Silk factory worker in China. Structural reforms are key to balanced, sustained growth, says IMF (photo: Tan Kaixing/FeatureChina/Newscom)
Economic Health Check
China’s growth was 7.7 percent in 2013 and is expected to be around 7½ percent in 2014, in line with the government’s target, the IMF said in its most recent report on the state of the Chinese economy. Much of China’s slowdown has been structural, reflecting the natural growth convergence, but weak global growth has also contributed.
In their annual assessment, the report’s authors emphasize that China’s heavy reliance on investment and credit to drive growth since the global financial crisis is running out of steam as investment efficiency has been declining. The result has been resource misallocation and rising vulnerabilities.
Web of vulnerabilities
The report says that the current growth pattern has created a web of rising vulnerabilities. To finance rapid investment growth, firms and local governments borrowed from both banks and nonbank financial entities (the so-called “shadow banks”). This has resulted in rising corporate and local government indebtedness, which is the flip side of the large increase in total credit since 2008. In addition, many strands of the web run through the real estate sector.
While an abrupt adjustment in the near term is unlikely, given China’s policy buffers, repeated use of this growth strategy would further weaken balance sheets, reduce investment efficiency, and leave China more vulnerable to shocks in the future.
Comprehensive reform agenda
The report’s main message is that China needs to quickly implement the announced reforms to transition to a more sustainable growth path. Priority reforms are in the following areas: financial sector, state-owned enterprises, exchange rate, and local governments. Reforms should aim to eliminate distortions and implicit guarantees, strengthen institutions, and give the market a more decisive role, as the authorities emphasized.
The report indicates that implementing these reforms would unleash new sources of productivity growth and ensure that resources are used more efficiently. The reforms will also support both domestic and external rebalancing. While external imbalances have declined considerably, China’s external position is still moderately stronger compared with the level consistent with medium-term fundamentals and desirable policy settings. While progress with domestic rebalancing—moving the economy toward consumption and away from investment—has been slower, successful implementation of the reform blueprint should also achieve the desired shift toward consumption.
Additional measures to contain risks
The report welcomes the authorities’ efforts to start addressing vulnerabilities. However, the authors also highlight that, while implementing the reform agenda will help contain risks, additional measures will be required. These include a reduction in local government off-budget spending, further slowdown of credit growth, and less investment growth.
While these measures would likely dampen activity somewhat, the report considers that vulnerabilities have risen to the point that containing them is a priority.
Slower but safer growth
The report points out that addressing vulnerabilities and implementing structural reforms will reduce growth in the near term. However, it will bring significant benefits over time in terms of higher income and consumption. The IMF argues that the authorities should accept somewhat lower growth in the near term and deploy a stimulus only if growth were to slow significantly below their target. To be concrete, for 2015, the IMF suggests to target a range of 6½-7 percent growth.
Faster implementation of reforms would have substantial benefits over the medium and long term not only to China, but also to the rest of the world. While spillovers to the global economy would reduce growth slightly in the short run, the benefits of a stronger and less vulnerable China dominate in the long run.
