off-budget investment and redirecting on-budget deficits to support rebalancing. - Under official legal-based definition: fiscal deficit ~3 percent of GDP in 2017 and debt 37 percent of GDP. - Under staff’s augmented definition: deficit ~11 percent of GDP in 2017 and debt 68 percent of GDP, projected to reach 92 percent by 2023. - Monetary policy: PBC 7-day repo rate increased only slightly since mid-2017 and remains barely positive in real terms; PBC should prepare to tighten gradually as inflationary pressures emerge; higher interest rates can reduce leverage but should not be sole tool for financial stability or exchange rate stabilization. - Macroprudential: consider tighter settings to rein in household debt (active use of debt service-to-income ratio caps, widening caps to include non-mortgage loans and fintech borrowing). - SOE reforms: harden budget constraints, phase out implicit subsidies, increase dividend payments, complete transfer of SOE social responsibilities to government, allow defaults where market warrants, force exits of zombie firms, centralize monitoring/data for local SOE reform. - Housing market: increase land supply for residential housing, promote rental markets, reduce local governments’ reliance on land sales, de-emphasize growth targets to let housing investment reflect fundamentals. - Environmental: impose substantial carbon or coal tax combined with the nationwide carbon emissions trading system launched in 2017 to include small-scale users. ### Financial regulation and FSAP-related implementation - Institutional changes: FSDC created; merged insurance and banking regulators; PBC given expanded regulatory formulation powers. - Regulatory measures: guideline on asset management business; new liquidity requirements; revised provisioning and NPL disposal measures; limits on WMPs; steps to reduce reliance on NCDs; strengthened management of entrusted loans. - Supervision & data: launch of integrated financial statistics system; enhanced off-site reporting; stress testing expanded to nonbanks and CIS; plans to identify domestic systemically important banks and impose additional capital requirements. - Shadow banking: guidance to ensure bankruptcy remoteness of CIS/WMPs; move towards eliminating sectoral lending limits conditional on eliminating implicit guarantees. - Fintech: fintech committee set up; centralized clearing house for third-party payments; ICOs banned; regulatory emphasis on “substance over form,” stronger KYC, treating systemic fintechs as SIFIs where appropriate. ### Capital flows and CFMs - Net capital outflows: US$640 billion a year in 2015–16; slowed to US$73 billion in 2017. - Measures taken since 2017: - RRR on banks’ offshore RMB deposits and RRR for FX derivatives set to zero (September 2017). - Limit on overseas RMB withdrawal by payment cards tightened to per person basis (100,000 yuan per year) in December 2017. - ODI approval for >US$1 billion abolished; QDLP/QDIE/QDII/RQDII quotas increased and resumed; QFII/RQFII lock-up and repatriation limits relaxed (June 2018). - Macroprudential assessment framework for cross-border financing introduced to influence volume and composition and mitigate currency/maturity/off-balance-sheet risks. - Staff assessment: recent easing of CFMs broadly consistent with Fund Institutional View; the new framework is more predictable and transparent; caution that the macroprudential parameter should not be used to actively manage capital flow cycles except in crisis/exceptional episodes. ### Debt dynamics and debt sustainability (DSA) - Two debt coverage concepts: - Budgetary coverage: central government debt and on-budget local government debt. - Augmented coverage: adds estimated off-budget local government borrowing (LGFVs, government-guided funds, special construction funds). - Projections: - Narrow (budgetary) scenario: government debt 37 percent of GDP end-2017; projected to rise to 43 percent of GDP in 2023. - Broad (augmented) scenario: augmented debt around 68 percent of GDP in 2017 rising to about 92 percent of GDP in 2023. - LGFV swap program: by end-2017 RMB 10.9 trillion LG borrowing exchanged (saved RMB 1.2 trillion in interest); another RMB 1.73 trillion needs swapping by August 2018. - Stress tests: - Budgetary contingent liability shock (10 percent of non-government banking assets): debt rises from ~37 percent of GDP in 2017 to above 60 percent in 2019. - Combined macro-fiscal shocks under augmented scenario: debt above 100 percent of GDP by 2023. - Policy implication: strict implementation of new budget law and moving off-budget investment onto budgeted local government bonds crucial to avoid elevated augmented debt trajectories; ensure future LGFV borrowing is commercial/market-based. ### Data gaps and statistical issues - Major gaps: lack of expenditure-side real GDP disaggregation; problematic deflation methods; fiscal data fall short of international standards. - Improvements underway: NBS to take over provincial economic data collection; full implementation of SNA 2008 progressing; China subscribed to SDDS in October 2015. - Specific shortcomings: - Expenditure components not available quarterly; annual GDP by expenditure compiled at constant prices but not published. - CPI weights not published; PPI base year 2010. - Government finance statistics: social security and extra budgetary funds data lagging and annual only; LGFVs operations excluded from general government coverage. - Monetary statistics: PBC ceased reporting separate central government deposit data since April 2005; SRF reporting not yet implemented. - Table of required surveillance indicators: exchange rates, reserves, broad money, central bank balance sheet, consolidated banking system, CPI, government finances, external accounts with specified latest observation dates preserved in source. ### Outlook and risks - Staff projections: - Growth projected to moderate to 6.6 percent in 2018 (staff baseline assumes authorities remain committed to 2020 GDP target but allow faster deceleration thereafter). - Headline inflation expected to rise gradually to around 2½ percent. - Current account surplus projected to narrow marginally to 0.9 percent of GDP in 2018. - Risks tilted to the downside: - Financial: uncoordinated regulatory action could trigger disorderly repricing of corporate/LGFV credit risks and rollover risks. - Trade: escalating tariffs and investment restrictions could disrupt supply chains and weaken confidence and investment. - Capital flows: renewed large outflows and exchange rate pressure if global financial conditions tighten sharply. - Illustrative “proactive” scenario: - Faster reform progress, particularly SOE reform and zombie firm resolution; near-term growth slows due to labor displacement but medium-term growth rebounds with faster TFP growth by about 1 percentage point; rebalancing accelerates; temporary fiscal stimulus targeted to cushion near-term impact could help. ### Authorities’ positions (summary) - Authorities attribute strong performance to fundamentals, supply-side structural reforms and recovering global trade; view leverage as brought under control; report PBC had not intervened in FX market for more than a year and RMB flexibility increased. - Authorities favor opening-up while disagreeing with staff on current account norms and some fiscal/monetary perimeter assessments. - On SOE reform: corporatization “basically completed,” central SOE zombie exits targeted by end-2018, central SOEs’ social functions to be phased out by 2020. - On CFMs and FX: CFMs are an additional macroprudential tool to be used under exceptional circumstances and promptly reversed; PBC agrees FX flexibility should increase. - On BRI: authorities see potential benefits and consider governance and project selection market decisions while acknowledging room for enhanced coordination. _Italic: IMF staff report excerpts (cr18240) as provided._ ### 1. Credit Efficiency: Recent Development and Outlook ___________________________________________ 11 ### 1. Credit Efficiency: Recent Development and Outlook ### Context: an historic juncture - "What we now face is the contradiction between unbalanced and inadequate development and the people’s ever-growing needs for a better life." (President Xi Jinping, 2017) - 2018 marks the 40th anniversary of China’s “reform and opening-up” policy; four decades of reform transformed China into the second largest economy that accounts for one-third of global growth. - Over 800 million people have been lifted out of poverty and the country has achieved upper-middle income status. - China’s per capita GDP continues to converge to that of the United States, albeit at a more moderate pace in the last few years; a few provinces have already achieved advanced-economy income levels while in most of the country per capita income is still a fraction of that in advanced economies. - The October Communist Party National Congress declared China’s entry into a “new era” and set a strategic vision for a “great modern socialist country” by mid-century. - Two key policy packages: (1) “Supply-Side Structural Reforms” (addressing overcapacity, excess housing inventory and high leverage); and (2) the “Three Critical Battles” — addressing financial risks (with a goal of stabilizing the debt/GDP ratio in three years), eliminating absolute poverty, and tackling pollution. - Authorities implemented major institutional restructuring, including forming Party “central committees” in key areas, restructuring the financial regulatory framework with the newly established Financial Stability and Development Committee (FSDC), merging the banking and insurance regulators, expanding the responsibility of the environment protection ministry, and setting up new government agencies for international aid and market regulation and supervision (including antitrust and intellectual property rights protection). ### Recent macroeconomic developments - GDP growth rate has been in the range of 6.7-6.9 percent for eleven consecutive quarters. - GDP growth reached 6.9 percent in 2017, the first annual acceleration since 2010, driven by a rebound in global trade; momentum continued into early 2018. - Headline consumer price index (CPI) inflation remained contained at around 2 percent. - A strong pickup in the producer price index (PPI) since 2016 led to higher nominal GDP growth and corporate profits. - The unemployment rate, as measured by the new survey-based indicator with expanded coverage, has fallen. - China to date has not been significantly affected by the recent tightening in Emerging Market (EM) financial conditions. ### External sector and capital flows - The RMB was broadly stable against the basket published by the China Foreign Exchange Trade System (CFETS) in 2017, with more fluctuation versus the dollar; it appreciated by about 2 percent in real effective terms in the first half of 2018. - The current account surplus continued to decline; the external position for 2017 is assessed as moderately stronger than the level consistent with medium-term fundamentals and desirable policies, with the exchange rate broadly in line (Appendix I). - At US$3.1 trillion, China’s foreign currency reserves are described as more than adequate to allow a continued gradual transition to a floating exchange rate. - The IMF’s reserve adequacy metrics suggest that the level of reserves at the end of 2017 ranged between 100 percent and 260 percent. - Based on staff estimates, there was minor net positive intervention (FX purchases) since the last Article IV; these estimates are subject to a margin of error which could include no intervention. - Capital flow management measures (CFMs) were generally eased and made more transparent since the last Article IV consultation: reserve requirement ratios for banks’ offshore RMB deposits and foreign exchange derivatives were lowered to zero; restrictions on overseas direct investment were eased. - A new “macroprudential framework for capital flows” was introduced, replacing a case-by-case and quota allocation system with a formula-based approach and a “macroprudential parameter” for ceilings on entities’ cross-border financing. ### Trade tensions and policy response - Amid trade tensions with the U.S., authorities said they would respond to U.S. tariffs with comprehensive measures while announcing new opening-up plans (lowering entry barriers on financial services and autos; reducing import tariffs for consumer goods and autos; loosening sectoral restrictions on foreign investment through a shortened negative list; seeking faster progress toward joining the WTO Government Procurement Agreement). - The direct macro impact of tariffs announced to date appears limited, but could be amplified through financial and investment channels and further rounds of retaliation, raising downside risks. ### Financial sector de-risking and regulatory tightening - Regulators adopted measures to tackle excessive expansion of riskier parts of the financial system (interbank borrowing, wealth management products (WMPs), and banks’ off-balance sheet activities), in line with the 2017 FSAP recommendations (Appendix IV). - Key measures included setting limits on the growth of WMPs and banks’ reliance on negotiable certificate of deposits (NCDs), stricter enforcement of the “look-through” principle, and adjustments to loan provisioning requirements to encourage NPL recognition and disposal. - These measures reduced the size of the shadow banking sector and interconnections between banks and nonbanks. - Banking sector assets grew by 8 percent in 2017, half of the rate in 2016. - Total bank assets fell as a ratio to GDP for the first time since 2011. - Funding costs rose somewhat reflecting more appropriate pricing of credit risks; risk differentiation led to an increased (but still relatively low) number of defaults in corporate bond markets. - The PBC maintained sufficient liquidity in the wholesale market to prevent any systemic liquidity risks. - Some lending activity migrated to sectors less affected by regulatory tightening (money market funds and trust loans), but these sectors are expected to be affected as reforms are phased in. ### Asset management sector and new guidelines - Authorities announced guidelines for the large asset management business, noted as "large (120 percent of GDP) asset management business." - The asset management sector had grown rapidly, with rapid expansion reflecting regulatory gaps and arbitrage through “channel” business and multiple layers of intermediation that produced maturity and liquidity mismatches. - New guidelines aim to harmonize regulations on all asset management products irrespective of issuer by setting principles on product classification, investor suitability, conduct of business rules by managers/distributors, risk management, disclosure, valuation and reporting. - The size of the asset management industry more than doubled since 2014 (graphical depiction; note: insurance AM plans excluded at 2.5 trillion RMB at end 2017). ### Progress on structural reforms and local government borrowing - Steel and coal capacity reduction continued and is on track to meet the 2020 targets. - Housing inventories in smaller cities declined considerably, partly due to social housing programs. - House price growth moderated following tightening measures since late 2016. - Production of heavily-polluting industries was restricted during the winter to meet air pollution targets. - Plans were published for the central government to take on some local government social spending responsibilities. - Government announced plans to strengthen protection of intellectual property rights for foreign and domestic companies. - Restrictions on non-compliant local government borrowing were further tightened: ban reinforced on local government off-budget borrowing through LGFVs, PPPs, and GGFs; officials are accountable for non-compliant borrowing over their lifetimes. - Authorities raised limits on local government general and special purpose bonds, the formal channel for local government borrowing. ### Debt dynamics and vulnerabilities - Nonfinancial sector debt growth slowed but continued to increase as a share of GDP. - Despite a sharp rebound in nominal GDP and industrial profits, total nonfinancial sector debt still rose significantly faster than nominal GDP growth in 2017. - The corporate debt to GDP ratio has stabilized, while government and especially household debt is rising, driven by continued strong off-budget investment spending and a rapid increase in mortgage and consumer loans. - Although total corporate debt as a share of GDP stabilized and the household sector retains a still-strong aggregate balance sheet, the average debt servicing capacity of listed companies did not improve and that of the household sector deteriorated further—highlighting the magnitude of the reform challenge and the likely need for determined actions over a long period to address underlying vulnerabilities. *cr18240 - 1. Credit Efficiency: Recent Development and Outlook* ### 14. Rebalancing continued in 2017, but slowed in several dimensions. Growth became less ### 14. Rebalancing continued in 2017, but slowed in several dimensions. Growth became less ### Mixed Rebalancing Progress in 2017 - Rebalancing continued: growth became less dependent on credit; investment growth moderated; the current account surplus continued to decline; environmental clean-up led to some improvement in air quality and energy efficiency. - Drivers that accelerated growth in 2017—external demand, domestic policy support and the PPI reflation—also slowed rebalancing. - Credit intensity improved in 2017, but this may be partly temporary due to the cyclical PPI rebound; the stock of credit remains high and rising. - The contribution of consumption to GDP declined for the first time since 2013; services’ share of GDP grew at a slower rate. - Income inequality, one of the highest in the world, stopped falling. ### Box 1. Credit Efficiency: Recent Development and Outlook - 2017 credit growth (TSF adjusted for local government bond swaps) slowed to 13 percent, down 3.1 percentage points from 2016. - Producer prices (PPI) grew 6.3 percent in 2017 after prolonged deflation; higher PPI raised the value of nominal investment and nominal GDP, contributing to improved nominal credit intensity. - Scenarios analyzed: - Scenario 1: Remove the one-off surge in PPI from the 2017 investment deflator, substituting an average post-Global Financial Crisis investment deflator of 1.6 percent; this lowers 2017 nominal GDP growth by 1.4 percentage points. Credit efficiency still improves relative to 2016, but to a smaller extent than under the baseline. - Scenario 2: Calculate real credit intensity (credit deflated by the investment deflator). Real credit intensity deteriorated more between 2011 and 2016 than suggested by the nominal measure. It improved in 2017 but remains high compared to post-Global Financial Crisis levels. - SOE performance and allocation: - Share of loss-making SOEs declined from 28 percent to 24 percent since 2015. - The ratio of SOE liabilities to profits improved, and SOE ROA improved. - Structural shift: - Growth rebalancing toward services and “new economy” sectors (IT, health and pharma) which are less credit intensive helped improve credit intensity in those sectors. - Medium-term outlook and scenarios: - Staff baseline: credit intensity improves from 3.1 (trillion of credit needed to generate 1 trillion of nominal GDP) in 2017 to 2.6 in 2023. This improvement would not be enough to stabilize the credit-to-GDP ratio. - Scenario A: Credit efficiency would need to improve by at least 5 percent per annum to stabilize the credit-to-GDP ratio; this would require SOE reforms and market-based credit allocation. - Scenario B: An improvement in credit efficiency of the worst-performing industrial sector by 10 percent per annum could allow the debt ratio to stabilize around 2020 and fall thereafter, without jeopardizing growth. ### Authorities’ Views (summary) - Authorities attributed strong performance to strengthening fundamentals, supply-side structural reforms and recovering global trade. - They noted leverage had been brought under control: growth of M2, bank loans and TSF slowed significantly. - Financial de-risking measures reduced the size and complexity of the shadow banking sector and led to more appropriate pricing of credit risks. - They reported the PBC had not intervened in the FX market for more than a year and that RMB exchange rate flexibility versus the US dollar had increased; RMB strengthened significantly against the US dollar and the basket. - Authorities disagreed with staff on the current account norm and on staff’s assessment of the fiscal perimeter and monetary stance in some respects, while agreeing on the need to de-emphasize growth targets and the importance of macro-financial measures. ### POLICIES: Resolving Policy Tensions to Deliver High-Quality Growth - Two policy imperatives to achieve higher-quality growth: - Strengthen underlying drivers for sustainable growth. - Stay the course on reforms even in the face of a growth slowdown. - Authorities should: continue to rein in credit growth; accelerate rebalancing efforts; increase the role of market forces; foster openness; and modernize policy frameworks. ### A. Continuing to Rein in Credit Growth - Rationale: - Despite 2017 improvement in credit efficiency, current levels imply that achieving growth objectives would still depend on further substantial and unsustainable increases in debt. - Need to de-emphasize quantitative annual growth targets and revise performance indicators for officials to reflect quality of growth (deleveraging, green development, reducing income inequality). - Recommended supply- and demand-side measures: - Continue strengthening financial regulations (e.g., unwind non-compliant asset management products by end-2020). - Impose harder budget constraints on SOEs, especially local SOEs and LGFVs. - Consider tighter macroprudential settings to rein in rapid increase in household debt (active use of debt service-to-income ratio caps, widen caps to include non-mortgage loans and fintech borrowing). - Transparency and data: - Improve transparency on nonfinancial debt by producing an official series on debt by types of borrowers and creditors, channels of credit, and debt-servicing capacities. - Maintain integrity of debt data to prevent form-over-substance compliance. - Fiscal policy to support deleveraging: - Under the official legal-based definition, fiscal deficit was around 3 percent of GDP in 2017 and debt 37 percent of GDP. - Under staff’s economic-based (“augmented”) definition (including estimated off-budget investment spending), the deficit was around 11 percent of GDP in 2017 and debt 68 percent of GDP, projected to reach 92 percent by 2023. - Staff recommendation: consolidate the augmented deficit on average by ½-1 percent of GDP a year to gradually bring the primary balance to the debt-stabilizing level, via lower off-budget investment while redirecting on-budget deficits to support rebalancing. - Resolve differences between official and staff estimates of general government deficit and debt; improve data on government balance sheet including government assets. - Monetary policy: - Monetary policy remains accommodative despite some recent tightening; the PBC’s 7-day repo rate has increased only slightly since mid-2017 and remains barely positive in real terms. - CPI inflation is expected to pick up to around 2½ percent in 2018. - PBC should prepare to tighten gradually as inflationary pressures emerge; pace of tightening dependent on data and other policy impacts on inflation. - Higher interest rates could help reduce leverage and limit pressure on the exchange rate, but interest rates should not be the primary tool for financial stability or exchange rate stabilization. ### B. Accelerating Rebalancing Efforts - Slower rebalancing in 2017 highlights need for more decisive structural reforms to improve quality of growth and prevent external imbalance as investment slows. - Recommended reforms: - Deepen fiscal structural reforms: make personal income tax (PIT) more progressive; increase spending on health, education and social transfers; reform intergovernmental relations to increase resources for local governments. - PIT reform specifics: widen the tax base, reduce the personal basic exemption, and remove imputed minimum earnings for social contributions to lower effective tax rates for the working poor. (Note: recent proposals by authorities raise the basic exemption and narrow the base by allowing mortgage interest deduction.) - Address urban-rural and spatial income inequality by removing barriers to labor mobility and strengthening equalizing fiscal transfers across regions. - Impose a substantial carbon or coal tax to tackle air pollution and climate change; combine the nationwide carbon emissions trading system launched in 2017 for large industrial users with a carbon or coal tax to increase environmental and revenue impact by including small-scale users. *Source: Haver Analytics and IMF staff estimates.* ### 28. Rebalancing efforts in general reinforce each other but there are also tensions across ### 28. Rebalancing efforts in general reinforce each other but there are also tensions across rebalancing dimensions that could usefully be addressed ### Rebalancing tensions and policy recommendations - Rebalancing dimensions reinforce each other but create tradeoffs that need a broader and more holistic approach to rebalancing and structural reforms. - Examples of tradeoffs and policy advice: - Tradeoff: Addressing regional disparity and income inequality requires more investment. - Policy advice: Support regions severely hit by restructuring with more spending on social safety nets; “Hukou” reform and centralizing social welfare and assistance spending. - Tradeoff: Environmental protection affects more severely ailing sectors and provinces. - Policy advice: Strengthen intra-government transfers to be more rule-based and targeted. - Tradeoff: Internal rebalancing -> Less investment-driven imports -> Greater net exports. - Policy advice: Boost consumption, further opening up, more flexible exchange rate. - Tradeoff: Environmental protection requires more investment initially. - Policy advice: Ensure appropriate on-budget funding for needed investment. - Specific fiscal and social measures recommended: - Increase targeted inter-government transfers to provinces most negatively affected by rebalancing policies such as overcapacity reduction and pollution control. - Increase spending on social safety nets. ### Diverging provinces and social spending - Definition: A province is considered “diverging” when its per capita GDP in 2016 and per capita GDP growth in 2017 are both below (“lagging”) or both above the national average (“advancing”). The rest are considered converging provinces, excluding Macao SAR, Hong Kong SAR, and Taiwan Province of China. - Observation: China’s social spending is relatively low (Social spending in percent of GDP). [Chart references present in source.] ### Digitalization: opportunities and risks - Findings: - Digitalization has the potential to become a long-run growth engine. - China became a global leader in frontier industries such as e-commerce and fintech due to the massive scale of the Chinese market and a supportive regulatory and supervisory environment in the early years of digitalization. - China’s fintech services include third-party payments by non-bank digital providers, internet-based banking and insurance, digital wealth management and credit-ratings. - Large, dominant fintech players have branched beyond their traditional niche to other areas of the finance supply chain, building an integrated ecosystem of financial services that link customers with businesses, but also posing regulatory/supervisory challenges. - China has more internet users than other major economies (In millions of persons). Relative ratios reported: 1.9x, 1.8x, 3.0x (chart context in source). - Risks and needed actions: - Balance allowing innovation to flourish with active roles in addressing risks such as privacy infringement and cyber-crimes. - Promote competition (including with foreign firms). - Strengthen protection of intellectual property rights and anti-money laundering. - Improve labor training to mitigate potential labor disruption. ### Authorities’ views on rebalancing and digitalization - Authorities noted progress on rebalancing: - Improvement in credit efficiency expected to be sustained given continued financial de-risking and supply-side structural reform. - Both the service sector and consumption contributed more than half of economic growth in 2017. - Household disposable income per capita accelerated, and the urban/rural income gap continued to narrow. - Authorities plan more proactive policies to support consumption, employment and income growth, including accelerating personal income tax reform and improving the social security system. - Recent reform initiatives on personal income tax (higher income thresholds for PIT and tax deductions of household mortgage interest) had been submitted to the National People’s Congress. - Plan to establish a comprehensive, equitable and unified pension system covering both urban and rural residents. - Authorities believed a carbon market was a good option and noted the national carbon emissions trading system launched in 2017. - On digitalization: - Authorities viewed digitalization as an opportunity to modernize China’s economic system; policies to focus on expanding and deepening convergence of e-commerce and other areas, promoting online and offline synergies, developing smart cities, and consolidating resources for electronic government services. ### Increasing the role of market forces: findings and recommended reforms - Concerns: - Continued and increasing state intervention threatens high-quality growth by crowding out private investment, reducing allocative efficiency, reinforcing perceptions of implicit guarantees, and increasing long-run policy uncertainty. - Findings: - SOEs structurally less efficient than the private sector (Return on assets, in percent) and SOE assets and share of investment have increased (charts in source). - Public fixed asset investment (In percent of total fixed asset investment) and SOE assets (In percent of GDP) rising (charts in source). - Despite measures to open healthcare and education to private investment and pilot land reforms, major distortions remain in services and in markets for land, labor and capital. - Structural reforms have often relied more on administrative than market-based mechanisms; examples: capacity reduction may have disproportionately affected private firms; campaign to reduce air pollution led to a surge in natural gas prices in winter 2017. - Shantytown renovation program improved living conditions but may have restrained market adjustments to absorb excessive housing inventories. - Recommended actions to boost market forces: - More decisive SOE reform: - Keep state shareholders at arm’s length from SOE management. - Increase dividend payments to the budget. - Complete the transfer of SOE social responsibilities to the government. - Recognize underlying bad assets and force more “zombie” firms to exit. - Control the “flow” of SOE debt by hardening budget constraints and phasing out preferential access to credit and implicit subsidies. - Allow defaults of over-exposed SOEs if market forces warrant. - Boost local SOE reform with centralized data and monitoring. - Accelerating market liberalization: - Balance public sector dominance in “strategically key industries” with further market liberalization, particularly in services. - Ensure competition policy applies equally to state- and privately-owned firms. - Improve labor market flexibility through further “hukou” reform and enhanced access to social services. - Advance land use rights reform to address urban-rural development gap and land demand-supply imbalance in housing. - More market-based overcapacity reduction: - Require loss-making firms to exit for lasting solutions; ensure private and smaller firms are not unduly penalized. - Increase transparency on data and policies (e.g., how overcapacity is defined, and targets set and allocated). - Use market-based approaches to develop new industries to prevent creation of new overcapacity. - Create a more sustainable housing market: - Increase land supply for residential housing, promote rental markets, reduce reliance of local governments on land sales. - De-emphasize growth targets to allow housing investment to be driven by long-run fundamentals. - Staff projection: residential investment, a key growth engine over the last decade, will decline as a share of GDP over the medium term. (Projection chart shows decline to pre-crisis levels; specific series and dates provided in source.) ### Authorities’ views on market reform - Authorities’ position: - Underscored commitment to allowing market forces to play a decisive role and saw more progress than staff. - On SOE reforms: - Corporatization of SOEs had been basically completed. - Profitability of SOEs had improved significantly and the number of zombie firm bankruptcies had increased. - All central SOE zombie firms would exit by the end of 2018. - Central SOEs’ social functions would be phased out by 2020. - Overcapacity reduction proceeding ahead of schedule. - Anti-Unfair Competition Law and Anti-Monopoly Law apply equally to SOEs and POEs, and to Chinese and foreign companies. - Anti-Unfair Competition Law revised to strengthen protection of intellectual property, especially trade secrets. - On industrial policy: - Plan to develop strategic sectors would be market-based; government does not set mandatory targets for domestic content. - Goal for self-sufficiency on key basic components and materials aimed to address potential supply chain disruptions due to some advanced economies’ embargos and export restrictions. - Emphasized equal treatment of domestic and foreign companies in updating the industrial sector and that industrial policies needed to be market-oriented. ### Fostering openness: trade and FDI findings and recommendations - Findings: - China has made progress in improving trade and foreign investment regime, with recent acceleration, but remains relatively less open than other G20 EM countries on service sector trade and investment. - Services: - Service Trade Restrictiveness Indexes (World Bank, OECD) suggest China’s restrictions on trade in services are relatively high. - OECD index indicates restrictions are higher for digital networks and transport and distribution supply chains; mainly driven by restrictions on foreign entry and, to a lesser extent, barriers to competition and regulatory transparency. - Services trade restrictiveness has improved but remains relatively high (Index; 1 = closed). (Chart in source comparing China, OECD average, EM average for 2014–2017.) - FDI: - China’s FDI restrictions are higher than in other G20 EM countries according to the OECD FDI Regulatory Restrictiveness Index. - Restrictions mainly affect the services sector. - China’s FDI as a share of GDP has fallen in recent years; China’s FDI is trending down and below EM average (In percent of GDP; chart in source). - FDI regulatory restrictiveness index has fallen in China (Index; 1 = closed); historical chart provided in source. - Recommendations: - Accelerating opening-up: - Increase productivity via greater competition and foreign technology by decisively addressing remaining distortions affecting trade and cross-border flows. - Implement and go beyond announced opening-up measures. - Ensure a level playing field for domestic and foreign companies by reducing entry barriers, greater protection of intellectual property, and equal access to resources and treatment in regulations, government procurement and administrative approvals. - Further reducing the external imbalance: - The RMB in 2017 was broadly in line with economic fundamentals and desirable policies, but the current account surplus was moderately stronger. - Structural distortions and policies that cause excessive savings, such as low social spending, contribute to the surplus; addressing these would benefit China and the global economy. - Mitigating trade tensions: - Seek resolutions that support and strengthen the international trading system and global economy. - Avoid exceptional measures and ensure trade actions are well-grounded in WTO rules to reduce risk of escalation and undermining dispute settlement mechanisms. ### Authorities’ views on openness and trade tensions - Authorities reiterated commitment to free trade and multilateralism despite trade tensions with the U.S. - Indicated it was in China’s own interests to further open the economy and increase imports. - Saw U.S. trade actions against China as a violation of the basic principles and spirit of the World Trade Organization (WTO). - Argued unilateral trade moves would impede efficient operation of global value chains and result in welfare losses for all countries and consumers involved. - Authorities’ contention on restrictiveness: - Disagreed that their trade and investment regime was relatively restrictive. - Noted that as a major contributor to global trade, China accounted for 24 percent of global goods imports growth and 20 percent of global services import growth over the last ten years. - Stated China’s overall tariff level had declined from 15.3 percent before joining the WTO to currently (statement truncated in source). *Source: IMF staff report excerpt (provided content).* ### 9.8 percent, far lower than that of many developing countries. ### cr18240 - 9.8 percent, far lower than that of many developing countries. ### Trade openness and investment - China’s trade facilitation improved with a “one-stop shop” for customs clearance and active implementation of the recent WTO Trade Facilitation Agreement. - Out of 160 sub-sectors of 12 broad sectors of the WTO General Agreement on Trade in Services, China has committed to opening 100 sub-sectors of 9 broad sectors, close to the advanced country average of 108 sub-sectors. - Recent measures included lowering many entry barriers for foreign investment (for example, in financial services), significant tariff reductions on autos and many consumer items, and pilot projects to develop services trade. - Protection of intellectual property rights of foreign firms had been strengthened recently, for example, with concerted strikes against violators in Q4 2017. - China’s commitment to further opening-up had recently been reaffirmed by President Xi in April. - Authorities did not support staff’s use of OECD trade and investment restrictiveness indicators, arguing: China is not an OECD member and could not assess the methodology/source; indicators did not reflect recent opening-up efforts; countries have different characteristics that simple indicators do not fully represent; and the indicators were only in an IMF Working Paper not formally discussed by the Executive Board. ### Modernizing policy frameworks — summary finding - Implementing the high-quality growth agenda requires modernizing policy frameworks. - Progress noted: abolishing quantitative monetary targets, merging local and central tax administrations, instituting a high-level financial oversight committee. - Much reliance remains on administrative measures; policies would benefit from more holistic, market-based and transparent frameworks. ### Financial regulation and macroprudential framework - The newly established FSDC should develop an ambitious agenda to strengthen regulatory and macroprudential policy frameworks, with key priority to foster and coordinate inter-agency efforts to assess the evolution of systemic risks. - Required actions: - Develop frameworks to identify and measure mechanisms of risk transmission within the financial sector and between the financial sector and the real economy. - Ensure continued rigorous supervision amid regulatory reorganization; PBC needs capacity to formulate regulations. - Coordinate implementation of new regulations over asset management products across regulators to avoid gaps. - Enhance banking system capital—identify domestic systemically important banks and impose additional capital requirements without further delay. - A roadmap aligned with FSAP recommendations is recommended to guide market expectations and an orderly repricing of risks, including a well-sequenced action plan to remove implicit guarantees and a transparent macroprudential framework defining design and activation of instruments by systemic risk type. ### Fintech and regulatory alignment with FSAP recommendations - Fintech developments and recent regulatory actions: - Set up a fintech committee to coordinate among regulators and industry. - Adopted a “substance over form” approach to close regulatory gaps. - Established a centralized clearing house for third-party payments. - Banned initial coin offerings. - Regulatory needs: - Stay nimble to head off emerging risks by strengthening data gathering/analysis and “know-your-customer” requirements for third-party payments. - Treat large fintech companies that pose systemic risks (e.g. to the payments system) as Systemically Important Financial Institutions (SIFIs). - Alignment table (reform measures and FSAP recommendations) includes items such as: Targeted reserve requirements; Fee limits in asset management guidelines; Operationalize FSDC; Map systemic risk; D-SIBs framework; Activate CCyB; Address weaknesses in the insurance sector; Well-sequenced plan to remove implicit guarantees; Enhance group supervision; Measures to downsize WMPs; Measures to strengthen bank capital and liquidity; Creation of FSDC; Improved inter-agency data sharing; Improved regulatory enforcement; Shift from institution to product-based regulation and supervision. ### Authorities’ views on financial regulation and fintech - Authorities agreed on the importance of staying the course on regulatory efforts and confidence in the new institutional framework for coordination. - Guidelines to regulate asset management businesses and rules on liquidity risk management of commercial banks had been announced; phase-in periods locked-in to give institutions time to adapt. Banks will need to increase capital and change funding modalities as they bring nonstandard credit assets back onto balance sheets. - On fintech, authorities focus more on regulation to prevent risk than on promotion of innovation at present, streamlining data collection and strengthening regulatory oversight, guided by level playing field, substance over form, support for financial inclusion, and avoiding jeopardizing financial stability. ### Monetary policy modernization - Recommended steps to build on recent progress (dropping quantitative M2 and TSF targets; further liberalization of bank deposit rates): - Give the PBC operational independence and accountability around a clear inflation objective and an explicit policy rate and corridor, and drop benchmark rates and window guidance. - Simplify liquidity management so policy actions focus on the seven-day interbank reverse repo rate and allow policy rates for different tenors of open market operations and liquidity facilities to adjust automatically. - Increase PBC information disclosure (hold regular press conferences, publish macroeconomic forecasts, make more information available in English). - Authorities’ view: price stability is primary but not the only objective; other objectives include growth, employment, balance of payments, and financial stability. Market-based system needs time; dropping benchmark rates should be gradual and orderly; transparency and communication will be improved. ### Exchange rate flexibility and capital flow management - Two-way exchange rate flexibility should continue to increase and be supported by deeper foreign exchange markets. - Recommendations: - Make central-parity mechanism for the daily trading band transparent and mechanical, with FX influenced by market intervention and public communication rather than administrative measures (e.g. countercyclical adjustment factor introduced in May 2017). - Do not use capital flow management measures (CFMs) to actively manage capital flow cycles or substitute for exchange rate flexibility; prioritize necessary supporting reforms (effective monetary policy, sound financial system, reduced fiscal dominance, exchange rate flexibility) before removing CFMs and further capital account liberalization. - Carefully sequence and target further capital account opening, especially for portfolio flows. - CFMs should be consistently and transparently enforced and clearly communicated. - Publish information on PBC’s foreign exchange intervention to improve market understanding and strengthen credibility. - Authorities’ view on FX: PBC agreed FX flexibility should increase and will continue to improve FX market functioning. On the daily central parity mechanism, authorities noted prior irrational depreciation pressures and that the countercyclical factor had been set back to zero. - Authorities’ view on CFMs: CFMs should not substitute for exchange rate adjustment; CFMs are an additional macroprudential tool to address pro-cyclical capital flows and only to be used under exceptional circumstances and promptly reversed after those circumstances disappear. ### Fiscal structural reforms - Announced measures to address misalignment of center-local fiscal responsibilities are welcome but the gap remains large. - Additional measures recommended: - Greater assignment of revenue raising to local governments (e.g. a recurrent property tax). - Further sharing/transfer of spending responsibilities to the central government (e.g. pensions/employment insurance). - Expand rules-based transfers from the central government to support the least-developed and vulnerable regions. - Strengthen fiscal discipline via careful sequencing: 1. Identify non-commercial off-budget local government investment (for example, financed by LGFVs and government guided funds). 2. Move such investment on budget with correspondingly larger local government bond allocations. 3. Carefully dismantle implicit guarantees on remaining projects. - Accompany these steps with greater coordination between agencies to ensure all government spending is on-budget. - Authorities noted the Party Congress plan to modernize the fiscal framework with three aspects: a clearer central-local fiscal relationship and responsibility that fosters balanced regional development; a more transparent budget system (including performance review); and strengthening the tax system. Central-local fiscal reforms are being carried through sequentially; a property tax is being considered. ### The Belt and Road Initiative (BRI) - Potential benefits: fill infrastructure gaps in partner countries, boost growth prospects, strengthen global supply chains and trade, increase employment. - To maximize benefits and manage risks, staff recommends: - A clearer overarching framework governing BRI investment. - Better coordination and oversight. - More focus on debt sustainability of partner countries. - A transparent mechanism for dealing with project disputes, non-performance and debt service problems. - More open procurement and greater transparency over contracts. - Support capacity development in BRI participating countries. - Authorities agreed on potential benefits and policies to maximize them while managing risks but thought staff overstated concerns; they view project selection and governance as market decisions and already strong, while acknowledging scope for enhanced coordination and risk assessment. ### Data gaps and statistical issues - Major macroeconomic data gaps remain: - Lack of expenditure-side real GDP disaggregation. - Problematic deflation methods. - Fiscal data that fall well short of international standards. - These gaps undermine policymaking, credibility, IMF surveillance, and G20 commitments. - Recent efforts encouraging: plan to have the National Bureau of Statistics take over production of provincial economic data; full implementation of the System of National Accounts (SNA) 2008 is progressing and rollout to local-level statistics is underway. - Authorities’ view: data improvements needed but production-side GDP remains the key gauge of aggregate activity because expenditure-side GDP deficiencies make publishing details impractical and potentially confusing. ### Outlook and risks (key projections and scenarios) - Growth projection: - Growth is projected to moderate to 6.6 percent in 2018. - Staff’s baseline assumes the authorities remain committed to their 2020 GDP target, but would allow faster growth deceleration thereafter. - Inflation and external: - Headline inflation is expected to rise gradually to around 2½ percent. - PPI inflation would moderate. - The current account surplus is projected to narrow marginally to 0.9 percent of GDP in 2018, driven by deteriorating terms of trade. - Risks and policy trade-offs: - Reforms such as financial de-risking and environmental control will likely weigh on GDP; productivity gains through structural reforms and digitalization will take time. - Authorities may need to maintain strong credit growth to meet growth targets, at the cost of further increases in nonfinancial sector debt. - Alternatively, decisively resolving policy tensions and focusing on higher-quality growth and a greater role for the market could yield weaker near-term growth but stronger, more sustainable longer-term growth. - Illustrative “proactive” scenario: - Features faster reform progress, particularly SOE reform and resolving zombie firms. - Under this scenario, growth slows in the near-term due to labor displacement but rebounds in the medium-term on the back of faster TFP growth by about 1 percentage point. - Rebalancing from investment to consumption accelerates. - A temporary fiscal stimulus package with resources to support rebalancing could help cushion the near-term adverse impact. *Source: IMF staff report (cr18240).* ### 61. Risks are tilted to the downside. On the positive side, growth could be stronger if previous ### 61. Risks are tilted to the downside. ### Major near-term risks - Financial: Uncoordinated financial and local government regulatory action could trigger disorderly repricing of corporate/LGFV credit risks, losses for investors, and rollover risks for financial institutions. - Trade and foreign investment: Escalating tariffs and investment restrictions could disrupt supply chains, have knock-on effects on global financial markets, and weaken confidence and investment in China and the rest of the world; could be coupled with a generalized rise of protectionism and an ensuing slowdown in global trade. - Capital flows: Large outflows and pressure on the exchange rate could resume due to tighter and more volatile global financial conditions, especially a surging dollar; weakened investor sentiment towards emerging markets could intensify and potentially spread to China. ### Authorities’ views (paragraph 62) - Outlook: Authorities broadly agreed on the outlook for growth. - Growth targets: Authorities were confident that the 2018 target of real GDP growth of around 6.5 percent was within reach, as was the target of doubling 2010 real GDP by 2020. - Inflation: CPI inflation would remain contained, despite upward pressure due to rising commodity prices. - Perceived risks: Authorities viewed downside risks in the near- to medium-term as mostly external—especially heightened trade tensions with the U.S., a global rise in protectionism, and market volatility due to faster-than-expected monetary policy normalization in the U.S. and sharp dollar appreciation. - Leverage: Authorities judged leverage had stabilized and should not pose major risks. ### Staff appraisal — performance and structural developments (paragraphs 63–65) - Recent outcomes: - Output growth picked up. - CPI inflation remained subdued. - Corporate profits improved. - Unemployment fell. - Financial sector de-risking accelerated with a wide range of decisive measures adopted; credit growth slowed; overcapacity reduction progressed; anti-pollution efforts intensified; and opening-up continued. - Rebalancing: - Rebalancing continued, but slowed in several dimensions: growth became less dependent on credit and the current account surplus continued to fall, but exports rather than consumption drove the growth pick up. - External position: Assessed as moderately stronger than the level consistent with medium-term fundamentals and desirable policies, due mainly to structural distortions, with the exchange rate broadly in line. - Credit expansion remains excessive. - Risk outlook: - Upside: Growth could be stronger if previous reforms gain greater traction in enhancing productivity and the private sector proves more dynamic than expected. - Downside: Key near-term risks include disorderly repricing of credit risks in the financial market, escalating trade tensions, and resumed pressure on capital outflows. - Medium/long-term divergence: Determined market-based reforms could lead to sustained, stable, and still-strong growth; continued state- and credit-driven policies will likely further build up risks, raising the likelihood of an eventual abrupt adjustment and dimming long-term growth prospects. ### Policy recommendations (paragraphs 66–74) - Macroeconomic stance and credit: - Stay the course on tightening macro-financial settings to rein in credit growth. - Follow through on stated intentions to de-emphasize growth targets and not loosen credit if growth falls below target. - Continue financial regulatory reforms, curb household borrowing, and rein in off-budget local government investment. - Rebalancing and fiscal policy: - Accelerate rebalancing efforts. - Increase health, education and social transfers, financed by taxes on income, property and carbon emissions, to support consumption and reduce income inequality and pollution. - Adopt a more comprehensive approach to structural reforms, including increasing transfers to regions most affected by overcapacity reduction or pollution control. - Market orientation and openness: - Allow market forces to play a more decisive role: reduce public sector dominance in many industries, open more markets to the private sector, and ensure fair competition. - Address distortions affecting cross-border trade and investment: expose sheltered sectors and firms to more domestic and foreign competition, ensure a level playing field, and better protect intellectual property rights. - Seek resolution to trade tensions that supports and strengthens the international trading system and the global economy; avoid exceptional measures and ensure trade actions are well-grounded in WTO rules. - Financial sector and macro frameworks: - Continue financial sector reforms and let the new institutional structure of financial supervisors take a more holistic, forceful and coordinated approach. - Make monetary policy more price- rather than quantity-based, and let the exchange rate continue to become more flexible. - Central government should share more of local governments’ spending responsibilities while increasing their ability to raise their own revenues. - Further strengthen macroeconomic data to improve policymaking and data credibility. - Capital account and CFMs (paragraph 72): - Continue to make the exchange rate more flexible and expedite reforms to support removal of CFMs and further capital account liberalization. - CFMs should not be used to actively manage the capital flow cycle or substitute for exchange rate flexibility; they should be phased out over time as supporting reforms increase the economy’s ability to handle greater capital flow volatility. - CFMs should be consistently and transparently enforced, clearly communicated, and publishing foreign exchange intervention would improve market understanding and strengthen credibility of the policy framework. - Belt and Road Initiative (paragraph 73): - The Initiative is welcome and potentially transformative; success will be enhanced by an overarching framework, better coordination and oversight, more open procurement and due attention to debt sustainability in partner countries. - Data: - Urgently address macroeconomic data gaps to further improve data credibility and policy making (paragraph 74). ### Procedural note - It is proposed that the next Article IV consultation with China take place on the standard 12-month cycle (paragraph 75). *International Monetary Fund — People’s Republic of China: selected excerpts (paragraphs 61–75).* ### 2.5 in 74 cities ### 2.5 in 74 cities ### Credit: Credit Gap Narrows but Remains Large - Credit-to-GDP ratio reached "over 210 percent of GDP" after years of rapid growth. - BIS series shown: Credit to the nonfinancial private sector ranged up to "230" (chart scale); nonfinancial credit to GDP reached high levels in 2017. - Credit gap measures: - BIS credit-to-GDP gap examples referenced through 2017Q4. - Total social financing (TSF) and flows: - TSF series: "Total social financing 3/17.5 14.3 12.4 12.9 12.0 10.5 11.5 10.9 10.1 9.5 9.2" (Table 1). - TSF in percent of GDP: "180 190 198 209 215 219 224 228 232 235 238" (Table 1). - Composition shifts: - Increasing share of credit allocated to households and services versus industrial sector (chart). - Household debt-to-GDP reported in Table 1: "33.0 35.4 38.2 44.2 49.2 51.0 52.8 54.9 56.8 59.0 61.3" (2013–2023 series). ### Monetary: Money Market Rates and Liquidity - Inflation: - CPI inflation series: "2.6 2.0 1.4 2.0 1.6 2.3 2.5 2.7 2.8 2.9 3.0" (Table 1, Consumer prices average). - Policy and market rates: - 7-day repo rate series shown; PBC 7-day reverse repo and wholesale market rates remained broadly stable after early-2017 increases. - Lending rates: annual lending rate charts show upward movement in market lending rates; weighted average lending rate series through 2018Q1. - Reserve requirement ratio (RRR) and facilities: - RRR reductions noted; chart annotated "2018M5 Jul.5th RRR cut". - Facilities: PSL, MLF, SLF indicated in charts and note: "PSL ... MLF ... SLF." ### Fiscal: Continued Loosening in 2017 - Augmented deficit and debt: - Augmented net lending/borrowing expanded in 2017 (chart and Table 1). - Augmented debt projections (Table 1): Augmented debt (percent of GDP) "48.1 52.3 56.6 62.0 67.5 72.4 77.1 81.3 85.0 88.5 91.6". - Government balance metrics (Table 1): - Net lending/borrowing 2013–2023: "-0.8 -0.9 -2.8 -3.7 -3.9 -4.1 -4.1 -4.1 -4.1 -4.1 -4.1". - Infrastructure and land: - Infrastructure investment contributed to the deficit expansion; financing gap for infrastructure investment charted. - Land sale revenues growth and local government on-budget spending vs revenues charts show continued reliance on land sales. - Primary market bond yields and LGFV costs: - Primary market bond yields increased, particularly for LGFV (chart). ### External: Outflow Pressure Abated - Exchange rates and reserves: - RMB exchange rates: CFETS basket index (Dec. 31, 2014 = 100) and onshore RMB/USD spot rate series through 2018M6 (chart). - Foreign exchange reserves series: changes shown; FX reserves picked up after declines (chart). - Capital flows and current account: - Capital outflows abated; capital account excluding errors and omissions turned positive in 2017 (chart). - Current account balance series (Table 2 and Table 1): "1.5 2.2 2.7 1.8 1.4 0.9 0.8 0.8 0.7 0.5 0.4" (2013–2023). - Trade balance (percent of GDP) series: "3.7 4.1 5.1 4.4 4.0 3.3 3.1 2.9 2.7 2.5 2.3" (2013–2023). - External debt and borrowing: - External debt (billion of US$) series Table 2: "1,533 1,788 1,383 1,416 1,711 1,826 1,947 2,074 2,212 2,361 2,521". - Loans and deposits series chart indicated pickup in external borrowing; non-bank sector loans borrowed from abroad increased (chart). ### Banking: Asset Growth Slowed; Reintermediation Evident - Bank asset growth decelerated, especially for city commercial and joint-stock banks (chart). - Contributions to bank asset growth: - Direct lending to the real economy remained strong while growth of other bank assets moderated (chart). - Balance sheet and ratios: - Loan-to-deposit ratio picked up (chart). - Core tier 1 capital ratio moderated; provision ratio improved (chart). - Intermediation and NBFIs: - Growth in bank claims on NBFIs moderated; interbank claims contracted (chart). - Bank liability composition shifts: bond issuance and liabilities to NBFIs contributed to liability growth (chart). ### Financial Conditions: Tighter and More Fragmented - Interest rates and bond markets: - Corporate and government bond yields rose in 2017–2018 (chart). Example yields charted: "Corporate bond (AAA, 3Y)", "Local government bond (AAA, 3Y)", "Central government bond (3Y)" (2018M5). - Corporate bond yield spreads over central government bonds widened (chart). - Nonbank credit and trust loans: - Growth rate of banks' claims on NBFIs slowed; outstanding size of trust loans (percent of GDP) charted and rising. - Trust loans continued to expand at a fast pace in 2017. - Equity market and offshore borrowing: - Stock market index and number of listed companies declined recently (chart). - RMB appreciation boosted external borrowing; loans borrowed from abroad by non-bank sector increased (chart). - Cross-country FDI restrictiveness: - FDI Regulatory Restrictiveness Index (2017) chart shows China "relatively more restrictive on FDI in most sectors" with scale 0–1. ### Key Macroeconomic Indicators and Projections (selected from Table 1 and Table 2) - Real GDP growth (2013–2023): "7.8 7.3 6.9 6.7 6.9 6.6 6.4 6.3 6.0 5.7 5.5" (Table 1, Real GDP base=2015). - Consumption and investment (2013–2023): - Consumption: "7.2 7.2 8.3 8.6 7.6 8.0 7.4 7.0 6.8 6.3 6.1". - Investment: "9.1 7.1 7.1 6.5 4.9 5.3 5.7 5.8 5.8 5.6 5.4". - Household debt (percent of GDP) series: "33.0 35.4 38.2 44.2 49.2 51.0 52.8 54.9 56.8 59.0 61.3". - BIS credit-to-GDP gap (latest observation Q3 2017 referenced): examples in Table 1 series "18.9 21.5 27.2 24.7 12.6". - Fiscal aggregates (percent of GDP): - Revenue (headline): "27.7 28.1 28.5 28.2 28.4 28.8 28.9 28.6 28.3 28.2 28.0". - Expenditure: "31.2 31.6 33.2 33.9 34.9 35.2 35.0 34.4 33.8 33.5 33.1". - Official net lending/borrowing: "-0.8 -0.9 -2.8 -3.7 -3.9 -4.1 -4.1 -4.1 -4.1 -4.1 -4.1". - International reserves and external indicators: - Gross official reserves (bn US$) series: "3,880 3,899 3,406 3,098 3,236 3,198 3,144 3,088 3,024 2,935 2,809". - Current account balance (percent of GDP) series: "1.5 2.2 2.7 1.8 1.4 0.9 0.8 0.8 0.7 0.5 0.4". _ Source: CEIC and IMF staff estimates._ ### 1. External rebalancing ### 1. External rebalancing ### Key indicators (selected) - Contribution of net exports to GDP growth: %0.4 -0.1 -0.6 0.6 - Current account balance: 2.2 2.7 1.8 1.4 - FX reserve coverage: 22.1 18.2 18.6 20.0 - National saving rate: 49.0 47.5 45.9 45.8 ### Current account: background, facts, and assessment - Background facts: - The CA surplus continued to decline, reaching 1.4 percent of GDP in 2017 (1.4 percent of GDP cyclically adjusted), about 0.4 percentage points lower than in 2016. - Decline mainly reflects a shrinking trade balance driven by high import volume growth, notwithstanding REER depreciation. - CA surplus peaked at about 10 percent of GDP in 2007 and has declined substantially since. - EBA and staff metrics: - EBA CA norm (2017): -0.3 percent of GDP - EBA CA gap: 1.7 percent of GDP - Staff-adjusted CA gap (staff CA Gap): 1.7 - Staff assesses the CA to be 0.2 to 3.2 percent of GDP stronger than implied by medium-term fundamentals and desirable policies. - Attribution: - The remaining total gap is mostly accounted for by the residual, reflecting factors other than identified policy gaps, including distortions that encourage excessive savings. - Identified policy gaps are, on net, largely mutually offsetting: loose fiscal policy and excessive credit growth narrow the CA gap; inadequate health spending, CFMs, and reserves widen the CA gap. ### Real exchange rate (REER): background and assessment - Facts: - In 2017, average REER depreciated by about 2.5 percent relative to 2016, driven by NEER depreciation (2.2 percent). - Estimates through May 2018 show REER appreciated by 3.4 percent relative to the 2017 average. - Assessment: - 2017 EBA REER index regression estimates China’s REER to be 5.3 percent lower than levels warranted by fundamentals and desirable policies (compared to 2.7 percent higher in 2016). - Staff assesses the REER to be broadly consistent with fundamentals and desirable policies, with the gap in the range of -13 to +7 percent. - Low elasticity of China’s CA to REER changes: 0.23. - Risks: - Distortions encouraging excessive savings and potential capital account liberalization and residents’ search for diversification may lead to resumption of capital outflow pressures and a weaker exchange rate over the medium term. ### Capital and financial accounts: flows, measures, and assessment - Facts: - Net capital outflows declined to US$82 billion in 2017, down from US$647 billion in 2015 and US$646 billion in 2016. - Net direct investment inflows turned positive in 2017: FDI inflows stable while Overseas Direct Investment declined over 50 percent due to tightened CFMs. - Net portfolio and other investments turned positive in 2017. - Errors and omissions remained negative and persistently high at -1.8 percent of GDP, suggesting unrecorded capital flows may have evaded CFMs. - China’s capital account remains relatively closed de jure; authorities materially increased enforcement of existing measures to reduce outflow pressure. - Policy measures and sequencing: - Authorities have loosened some CFMs (reserve requirement on bank’s offshore RMB deposits and on bank’s FX derivatives positions set to zero) and tightened others (limit on overseas RMB withdrawal by payment cards changed to apply on an individual basis). - A framework to regulate cross-border financing by financial and non-financial corporations has been put in place to alter volume and composition of capital flows. - Assessment and recommendation: - Over the medium term, the sequence of capital control loosening consistent with exchange rate flexibility should carefully consider domestic financial stability. - Further opening of the capital account likely to create substantially larger two-way gross flows; balance sheet adjustments and shifts in market sentiment call for prioritizing the shift to an effective float while using FX intervention to smooth excessive FX volatility. - Strengthen domestic financial stability prior to substantial further liberalization; step up efforts to encourage inward FDI to generate positive growth spillovers and improve corporate governance. ### FX intervention and reserves: facts and assessment - Facts: - FX reserves rose by US$129 billion in 2017 after declines of US$513 billion (2015) and US$320 billion (2016). - Reserve assets reached US$3.2 trillion by end-2017 (about 27 percent of 2017 GDP), about US$138 billion higher than in 2016. - Metrics: - Reserves stood at 97 percent of the IMF’s composite metric unadjusted for capital controls at end-2017 (down from 106 in 2016). - Reserves stood at 157 percent relative to the metric adjusted for capital controls (down from 172 in 2016). - Assessment: - The change in reserves in 2017 mainly reflected valuation changes, return on reserves, and minor net FX purchases accompanying the unwinding of forward positions built in 2016; estimates are subject to a margin of error which could include no intervention. - Given partial reversal of prior capital account liberalization, the capital account is considered partially open; consequently, reserves are considered adequate in the range indicated by the adjusted and unadjusted metrics. - As the transition to greater flexibility advances, intervention should be limited to smoothing excessive volatility. ### Overall assessment of the external position (2017) - The external position in 2017 was moderately stronger compared with the level consistent with medium-term fundamentals and desirable policies. - This reflects remaining distortions and policy gaps that affect the saving-investment balance, such as inadequate social spending. - The renminbi in 2017 was broadly in line with fundamentals and desirable policies. - The CA is less sensitive to REER fluctuations because of distortions encouraging excessive savings. - Important for China to address those distortions and the resulting current account gap decisively—doing so would benefit both China and the global economy. ### Potential policy responses and priorities - Continued progress in closing domestic policy gaps and addressing distortions to achieve lasting external balance. - Implement authorities’ reform agenda and maintain consistent macroeconomic policies to shift to more sustainable growth with higher consumption and lower overall saving. - Priorities: - Improve the social safety net. - SOE reform and opening markets to more competition. - Create a more market-based and robust financial system. - Attract more inward FDI by ensuring foreign investors receive the same treatment as domestic investors. - Achieve a flexible, market-based exchange rate with better communication strategy. - Move toward a more market-based and transparent monetary policy framework to ensure an orderly transition to an effective float; use foreign exchange reserves to smooth excessive volatility when necessary. - Seek negotiated settlements to trade disputes to support and strengthen the international trading system and the global economy. *Sources: CEIC and IMF staff estimates and projections; Appendix I. External Sector Report (selected extracts).* ### 15.7 to 6.9 percent, starting from July 1, 2018. ### 15.7 to 6.9 percent, starting from July 1, 2018. ### Corporate deleveraging - Central SOEs face more strict restrictions on leverage, and are required to reduce average asset liability ratio by 2 percentage points by 2020. - Plans to set up a special fund of 100 billion yuan ($15.19 billion) by 2018H1 to accelerate mixed ownership reform, and encourage M&A. (Aug 2017, Jan 2018) - The State Council announced a plan to set up a scheme to share zombie companies’ bankruptcy loss among shareholders, banks and the government to speed up zombie exits. (Nov 2017) - The State-owned Assets Supervision and Administration Commission (SASAC) tightened the debt ceiling for central SOEs by 5 percentage points to 60-70 percent. (Nov 2017) - MOF published a notice to regulate state-owned financial institutions’ investment and fund-providing for local governments. (Feb 2018) - MOF published a notice on further strengthening regulation and management of PPP projects. (Mar 2018) - MOF published a notice on further strengthening regulation of local government bond issuance. (Apr 2018) ### Reducing overcapacity and tackling pollution - The government announced coal and steel capacity reduction targets for 2018. (Mar 2018) - Production of heavily polluting industries was curbed during the winter to meet air quality targets. (2017-18) - The government started collecting an environmental tax to better protect the environment and cut pollutant discharge. (Jan 2018) ### Making fiscal policies more sustainable and progressive; Tackling local government debt - The National Development and Reform Commission (NDRC) and the Ministry of Finance (MOF) announced a ban on local governments guarantees for enterprise bonds. (Feb 2018) - MOF published a notice to regulate state-owned financial institutions’ investment and fund-providing for local governments. (Feb 2018) - MOF published a notice on further strengthening regulation and management of PPP projects. (Mar 2018) - MOF published a notice on further strengthening regulation of local government bond issuance. (Apr 2018) ### Addressing central-local fiscal imbalance - The government announced inter-government sharing plans to allow the central government to take some responsibility of local governments’ social spending from 2019 and onwards. (Feb 2018) - Some integration of the national and the local tax systems was announced. (Mar 2018) ### Enhancing social protection - The State Council published guidelines on supporting private sector to provide multi-tiered and diversified healthcare services. (May 2018) - The government will establish a central pension fund adjustment mechanism to balance the payment burden of local governments, to be implemented beginning from July 1. (Jun 2018) ### Tax policy - The government proposed to the National People’s Congress to raise the personal income tax threshold and allow for special expense deductions, including spending on major diseases, child education, mortgage interest payment etc. (Jun 2018) - The government unified the multiple VAT rates and VAT rates on the manufacturing, transportation, construction, telecommunication and agricultural sectors were lowered from May 1, 2018. (May 2018) ### Enhancing transparency and communication - NBS published a new quarterly series on survey-based unemployment rate. (2017-18) - It was announced that the National Bureau of Statistics will take over data collection at the regional level from 2019. (Oct 2017) *Source: IMF staff compilation from the provided document.* ### Appendix IV. Implementation of Main Recommendations from ### Appendix IV. Implementation of Main Recommendations from the 2017 FSAP ### Overview - Authorities launched comprehensive regulatory and institutional reforms closely aligned with the 2017 Financial Sector Assessment Program (FSAP) recommendations aimed to: improve interagency coordination, close regulatory and supervisory gaps, and contain systemic risks. - Reforms grouped into two categories: - Institutional reorganization: merged insurance and banking regulators, transferred some regulatory formulation powers to the People’s Bank of China (PBC), and created the Financial Stability and Development Committee (FSDC). - Regulatory measures phased in for financial intermediaries and activities: guideline on asset management business, new bank liquidity requirements, new framework for evaluation of insurance companies, limits on WMPs, steps to reduce reliance on negotiable certificates of deposit, changes in loan loss provisioning, measures to facilitate disposal of NPLs, and strengthened management of entrusted loans. ### Macroeconomic recommendations - De-emphasize high GDP growth projections in national plans: - The GDP growth target for China is an indicative target; the Chinese government set the indicative target for GDP growth in 2018 at around 6.5%, which is lower than the actual growth rate of last year. ### Systemic Risk, Macroprudential Policy, and Strengthening Oversight - Create a Financial Stability and Development Committee (FSDC): - Purpose: strengthen coordination of financial oversight, prevent financial risks, promote healthy development, maintain stability. The General Office has started holding regular meetings. - Information sharing and cooperation: - PBC and China Banking and Insurance Regulatory Commission (CBIRC) established an information sharing mechanism; PBC informs CBIRC timely of on-site inspection issues. - China Securities Regulatory Commission (CSRC) shares securities fund industry data regularly. - CBIRC promoting cross-border information exchange and cooperation on G-SIFIs; joint meeting of core regulators of four G-SIBs held in 2017; MoU with Guernsey Financial Services Commission and framework agreement with Hong Kong Insurance Authority in 2017; four joint working meetings held on equal effectiveness of solvency regulation. - Countercyclical capital buffer and capital requirements: - Macroprudential capital adequacy ratio in the macroprudential assessment (MPA) is a core indicator influenced by growth rate of broad credit, target GDP and CPI increase; authorities preparing countercyclical regulatory capital standards and continuously monitor capital adequacy ratio. - Amend primary laws and increase resources for PBC and regulators: - PBC pushing adoption and amendment of major financial laws including the People's Bank of China Law. - Fifth National Financial Work Conference proposed optimizing regulatory resource allocation and strengthening field-level regulatory capacity. - CBIRC broadened recruitment and increased 2017 budget by 299 million yuan from 2016, representing a year-on-year increase of 5.7%. - Address data gaps for systemic risk monitoring: - March 2018: General Office of the State Council issued Opinions on Comprehensively Promoting Integrated Statistics on the Financial Industry; PBC to lead establishment of integrated statistics system based on "uniform standards, simultaneous data collection, centralized check and verification and aggregating and sharing". - CBIRC to improve off-site regulatory reporting framework and monitoring of off-balance sheet operations. - CSRC strengthened information sharing with PBC, CBIRC, SAFE, SAMS to deepen monitoring of investor trading behavior and capital flow. - Review PBC’s MPA purpose and structure: - Consensus to make PBC lead agency for macroprudential policies; MPA is an important experiment for macroprudential policy and systemic risk prevention. ### Regulation and Supervision: Banks - Enhance group risk supervision, ownership structure oversight, and UBO identification: - PBC drafted Trial Regulatory Measures for Financial Holding Companies to apply comprehensive, continuous, look-through supervision; strengthen shareholder qualifications and equity structure checks. - April 2018 Guidance on Strengthening the Supervision and Regulation of Investment in Financial Institutions by Non-financial Enterprises issued. - January 2018 Interim Regulatory Measures Regarding Equity in Commercial Banks issued; established look-through regulatory system for major shareholders and ultimate beneficiaries. - Loan classification and NPL recognition: - CBIRC intends to require banks to classify loan risks mainly based on debtor solvency; loans rolled over or granted concessions to distressed companies to be treated as restructured; loans overdue by more than 90 days (not considering collateral) will be classified as nonperforming. - Strengthen enforcement of look-through principle: - April 2018 Guidance on Regulating the Asset Management Business of Financial Institutions adopts look-through approach for multi-layered products. - CBIRC requires banks to measure risk-weighted assets using look-through when determining regulatory capital charge; principle applied in onsite inspections and special inspections on shadow banking and cross financial products. - Increase Liquidity Coverage Ratio (LCR) coverage for interbank products and off-balance sheet WMPs: - Rules applied to interbank products in China’s LCR are consistent with Basel standards. - December 2017: public consultation on Regulatory Measures for Liquidity Risks of Commercial Banks (Revised Draft); CBIRC intends to increase the loss rate of off-balance sheet wealth management products from 2.5% to 5%; change to be reflected in forthcoming Measures. - Enhance regulatory reporting to collect granular supervisory data on investment holdings and provisioning: - CBIRC revised off-site regulatory statements; improved classification and grouping of underlying assets; asset quality and reserve requirement statement requires five-level classification for investment operations and reflect reserve provisioning. - Enhance forward-looking integrated risk analysis: - CBIRC upgrading Risk Early Warning Analysis Supporting System (REASS); collecting comprehensive data via off-site supervision system, on-site inspection system, REASS and customer risk early warning system. - Regular stress testing and ICAAP; quarterly and monthly analysis reports; development of four major offsite regulatory tools: risk assessment reports, regulatory rating, enhanced regulatory standards and regulatory issue rectification/tracking/evaluation system. ### Stress Testing - Enhance data sharing and granular data use: - 2018: PBC continuing stress tests on banks (solvency macro scenarios, sensitivity, liquidity risks and contagion) using internal and regulatory data. - CBIRC plans to use detailed data on underlying assets and industries in banking stress tests. - C-ROSS Phase II Plan (September 2017) to improve regulatory rules and implementation guidelines for insurance stress tests. - CSRC refined uniform hypothetical scenario indicators for securities industry stress testing (bond default rate assumptions, interest rate assumptions); organized system-wide trials and issued Measures for Regulatory Risk Indicators on Futures Companies (April 2017). - Expand coverage to nonbanks and CIS: - PBC considers operational interconnection and contagion between nonbanks and banks in contagion stress tests. - CBIRC conducted stress testing on liquidity and credit risks of trust companies and on insurance asset management industry products. - CSRC established uniform scenario stress testing mechanism for collective investment schemes. - Enhance inter-agency coordination and analytical capacity: - PBC, CBIRC and other authorities consult on stress testing scope and methods; PBC designs macro stress scenarios using second-generation macroeconometric model. - CBIRC participates in Basel Stress Testing Working Group and organizes training; CSRC refines scenario indicators and established data-sharing mechanism with CBIRC. ### Shadow Banking and Implicit Guarantees - Ensure bankruptcy remoteness of CIS including WMPs: - CBIRC to cooperate with authorities to develop/revise laws following Guidance on Regulating the Asset Management Business. - Trust Law clarifies trust assets are independent and bankruptcy remote. - Securities Investment Fund Law Article 5 stipulates fund assets are independent of manager/custodian; CSRC amending rules to apply bankruptcy remoteness to collective asset management schemes of securities companies. - Move towards eliminating sectoral lending limits conditional on eliminating implicit guarantees: - No restriction remains on size of commercial bank lending; banks may adjust asset structure in line with macroprudential requirements. - Since 2017, PBC guiding credit structure and encouraging support to agriculture and micro/small enterprises; providing differentiated treatment to overcapacity industries and supporting industrial upgrading. - CBIRC working with Ministry of Finance to promote market-based transformation of local government financing platforms; transformed platforms will no longer have local government obligations. - Limit interventions in asset markets to episodes of systemic risk: - CBIRC emphasizes prevention and control of real estate-related risks and strengthens onsite inspections, monitoring and early warning. - CSRC monitoring regulation process for asset management products to avoid destabilizing impacts during transition; strengthened monitoring of implicit guarantees and selected monitoring of stocks and bonds affected by debt risks. ### Regulation and Supervision: Securities Markets - Improve disclosure of CIS; prohibit specifying expected returns in WMP prospectuses: - April 2018 Guidance on Regulating the Asset Management Business forbids principal protection and guaranteed yield, guides net value-based management, fair value measurement, identifies rigid redemption and penalizes it. - Regulatory Measures for Collective Fund Trust Schemes prohibit trust companies from promising no-loss or minimum rate of return when marketing a trust scheme. - 2016 CSRC Interim Provisions prohibit selling asset management schemes in violation of regulations or promising no-loss of principal or minimum yield. - Functional overlay to supervision to ensure similar products are regulated similarly: - April 2018 Guidance establishes uniform regulatory standards for similar asset management products and minimizes regulatory arbitrage. - PBC working with authorities to formulate uniform regulations for asset securitization. - Tighten repo collateral eligibility and haircut methodology: - April 2017: CSRC instructed CSDC to revise Access Qualifications for Collateralized Repo and Guidelines for Ascertaining the Standard Bond Discount Coefficients; increased repo standard for credit debts from AA to AAA and will dynamically adjust haircut. - Interbank repo primarily uses treasury and policy financial bonds; PBC to promote tripartite repo and improve collateral management. - Strengthen systemic risk monitoring across securities and other financial sectors: - PBC actions under inter-ministerial coordination for corporate credit bonds: action plan to prevent bond default risk; information exchange mechanism for bond defaults; dynamic monitoring by PBC branches. - CSRC strengthening cross-market risk monitoring covering stocks, bonds, futures, currencies and foreign exchange; following quarterly Leading Group on Stock Market Risk Monitoring and Response; improving centralized capital market monitoring system and IT-based early warning. ### Regulation and Supervision: Insurance - Develop risk-based supervision plans and market conduct oversight: - CBIRC bases solvency supervision on China Risk Oriented Solvency System (C-ROSS) and conducts quarterly comprehensive risk rating covering underwriting, claim payment, reinsurance, reserve and liquidity risks. - CBIRC working on personal insurance liability supervision assessment, information platform for policy registration, actuarial supervision and reporting rules, market analysis and high-risk company monitoring. - Move valuation to market-consistent basis: - GAAP+ valuation method used by C-ROSS is in line with China’s market reality and is an ICP-allowed solvency assessment method. ### Supervision of Financial Market Infrastructures (FMIs) - Adopt full delivery-versus-payment (DVP) in CSDC: - Current model is non-standard “T+0 delivery and T+1 payment” due to payment system constraints; Securities Law and Regulatory Measures give CSDC power to stop delivery if buyer fails to pay; CSDC has full security deposit and third party escrow systems. - CSRC included improvement of registration and settlement system and start of A-share DVP settlement model reform among key 2018 tasks; CSDC to prepare reform plan based on FMI principles. - Strengthen FMI resilience and legal framework: - China Securities and Futures Exchange adopted measures to strengthen legal framework and implement FMI principles. - Futures Law (Draft) under review to define legal status of central counterparty; listed in 2018 legislative work plan. - CSDC improving front-end control of funds, revising Regulatory Measures for Securities Settlement Risk Funds, signed Agreement on Liquidity Support for Clearing Banks with five largest state-owned commercial banks, developing unified risk monitoring system and daily risk monitoring and stress testing. - PBC revising People's Bank of China Law to improve payment, liquidation and settlement provisions and formulating Regulatory Measures for Financial Infrastructure to reflect PFMI. - Expand central bank services to systemically-important CCPs: - No progress so far. ### AML/CFT - Mandate enhanced CDD for domestic politically-exposed persons (PEPs) on a risk-sensitive basis: - January 2013 PBC Guidelines require financial institutions to classify customers into risk classes; political leaders of domestic and international organizations classified as high-risk with strengthened CDD including senior management approval, deeper knowledge of assets and funding sources, and increased transaction monitoring. - Ensure self-laundering effectively investigated and prosecuted: - Article 312 of Criminal Law on concealing/transferring loot does not exclude "self-laundering." - Judicial practice has cases convicting self-money laundering (example cited: Wei case, Qingdao, Shandong, 2015). ### Crisis Management - Clarify triggers for government-led crisis response and limit to systemic cases: - Relevant authorities drafting Regulations on Addressing Bankruptcy Risks of Commercial Banks. - CSRC strives to define trigger conditions as clearly as possible; examples of triggers used internationally include large-scale liquidity crises, concentrated breakout of debt default risks, and rapid cross-market spread of risks. - Special resolution regime for banks and systemically important insurers: - PBC drafting guidance on regulation of systemically important financial institutions. - Drafting Regulations on Addressing Bankruptcy Risks of Commercial Banks in progress. - 2017 Cross-Border Crisis Management Working Group meeting reviewed updated recovery and resolution plans of ICBC, ABC, BOC and CCB and resolvability assessment of CCB. - PBC preparing draft regulatory measures for early correction and risk management of deposit insurance and has established a “consultation and joint research” working mechanism with CBIRC for risk resolution notifications. - Formal framework for emergency liquidity assistance by PBC: - PBC worked with authorities to prepare and improve emergency plans for liquidity risks covering identification, prevention, response and responsibilities. - Enhance design of protection funds to limit moral hazard: - PBC studied differentiated deposit insurance premiums based on risks, early correction mechanisms, triggers for resolution, acquisition and takeover and deposit repayment to prevent moral hazard. - CBIRC started ex post assessment and revision of trust protection fund system to improve fund-raising and clarify conditions/methods of use to prevent moral hazard. - Regulatory Measures for Insurance Protection Funds are being revised and consultation completed. ### Financial Inclusion and Fintech - Enhance legal, regulatory and supervisory frameworks for fintech: - PBC research on fintech development constraints; preparing guidance on integrated development of finance and the Internet. - Since 2017, PBC working with 16 authorities on special measures to address internet finance risks; established regulatory framework of “one approach and three guiding principles” for P2P online lending; regulatory system for non-bank payment and internet insurance gradually established. - Announcement clarifying initial coin offerings are unauthorized and illegal public fund-raising activities. - Measures introduced for "cash loan" business regulation and rectification; PBC and CBIRC to continue special measures and study fintech legal applicability. - CBIRC established institutional framework for online loans ("one approach and three guiding principles"), revised Interim Measures for Internet Insurance Business; directed >100 financial institutions to set up fintech working groups; tightened approval for online small loans and cracked down on illegal online small loan institutions. - CSRC prepared Guidance on Promoting the Healthy Development of Fintech and Compliance Technology in the Securities and Futures Industry (draft) and will revise and implement after full solicitation of inputs. *Source: Appendix IV. Implementation of Main Recommendations from the 2017 FSAP (authorities’ responses and measures reported to IMF staff).* ### Appendix V. Debt Sustainability Analysis ### Appendix V. Debt Sustainability Analysis ### Coverage and definitions of public debt - Two definitions of debt are used: budgetary coverage and “augmented” coverage. - Budgetary coverage scenario: - 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). - The change of definition in 2014 reflects the change of official data coverage when 2/3 of LGFV debt was explicitly recognized as government liability. - “Augmented” debt (broad coverage scenario): - 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. - Covers debt of government-guided funds and special construction funds, whose activities are considered quasi-fiscal. - The augmented deficit is the flow counterpart of augmented debt. - Augmented data are staff’s best estimate of general government data; data limitations mean some nongovernment activity is likely included, and some LGFV and funds may end up having substantial revenues. - Some general government activity may take place outside staff’s augmented definition (e.g. PPPs). ### Macroeconomic and fiscal assumptions used in the DSA - Growth and prices: - Real GDP growth is projected to slow to 5.5 percent y/y by 2023. - GDP deflator growth of about 2.3 percent. - Fiscal balance assumptions differ by coverage scenario: - Budgetary coverage scenario: - Assumes all spending is done within the confines of the budget and the new budget law is strictly implemented with off-budget public investment sharply reduced. - Primary fiscal deficits assumed to decline from 3.0 percent of GDP in 2017 to 2.8 percent of GDP in 2023. - Decline driven chiefly by assumption of a gradual decline in managed funds’ spending financed by land sales while the remaining on-budget primary balance remains flat. - Augmented coverage scenario: - Assumes off-budget local government spending declines only marginally. - Augmented primary deficit (includes on-budget fiscal deficit and off-budget spending financed by LGFV debt and government funds) projected to decline from around 7.9 percent of GDP in 2017 to around 5.7 percent of GDP by 2023. - Augmented expenditure to GDP ratio projected to decline owing to: (i) lower expenditure financed by net land sales; and (ii) the authorities’ reforms to limit local government borrowing. - Local government financing: - DSA assumes future financing needs increasingly met by bond issuance, in line with authorities’ plan to replace all local government debt with bonds within three years. - Historically many local governments relied on net revenue from land sales and LGFV borrowing to finance investment. - Interest rates and amortization: - Interest rates for central government and local government bonds assumed to be about 3–4 percent (in line with historical average). - Interest rates of off-budget borrowing (only in the augmented scenario) assumed to be about 6-7 percent (based on the yield differential between sovereign bond and LGFV bank loans and other short-term instruments). - Staff assume all maturing debt will be rolled over, noting a front loading of refinancing due to the ongoing swap of legacy LGFV loans for LG bonds. ### Debt dynamics and key quantitative findings - General observation: - Official budgetary government debt remains low and sustainable; “augmented” debt is high and on an upward trajectory. - Results reflect a slight improvement of debt dynamics compared to last year’s DSA, but still suggest risks of debt stress at the augmented level. - The risk of debt stress depends fundamentally on public investment via off-budget spending of local governments and LGFVs. - Narrow-coverage (budgetary) scenario: - Government debt at 37 percent of GDP in end-2017. - Projected to rise to 43 percent of GDP in 2023. - A favorable growth-interest rate differential contributes to the slightly increasing path. - Assumes off-budget local government spending stops immediately after implementation of the new budget law in 2015. - Broad-coverage (augmented) scenario: - Augmented debt rises to about 92 percent of GDP in 2023 from around 68 percent of GDP in *Appendix V. Debt Sustainability Analysis* ### 2017. This is because the broad-coverage scenario assumes that local-government off-budget ### cr18240 - 2017. This is because the broad-coverage scenario assumes that local-government off-budget ### Debt-sustainability overview - China faces relatively low risks to debt sustainability for the budgetary government; however, off-budget activities pose large risks to debt sustainability in augmented debt. - Based on projected debt dynamics under the narrow coverage, China’s debt profile is still manageable, especially given that it is mostly domestically financed. - The debt profile crucially depends on off-budget activities and implementation of the new budget law: strict implementation and fully commercial LGFV borrowing imply debt-to-GDP will rise only gradually and stabilize; continued off-budget liabilities imply debt-to-GDP will continue to rise in the medium term and only stabilize at very high levels. - Fiscal risks may also arise from new financing avenues that have emerged, such as PPPs. ### Local Government Financing Vehicle (LGFV) debt-to-bond swap program - In 2014, around RMB 14 trillion of LGFV borrowing was recognized as explicit LG debt. - The government embarked on a three-year debt-to-bond swap program for local governments to exchange the LGFV loans into LG bonds from 2015. - By the end of 2017, RMB 10.9 trillion LG borrowing was exchanged, which saved RMB 1.2 trillion in interest payments and mitigated debt refinancing risks, according to the authorities. - Another RMB 1.73 trillion of debt needs to be swapped by August 2018. ### Narrow-coverage (budgetary government) scenario — key findings and risks - In the narrow-coverage scenario, budgetary government debt remains relatively low at a still reasonable level in all standard stress tests except for the scenario with contingent liability shocks. - A contingent liability shock in 2019 will result in a sharp increase from about 37 percent of GDP in 2017 to above 60 percent of GDP in 2019. - While the budgetary debt level is still manageable, the authorities would potentially have to deal with an increase in gross financing needs that could be sensitive to market financing conditions and may entail rollover risks. ### Broad-coverage (augmented debt) scenario — key findings and stress outcomes - In the broad-coverage scenario, the augmented debt level is also sensitive to macro-fiscal shocks. - Combined macro-fiscal shocks would push debt to above 100 percent of GDP in 2023. - Figure summaries (as provided): - Nominal gross public debt (augmented): 45.3 (2016), 62.0 (2017), 67.5 (2018), 72.4 (2019), 77.1 (2020), 81.3 (2021), 85.0 (2022), 88.5 (2023) (in percent of GDP). - Public gross financing needs (augmented): 16.5 (2016), 23.2 (2017), 21.6 (2018), 21.6 (2019), 20.7 (2020), 21.8 (2021), 23.4 (2022), 22.7 (2023) (in percent of GDP). - Effective interest rate (augmented): 4/5.2 (2016), 5.2 (2017), 5.2 (2018), 5.2 (2019), 5.3 (2020), 5.5 (2021), 5.5 (2022), 5.6 (2023) (in percent). - Primary deficit (augmented): 4.4 (2016), 7.6 (2017), 7.9 (2018), 7.4 (2019), 7.4 (2020), 7.0 (2021), 6.5 (2022), 6.0 (2023) (in percent of GDP). ### Stress tests and contingent liability mechanics - 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). - Under the budgetary government contingent liability shock, debt rises from about 37 percent of GDP in 2017 to above 60 percent of GDP in 2019. - Under combined macro-fiscal shocks in the broad-coverage scenario, debt exceeds 100 percent of GDP by 2023. ### Projections and identified drivers (selected figures preserved) - Budgetary government (baseline projections excerpt): - Nominal gross public debt: 21.9 (2016), 36.7 (2017), 36.9 (2018), 38.1 (2019), 39.3 (2020), 40.4 (2021), 41.4 (2022), 42.4 (2023) (in percent of GDP). - Public gross financing needs: 6.2 (2016), 13.3 (2017), 10.3 (2018), 9.5 (2019), 7.6 (2020), 8.1 (2021), 9.3 (2022), 8.3 (2023) (in percent of GDP). - Real GDP growth (projections): 9.2 (2016), 6.7 (2017), 6.9 (2018), 6.6 (2019), 6.4 (2020), 6.3 (2021), 6.0 (2022), 5.7 (2023) (in percent). - Inflation (GDP deflator): 4.1 (2016), -0.1 (2017), 1.9 (2018), 2.0 (2019), 2.3 (2020), 2.3 (2021), 2.2 (2022), 2.2 (2023) (in percent). - Change in gross public sector debt (cumulative 2016–2023): 6.3 (in percent of GDP). - Identified debt-creating flows (cumulative): 6.2 (in percent of GDP). - Primary deficit (cumulative projection): 17.8 (in percent of GDP). - Augmented public sector (cumulative projections excerpt): - Change in gross public sector debt (cumulative 2016–2023): 24.1 (in percent of GDP). - Identified debt-creating flows (cumulative): 27.2 (in percent of GDP). - Primary deficit (cumulative projection): 39.9 (in percent of GDP). - Primary (noninterest) revenue and grants (2016–2023 cumulative): 170.9 (in percent of GDP). - Primary (noninterest) expenditure (2016–2023 cumulative): 210.8 (in percent of GDP). ### Policy implications and priorities highlighted - Implementation of the new budget law is crucial: it determines whether debt dynamics will be closer to the narrow-coverage scenario or the broad-coverage scenario. - Efforts to reduce public investment are fundamental for improving the debt profile. - Ensuring that future LGFV borrowing is commercial (on-budget/market-based) would limit debt-to-GDP increases. - Monitor and manage fiscal risks from off-budget activities and new financing avenues such as PPPs. *Source: IMF staff (cr18240 - 2017).* ### Appendix VI. Assessment of the Authorities’ Approach to ### Appendix VI. Assessment of the Authorities’ Approach to Managing Capital Flows ### Context and recent trends - Net capital outflows reached $640 billion a year in 2015 and 2016. - Capital outflows slowed to $73 billion in 2017, a trend that continued into 2018. - Most components in the financial account contributed to the slowdown; errors and omissions—which mostly represent unrecorded capital flight—remain persistently high. - Drivers of outflows in 2015–16 included external debt repayments and a surge of overseas direct investments (ODI). Interest and growth differentials, and relative policy uncertainties continued to remain key drivers of capital outflows. ### Authorities’ policy response in 2015–16 and since - Authorities combined conventional policies and capital flow management measures (CFMs): FX market intervention, allowing some exchange rate depreciation, introducing CFMs, and tightening enforcement where supporting reforms lagged. - Since the last Article IV consultation, authorities mainly eased CFMs and introduced a macroprudential assessment framework for cross-border financing designed to influence the overall volume and composition of capital flows in a counter-cyclical manner and to mitigate: - currency and maturity risks, - risks associated with off-balance-sheet exposures, - excess leverage. - Specific policy actions taken: - The macroprudential assessment framework’s leverage ratio for non-financial enterprises’ cross-border borrowing was relaxed to align the framework with the overall volume of capital flows allowed under the previous administrative framework. - Reserve requirement ratios (RRR) for banks’ offshore RMB deposits and the RRR for foreign exchange derivatives were set to zero (September 2017). - Limits on overseas RMB withdrawal by payment cards were lowered from 100,000 yuan per card per year (individuals can hold multiple cards) to 100,000 yuan per year per person (December 2017). - Overseas direct investment (ODI) measures were overall eased: - the approval requirement for ODI above US$1 billion was abolished; - ODI in non-sensitive projects is subject only to record-filing and, if above US$300 million, to submission of Non-sensitive Project Status Report; - the coverage of sensitive industries was modified; - indirect investments by individuals through offshore entities was included in ODI coverage. - Financial institutions’ limit of overseas RMB lending was increased to 3 percent from 1 percent of the previous year’s end-year balance on all RMB deposits; a countercyclical factor was added to the framework without changing the limits. - The Qualified Domestic Limited Partnership (QDLP) scheme was resumed after a two-year halt; quotas were further increased to US$5 billion in April 2018. - The Qualified Domestic Investment Enterprises (QDIE) program in Shanghai and Shenzhen was expanded; quotas increased to US$5 billion, up from US$1.3bn, in April 2018. - The Qualified Domestic Institutional Investor (QDII) scheme was expanded in April 2018 for the first time since 2015. - The RMB Qualified Domestic Institutional Investor (RQDII) scheme was resumed, with tightened reporting and enforcement requirements (May 2018); authorities indicated the scheme is linked to “macroprudential” measures for overseas investment on cross-border capital flows, off-shore RMB market liquidity, and RMB product development. - The dollar-denominated Qualified foreign institutional investor (QFII) and the RMB Qualified Foreign Institutional Investor (RFQII) were modified to ease restrictions on foreign institutional investors’ outflow of funds from China: - the three-month capital lock-up period and the 20 percent monthly repatriation limit for the QFII and the RQFII were eliminated; - FX hedging on onshore investment was allowed (June 2018). ### Assessment by IMF staff - Staff assesses that recent easing of CFMs is in line with the Fund’s Institutional View (IV). - Specific assessments: - Setting the RRR on FX derivatives to zero is appropriate as it supports development of the derivatives market by improving hedging operations to manage currency-related risks. - Setting the RRR on banks’ offshore renminbi deposits to zero removes a discriminatory practice. - Measures that gradually ease constraints on outbound investment (ODI, quota schemes such as QDLP, QDIE, QDII and RQDII) are appropriate and consistent with a gradual and cautious liberalization process. - Changes to QFII and RQFII eliminating discriminatory restrictions on capital outflows by foreign investors are appropriate. - The adjustment to the leverage ratio aligned the new framework with the overall level of capital flows allowed under the previous administrative framework (January 2018). - The change in limits of overseas RMB withdrawals by payment cards, a CFM tightening, may be appropriate on AML grounds; further analysis will be conducted in the context of the next AML/CFT Review on China. - The new macroprudential framework is an improvement over the previous ad-hoc system of case-by-case approval and quota allocations: it is more predictable and transparent and addresses mismatches (currency, maturity, on/off balance sheet) and includes a macroprudential adjustment parameter. - Cautionary note: - Using the framework to actively manage the capital flow cycle would be inconsistent with the Fund’s IV. The macroprudential adjustment parameter should be adjusted only in crisis or exceptional episodes to address potential risks, and should not substitute for warranted macroeconomic adjustment. - Adjusting the parameter to actively manage cross-border financing in the absence of well identified risks would deem the measure inconsistent with the Fund’s IV. ### Implementation and institutional challenges - Consistent and transparent enforcement remains a challenge: regulations remain “confidential” or are not always readily available to the market. - Transparent and consistent enforcement of CFMs together with clear communication is important to strengthen market participants’ confidence in the regulatory framework. ### Policy guidance and priorities - Primary reliance should be on macroeconomic policies to deal with capital flow risks, including: - an effectively floating exchange rate, - strengthened standard micro/macro-prudential frameworks to mitigate procyclical systemic risk over the financial cycle, in line with FSAP recommendations. - CFMs can play a transitional role while supporting reforms are phased in; liberalization should be gradual, carefully sequenced, and paced with supporting reforms. - CFMs should not be used to fine-tune capital flows and should be phased out over time as the economy’s ability to handle greater capital flow volatility improves. _Appendix VI. Assessment of the Authorities’ Approach to Managing Capital Flows (cr18240)_ ### 4. The teams agreed to the following division of labor. ### 4. The teams agreed to the following division of labor. ### Financial sector reforms - The Bank and the Fund jointly conducted the 2017 FSAP; assess financial sector risks and provide recommendations on the needed reforms. - The Fund will follow up to provide technical assistance to the Chinese authorities as needed. ### Fiscal reforms - The Bank will continue to work with the Ministry of Finance (MOF) to help in implementing key reforms in public finance through analytical work, continued cooperation at the local government level, and an ongoing fiscal technical assistance investment project. - The Fund will continue its technical cooperation on the fiscal framework and budgetary preparation, including: - strengthening the medium-term macro and fiscal framework, - enhancing local government borrowing monitoring, - modernizing accounting and treasury management. - The Fund will also continue to discuss the fiscal space in China and policy choices on the broader economy as well as implications for global spillovers. ### Social Security System - The Bank will: - continue to work with the Chinese authorities on reforms to improve the equity, sustainability, and portability of the social security system, - help provincial governments in developing more integrated social security information systems, - work with MOF to provide technical support on the overall reform and the pooling and financing strategies, - optimize fiscal risk management associated with social security liabilities through policy dialogue and engagement. - The Fund will: - examine how different social insurance schemes (including pensions and health care) fit into the medium-term fiscal and macroeconomic policy framework, - review the balance between benefits and financing from different revenue sources, including social contributions and other revenue. - Both the Bank and the Fund will continue to encourage the authorities to undertake regular and robust actuarial modeling of social insurance liabilities. ### Green growth - The Bank’s focus will continue on climate change and renewable energy and pollution reduction and prevention in China, emphasizing: - cutting-edge green technologies, - scale-up of energy conservation and investments in energy efficiency, - green transport and green building policies (for heat and energy efficiency). - Engagements with a climate change focus will extend to: - expansion of distribution of electricity from natural gas generation, - analysis of carbon capture and storage potential, - development of green finance, including carbon markets. ### New Drivers of Growth - The Bank is cooperating with Development Research Center (DRC) of the State Council on a flagship report focused on identifying and nurturing new sources of growth to sustain China’s development into high income status. - The focus is on policies and reforms to accelerate productivity growth by removing distortions, accelerating diffusion, and fostering discovery and innovation (the three ‘D’s). - Separate draft thematic reports have been prepared in relevant areas, which will feed into a single integrated document under preparation. ### Requests for information between teams - 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. ### Bank and Fund planned activities (June 2017 to June 2018) — key entries Bank Work Program (selected items and status) - 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 - Mid-term Assessment of 13th Five Year Plan Implementation — 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 - Financial Sector Development and Inclusion — 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 - Province-level projects on poverty reduction — Ongoing Fund Work Program (selected items and dates) - 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 - 2018 Staff Visit — Jan 2018 - 2018 Article IV — May 2018 Joint Work Program - Financial Sector Assessment Program — Nov 2017 *Source: cr18240 - 4. The teams agreed to the following division of labor.* ### 6. The nonlending program for 2018-2020 will enhance the design, preparation and ### 6. The nonlending program for 2018-2020 will enhance the design, preparation and readiness of the lending program and support knowledge creation, management and sharing, both within the PRC and with other developing economies. ### Nonlending program objectives and thematic focus - Enhance the design, preparation and readiness of the lending program for 2018-2020. - Support knowledge creation, management and sharing, both within the PRC and with other developing economies. - The TA program has a strong thematic focus, in line with the lending program and in response to the government’s priorities. ### China: AsDB’s Commitments and Disbursements (Public Sector Loans), 1993–2017 (In millions of U.S. dollars) - Yearly commitments and disbursements (exact figures as presented): - 1993: Commitments 1,031; Disbursements 371 - 1994: Commitments 1,618; Disbursements 492 - 1995: Commitments 2,304; Disbursements 558 - 1996: Commitments 3,282; Disbursements 707 - 1997: Commitments 4,033; Disbursements 715 - 1998: Commitments 4,518; Disbursements 818 - 1999: Commitments 5,337; Disbursements 792 - 2000: Commitments 6,159; Disbursements 832 - 2001: Commitments 6,748; Disbursements 1,313 - 2002: Commitments 7,563; Disbursements 782 - 2003: Commitments 8,075; Disbursements 705 - 2004: Commitments 8,733; Disbursements 636 - 2005: Commitments 11,060; Disbursements 892 - 2006: Commitments 11,794; Disbursements 988 - 2007: Commitments 13,214; Disbursements 1,190 - 2008: Commitments 14,519; Disbursements 1,234 - 2009: Commitments 15,623; Disbursements 1,342 - 2010: Commitments 16,964; Disbursements 1,342 - 2011: Commitments 18,244; Disbursements 1,580 - 2012: Commitments 19,476; Disbursements 1,343 - 2013: Commitments 20,416; Disbursements 1,063 - 2014: Commitments 21,748; Disbursements 1,303 - 2015: Commitments 23,096; Disbursements 1,152 - 2017: Commitments 26,600; Disbursements 1,367 - Footnotes: - 1/ Refers to cumulative contract awards. - 2/ Refers to disbursements for the year. ### Assessment of Data Adequacy for Surveillance (As of June 1, 2018) - General finding: - Data are broadly adequate for surveillance, but only barely so. - Efforts at strengthening the statistical system and enhancing data transparency led to China’s subscription to the SDDS in October 2015. - Significant gaps remain, mainly in national accounts data and government finance statistics. - China has endorsed and is implementing recommendations of the Data Gaps Initiative of the G-20. - National Accounts: - NBS compiles and disseminates annual GDP by activity and by expenditure in current prices, by activity at constant prices (2015), and quarterly GDP by activity at current and constant prices. - Transitioning from 1993 SNA to 2008 SNA; 2008 SNA implemented for financial intermediation services indirectly measured and capitalization of research and development. - Techniques for deriving volume measures of some GDP components are not sound and need improvement. - Annual GDP by expenditure is compiled at constant prices but is not published. - Expenditure components of GDP are not available on a quarterly basis. - Improvements made to exhaustiveness of GDP estimates by activity; further improvements intended but no target dates set. - Data collection constrained by decentralized statistical system. - Monthly industrial production, retail sales, and fixed investment indices are disseminated as year-on-year ratios; no chain-linked indices produced. - Data revisions tend to be made without publishing the entire revised series. - Price Statistics: - CPI covers approximately 500 areas (around 200 counties and around 300 cities). - CPI is a chained Laspeyres price index compiled and disseminated since 2001. - Weights derived from urban and rural households’ surveys every five years; current weights are for 2008-2010 and are price-updated every month; weights are not published. - 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; current base year is 2010. - PPI definitions consistent with PPI manual (2010); PPI is not seasonally adjusted. - Government Finance Statistics: - Serious data shortcomings hamper fiscal analysis. - Data on social security and extra budgetary funds are only provided annually and with a long lag. - China reports GFS for general government with no breakdown of expenditure by economic type except interest; includes data under Classification of Functions of Government for GFS yearbook. - Expenditure classification needs improvement; expenditures by economic type are not published. - Authorities intend to begin collecting these data and to develop accrual-based measures of fiscal performance over the medium term while strengthening cash-based GFS. - China committed under the G20 Data Gaps Initiative to develop quarterly general government data, although no specific timeframe has been communicated. - General Government coverage excludes operations of local government financing vehicles (LGFVs), which are substantial. - Monetary and Financial Statistics: - Improvements made, but surveys lack sufficient detail on bank claims on the government, hampering fiscal deficit estimation from the financing side. - Reported net foreign assets position of PBC does not include exchange rate valuation effects and interest earnings on foreign reserves. - PBC ceased to report separate data on central government deposits in its balance sheet since April 2005, producing breaks in monetary series. - Missions in March 2015 recommended accelerating PBC’s implementation of standardized report forms (SRFs). - PBC technically capable of compiling and reporting monetary statistics in SRF format for central bank and other depository corporations, but reporting of SRFs has not begun pending internal review and approval. - Financial Sector Surveillance: - China reports financial soundness indicators (FSIs) to the Fund. - In early 2015, authorities included two encouraged FSIs for deposit takers in regular reporting. - Periodicity of data improved in May 2015 from annual to semi-annual. - External Sector Statistics: - Historic BOP data starting 2005:Q1 and IIP starting 2011:Q1 compiled largely in accordance with BPM6 and disseminated in the IFS. - Transition to BPM6 revealed data gaps in workers remittances, merchanting, and primary income (portfolio investment income). - International Transactions Reporting System is major data source; regular training for provincial SAFE staff recommended. - Improvements include participation in CDIS (commenced 2011; only inward direct investment positions recorded), initiation of CPIS reporting at end-2015, reporting to COFER since 2015, and compiling and disseminating the International Reserves and Foreign Currency Liquidity Template starting September 2015. - Need to strengthen external debt monitoring and compilation. - In 2010, China began submitting 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. ### China: Table of Common Indicators Required for Surveillance (As of June 2018) — selected entries (Date of Latest Observation / Date Received / Frequency of Data / Frequency of Reporting / Frequency of Publication) - Exchange rates: 05/18; 06/18; D; M; D - International reserve assets and reserve liabilities of the monetary authorities: 05/18; 06/18; M; M; M - Reserve/base money: 05/18; 06/18; Q, M; Q, M; Q, M - Broad money: 05/18; 06/18; M; M; M - Central bank balance sheet: 05/18; 06/18; M; M; M - Consolidated balance sheet of the banking system: 04/18; 05/18; M; M; M - Interest rates: 04/18; 05/18; (frequency codes provided in table) - Consumer price index: 05/18; 06/18; M; M; M - Revenue, expenditure, balance and composition of financing — general government: 2016; 07/17; A; A; A - Revenue, expenditure, balance and composition of financing — central government: 04/18; 05/18; M; M; M - Stocks of central government and central government-guaranteed debt: Q4/17; 03/18; Q; Q; Q - External current account balance: Q4/17; 04/18; Q; A, Q; A, Q - Exports and imports of goods and services: 04/18; 06/18; M; M; M - GDP/GNP: Q1/18; 04/18; A, Q (cumulative); A, Q (cumulative); A, Q (cumulative) - Gross external debt: Q4/17; 03/18; A, Q; A, Q; A, Q - International investment position: Q4/17; 04/18; A, Q; A, Q; A, Q - Notes and footnotes preserve the exact definitions and frequency codes as presented. ### Capacity Development and Technical Assistance (Summary of 2011–18) - Major areas of TA and capacity development missions and training include: - Tax System Reform and Tax Administration Reform (missions on Tax Gap Analysis, Micro-Simulation Models, Reforming the Personal Income Tax, Large Taxpayer Administration, Tax Collection Law Revision, etc.). - Public Financial Management (missions on Treasury reforms, government accounting modernization, Medium-Term Expenditure Frameworks, local government borrowing reform). - Market Development and Treasury–Central Bank coordination. - Statistics (SDDS workshops and assessments, Quarterly National Accounts, TSF/Monetary Data reported in SRFs, Balance of Payments statistics, Debt Securities Statistics, Cross-border Position Statistics). - Monetary Policy, Bank and Financial Supervision, AML/CFT legislative drafting, bank resolution, securities market supervision. - Training courses and workshops by INS/ICD, STA, MCM, FAD, LEG covering macroeconomic forecasting, monetary and financial statistics, balance of payments, FSI, DSGE modeling, financial sector surveillance, and other topics. - Note: 1/ The new Institute for Capacity Development (ICD) was formed from the merger of the former IMF Institute (INS) and Office of Technical Assistance Management (OTM) on May 1, 2012. ### Statement by the IMF Staff Representative (July 16, 2018) — updates since staff report - US–China trade measures: - The US began implementing an additional tariff of 25 percent on US$34 billion of Chinese imports on July 6, with a further US$16 billion identified. - China responded by imposing an additional tariff of 25 percent on US$34 billion of imports from the US, with a further US$16 billion identified. - On July 10, President Trump ordered the US Trade Representative to begin the process of imposing tariffs of 10 percent on an additional US$200 billion of Chinese imports. - Recent data broadly in line with staff projections: - Q2 GDP growth was 6.7 percent (y/y), marginally lower than 6.8 percent in Q1. - Services contribution to growth: 4.0 percentage points. - Industry contribution to growth: 2.5 percentage points. - Consumption contribution to growth: 5.3 percentage points. - Investment contribution to growth: 2.1 percentage points. - Net exports: slight drag. - Nominal GDP growth slowed to 9.8 percent (y/y) in Q2 from 10.2 percent in Q1. - High-frequency indicators suggest some weakening in activity in May/June: - Industrial value-added slowed to 6.0 percent (y/y) in June from 6.8 percent (y/y) in May. - Infrastructure fixed asset investment growth slowed to around zero. - Total social financing growth fell to 9.8 percent in June, driven by shrinking shadow banking. - Adjusting for the local government bond swap, total social financing moderated to 10.7 percent (y/y) in June and bank asset growth fell further to 6.8 percent (y/y). - Trade and reserves: - Trade surplus widened in June compared to May. - Export growth (in US$ terms) eased to 10 percent (y/y). - Import growth fell to 14 percent (y/y). - FX reserves increased slightly to US$3,111 billion. - Inflation: - Headline CPI inflation ticked up to 1.9 percent (y/y) in June. - Core CPI stable at 1.9 percent (y/y). - PPI inflation picked up to 4.7 percent (y/y). *IMF staff report content (cr18240) as provided.* ### 4. Since the Staff Report was finalized on June 28 the RMB has depreciated 0.6 percent ### cr18240 - 4. Since the Staff Report was finalized on June 28 the RMB has depreciated 0.6 percent ### Market developments since June 28 - RMB movements: - RMB depreciated 0.6 percent against the CFETS basket. - RMB depreciated 0.9 percent against the US dollar. - Asset prices and yields: - Equity market fell 1 percent. - 5-year central government bond yield fell 12bps to 3.3 percent. - 3-month yield fell 64bps to 2.5 percent. ### Recent macroeconomic performance and outlook - Growth and inflation: - GDP growth: 6.9 percent in 2017; grew by 6.8 percent in the first half of 2018; projected to grow at around 6.5 percent for the year as a whole. - CPI increased by 2.0 percent y-o-y in the first half of 2018. - Labor market: - Surveyed urban unemployment rate at 4.8 percent in June. - Demand composition: - Consumption contributed to 58.8 percent of growth in 2017. - Consumption reached 78.5 percent of growth in the first half of 2018. - Trade and corporate performance (first half / first five months of 2018): - In dollar terms, China’s trade in goods went up 16 percent to about 2.2 trillion U.S. dollars. - Exports rose by 12.8 percent. - Imports rose by 19.9 percent. - Trade surplus narrowed by 24.5 percent. - FDI rose by 4.1 percent. - Profits of industrial enterprises grew by 16.5 percent (first five months of 2018). ### Policy stance and measures - Monetary policy: - Monetary policy described as prudent and neutral. - People’s Bank of China (PBC) cut the reserve requirement ratio (RRR) by 50 basis points for banks to promote legal and market-based debt-for-equity swaps and enhance support to SMEs. - Fiscal policy: - China adopts a proactive fiscal policy. - VAT reform measures: VAT rate lowered from 17 to 16 percent for the manufacturing sector and from 11 to 10 percent for the transportation sector. - Combined measures will reduce taxes for businesses and individuals by more than 120 billion U.S. dollars this year. ### Local government debt and public balance-sheet perspective - Authorities’ view: - Emphasis on assessing fiscal position by looking at both assets and liabilities rather than focusing only on liabilities or “augmented debt.” - Argument that assets of sampled LGFVs far exceed their liabilities and that infrastructure-related debts contribute to medium- and long-term potential growth and externalities. ### Financial regulation, FSDC, and deleveraging - Institutional reform: - Financial Stability and Development Committee (FSDC) fully operational with its first meeting in early July; announced leadership and membership from key institutions. - Deleveraging outcomes and leverage ratios: - China’s overall leverage ratio was 250.3 percent in 2017 and tended to stabilize. - Credit to the nonfinancial corporate sector declined by 0.7 percentage point to 159 percent (first time decline since 2011). - Leverage ratio of the government sector was 36.2 percent, down by 0.5 percentage point. - Leverage ratio of the household sector increased by 4 percentage points to 55.1 percent. - Average debt-to-asset ratio for central SOEs stood at 66 percent as of end June, down 0.3 percentage point since this year. ### Rebalancing and external position - Current account and energy intensity: - Current account surplus declined from about 10 percent of GDP in 2007 to 1.3 percent in 2017. - In the first quarter of 2018, the current account registered a deficit of 34.1 billion U.S. dollars. - Consumption of energy per unit GDP declined by 3.2 percent y-o-y in the first quarter of 2018. - Environmental efforts: - Government has made arduous efforts to strengthen environmental protection; various environmental indicators have steadily improved. ### SOE reforms and corporate sector adjustments - Measures and outcomes: - Actions: M&A, restructuring, strengthening corporate governance, and allowing non-viable zombie firms to exit by the end of this year. - By end of 2017, authorities dealt with 1,200 zombie firms, cutting losses by 25.1 billion U.S. dollars equivalent. - Plan to tackle another 800 zombie firms in the current year. - Combined profits of central SOEs went up by 23 percent in the first half of this year. - Share of SOEs in total employment fell to 15 percent. - Privately-owned and foreign-owned firms account for almost 90 percent of total export; privately-owned firms have outperformed SOEs in the highly competitive export sector since 2007. ### Trade policy, opening-up, and intellectual property - Opening-up measures: - Removed most limits on foreign ownership in the financial sector; substantially expanded business scope for foreign banks. - Lowered import tariffs in automobile and agriculture products and various consumer goods. - Allowed foreign investors to set up wholly-owned automobile companies. - Negative list on foreign investment shortened from 63 to 48 items; negative list for free trade zones shortened to 45 items. - WTO and tariffs: - China cut overall nominal tariff rate from 15 percent to 9.8 percent since WTO accession. - Effective tariff rate lowered to 2.4 percent. - Intellectual property and technology transfer: - China ranked number one in total patent applications and number two in international patent applications (WIPO). - In 2017, China paid US$28.6 billion for intellectual property rights. - Authorities emphasize contractual freedom and legal dispute resolution under WTO framework. - R&D and human capital: - China’s visible progress in science and technology owed to culture of education, steady increase in R&D, and large pool of educated labor force (8.2 million new graduates in 2018 alone). ### Social outcomes and poverty alleviation - Poverty and relocation: - In the past five years, more than 68 million people lifted out of poverty. - More than 8 million relocated from inhospitable areas. - Social protection and health: - National pension schemes cover more than 900 million people. - Basic health insurance plans have covered 1.35 billion people. - Infrastructure and housing: - 99 percent of villages now accessible to modern paved roads. - Over 26 million housing units rebuilt in rundown urban areas. - More than 17 million dilapidated houses renovated in rural areas. - More than one hundred million ordinary people have benefited from these efforts. - Inequality: - Gini Coefficient declined from 0.491 in 2008 to 0.469 in 2017. ### Belt and Road Initiative and international cooperation - Authorities’ stance: - Appreciate interest from EDs and recognition of potential benefits; welcome constructive advice and broad participation. - Commit to promoting the Belt and Road Initiative based on relevant international standards and rules. - Willing to share risks and benefits jointly with partners. ### Data and transparency - Commitment: - Authorities will continue to make serious efforts to fill data gaps. *Statement by Executive Director for the People’s Republic of China, July 18, 2018* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18240.pdf_