Transcript of a Press Conference on the Conclusion of the Article IV Consultation Mission with China

June 10, 2015

Beijing, China
Tuesday May 26, 2015

David Lipton, First Deputy Managing Director, IMF
Markus Rodlauer, Deputy Director, Asia and Pacific Department of the IMF and Mission Chief for China
Steve Barnett, China Division Chief, Asia and Pacific Department of the IMF
Alfred Schipke, IMF’s Senior Resident Representative to China
Dezhi Ma, Communications Department

Webcast of the press briefing Webcast


MR. MA: Welcome to today’s press conference on the conclusion of the IMF's annual policy consultation mission with China, an annual exercise that we conduct with all members also known as the Article IV consultation. I'm Dezhi Ma with the Communications Department of the IMF.

We are very pleased today to have with us Mr. David Lipton, the First Deputy Managing Director from the IMF. We also have a number of other colleagues who have worked on China for many years. Sitting on my right hand is Steve Barnett. He's the Division Chief for China at the IMF's Asian-Pacific Department.

Sitting on Steve's right is Markus Rodlauer. He's the Deputy Director of the Asian-Pacific Department of the IMF. And he's also the Mission Chief for China.

Alfred Shipke, another colleague, who is the Chief Rep here in Beijing will join us shortly. The press briefing will be conducted in English with translation into Chinese. So please grab an earphone if you need one. Channel one is Chinese and channel two is English.

Let me also remind you that this is on the record briefing on the preliminary findings of our annual assessment of the Chinese economy.

Mr. Lipton will offer some opening remarks. We will then proceed to take your questions.

MR. LIPTON: Welcome, everybody. Welcome to our press conference. It's a pleasure to be back in Beijing. I was last here in late January but haven't had a press conference since I was here with you a year ago.

During my short visit which comes at the end of our team's lengthy policy dialogue discussions, I have had the pleasure of meeting with Vice Premier Ma Kai, with People's Bank of China Governor Zhou Xiaochuan and with China Securities Regulation Commission Chairman Xiao Gang, among other senior officials.

China's economy is transitioning to a new normal aimed at a safer and a higher quality, if even a bit slower, growth. That's a transition that's challenging but we think is necessary. Our discussions focused on the policies needed to successfully meet that challenge.

As one of the world's largest economies, China's success is of vital importance for its future but also for the global economy. Growth in China is moderating. That's a by-product of moving the economy away from an unsustainable growth pattern of the last decade. We project growth in China this year at six point eight percent and that's consistent with the authorities' growth target of around seven percent and well within the six-and-a-half to seven percent range that we have considered appropriate for this year.

The labor market has remained resilient despite the lower growth which, in turn, has supported household consumption. Inflation is expected to end the year at around one-and-a-half percent.

Since the global financial crisis, growth has relied on a mix of credit and investment that we thought really couldn’t be and shouldn't be sustained and that's resulted in rising vulnerabilities. The authorities have moved on several fronts to address these vulnerabilities. As we've seen the decline in total social financing growth, tighter oversight of shadow banking, moderating investment growth and a slowdown in real estate construction, nevertheless, there are vulnerabilities still in these areas. And continued determined efforts to reduce vulnerabilities is a priority.

At this juncture, our assessment is that the macro policy stance is broadly appropriate and consistent with the annual outlook for growth and for inflation. The impact of recent development such as the appreciation of the real exchange rate, lower oil prices, adjustments in reserve requirements and interest rates and the implementation of the new budget law are all still reverberating across the economy. If the incoming data suggests that growth is likely to exceed seven percent, the authorities should take advantage of that opportunity to reduce vulnerabilities further and faster.

If, instead, growth looks to dip below
six-and-a-half percent, then we think fiscal policy should be eased somewhat. Fiscal stimulus, if needed, should be on budget and rely on measures that protect the vulnerable, support the rebalancing of the economy towards the household sector and are consistent with the longer term reform agenda. Those are all goals that can be best achieved through fiscal policy.

Next year policy should continue to address vulnerabilities even if that requires allowing growth to slow into the range to six, six-and-a-half percent. Our forecast of six-and-a-quarter percent growth for 2016 assumes such progress.

Slower growth, of course, is not a goal but it's a by-product of efforts to move the economy to a safer and a higher quality growth path. China has a comprehensive plan. It's ambitious third plenum blueprint to achieve this transformation. And now, the key is to press ahead in a timely way with implementation of that blueprint.

And that includes financial, fiscal, state-owned enterprise and external sector reforms. Successful implementation will mean reducing excessive savings, lowering investment while making it more productive, boosting consumption, allowing China to continue its convergence towards high income status.

Moving to a market-based financial system is essential for boosting productivity growth. With deposit insurance now in place, the time has come to complete the process of the liberalization of deposit rates. Doing so will facilitate the move toward using interest rates as the primary tool of monetary policy. This, in turn, involves establishing a policy interest rate and using it as the main tool to adjust monetary conditions in the economy and to signal changes in monetary policy.

Another priority is to break the web of implicit guarantees which are still prevalent throughout the financial system. We know this can't be done overnight but the process should start and will involve greater acceptance of default and bankruptcy.

Leveling the playing field between the private and the public sectors is a key goal of the blueprint and that's rightly so. Progress with state-owned enterprise reform, however, has been slow. Important reforms will include increasing the dividends to the budget, eliminating direct or indirect subsidies of factor costs, strengthening governance and greater tolerance of state-owned enterprise bankruptcy and exit when that's necessary. Successful state-owned enterprise reform has the potential to significantly boost productivity while creating millions of new jobs.

Implementation of the new budget law is important. It will create a much needed new framework for local government borrowing. It'll improve transparency and strengthen medium-term fiscal planning. While implementation is complex and it may take some time, it's important for the authorities to announce a clear and comprehensive transition plan for local government financing as soon as possible. Finding a long-term solution to the imbalance between local government spending responsibilities and their revenue assignments is a priority.

On the external side, China has made good progress in recent years in reducing the very large current account surplus and accumulation of foreign exchange reserves. Nevertheless, our projections for 2015 suggest that China's external position is still moderately stronger than consistent with medium-term fundamentals and desirable policies.

There are several factors that, in general, influence a country's external position. With the exchange rate being one of them while the undervaluation of the renminbi was a major factor causing these large imbalances in the past, our assessment now is that the substantial, real effective appreciation over the past year has brought the exchange rate to a level that is no longer undervalued.

However, the still too strong external position highlights the need for other policy reforms which are, indeed, part of the authority's agenda to reduce excess savings and achieve a sustainable external balance. This will also require that going forward, the exchange rate adjusts with changes in fundamentals and, for example that the currency appreciates in line with faster productivity growth in China relative to its trading partners.

On the exchange rate system, we urge the authorities to make rapid progress toward greater exchange rate flexibility, a key requirement for a large economy like China that strives for market-based pricing and is integrating rapidly into global financial markets. Greater flexibility with intervention, limited to avoiding disorderly market conditions or excess volatility will also be key in preventing the exchange rate from moving away from equilibrium in the future. We believe that China should aim to achieve an effectively floating exchange rate system within two to three years.

Lastly, in recent years China has played an increasingly important role in driving global growth, contributing to global economic and financial stability and helping to improve the international monetary system. As part of our ongoing review of the special drawing rights, the SDR basket at the IMF, the Chinese authorities have stated publicly their interest in seeing the renminbi included in the SDR basket.

We welcome and share this objective and will work closely with the Chinese authorities in this regard. As Managing Director Lagarde of the IMF has said, renminbi inclusion in the SDR basket is not a matter of “if” but “when”. Let me stop with those comments and I'm happy to answer any questions.

If you could please identify yourself and your news organization, that would be appreciated.

QUESTIONER: Thank you, Mr. Lipton. You referred to the web of implicit guarantees in the financial system still being a problem and saying the government needs to continue to address vulnerabilities. While you were here, the Chinese government basically instructed banks to continue to support local government infrastructure projects even if those projects are not necessarily solvent. What's your reaction to that and doesn't that contradict the gist of what you're advising them to do?

MR. LIPTON: Well, I've not seen a story that you're referred to but let me say what our general view is. I mean, first, there is the need to have proper governance in place for state-owned enterprise investment decisions, for local government infrastructure decisions and for the financing, whether it comes from bond issuance finance or from commercial bank funding. And it's important that such governance changes occur and that that happen soon.

That is because the vulnerabilities that I spoke of have been mounting with lending that is not necessarily going to the best use and with rising non-performing loans that will have to be sorted out. Now, that said, there is a special transition going on in the case of local governments that comes from the implementation of the new budget law where local governments have, in the past, used various lending vehicles or financing vehicles in order to fund infrastructure, the transition is underway to allocating financing through municipal bond issuance and that's a process that, as I said, is going to take some time to get exactly right.

So we have an understanding. We understand if there have to be adjustments in this process as it unfolds and in order to make sure that local governments this year are undertaking the activities that they should and that there isn't an unanticipated or an unplanned contractionary impulse in the economy. But at the same time, we believe that there should still be scrutiny of the activities they undertake so that infrastructure projects that are undertaken are the right ones and will bring benefits that exceed the cost of their financing.

QUESTIONER: In China, Internet banking is very popular and would you give some suggestion for how to create a fair and easy doing business environment -- regulatory environment for banking since the Internet companies are into the banking sector?

MR. LIPTON: I think as a general matter, the regulatory and supervisory authorities that cover banks should cover the breadth of financing activities and it is important where there are -- wherever there is deposit taking and lending and especially wherever there is leverage or the transformation of maturities which is what banks do, that there's a proper regulatory framework so that financial stability is protected.

I think there's an additional challenge which is consumer protection that, you know, with banks it's important that depositors understand the nature of and the financial strength of the institution in which they're placing their money and, likewise, where people are doing Internet banking whether depositing or borrowing, that they understand who they're dealing with, what are the terms of the transactions and have some way to understand that the company they're doing business with is financially sound.

So I think it is important that irrespective of the forum including whether it's on the Internet, that there's a proper supervisory framework.

QUESTIONER: I have two questions. One, why do you think SOE reforms have been so slow?

And second question, do you think the Yuan is ready for the SDR basket and if it's not, what else do you think China needs to do?

MR. LIPTON: Thank you, good questions. Now, state-owned enterprises and large enterprises in general have been an important part of the growth model and the growth strategy for China and they've delivered. There's been an awful lot of hiring and an awful lot of infrastructure in this country that's attributable to state-owned enterprise activity.

But, of course, it's important that as the growth possibilities from that strategy diminish that there be changes and reforms. And I think most important is that state-owned enterprises, just like any private enterprise, have what you might call a hard budget constraint, that there's a governance structure that ensures that the resources that they have are used wisely and not wasted.

And that if they borrow money, whether from banks or through bond issuance, that they have an obligation to pay it back. And that means that if they have financial difficulties, that those difficulties are dealt with. And if they become insolvent, that they go out of business.

Now, I think it's understandable given the size of enterprises, the number of people who are employed, the political influence that comes with that, the reform is slow but that doesn't diminish the fact that the growth in the future here in China depends on not directing resources to companies that will not really produce, that will not generate success. But rather, by asking enterprises, state-owned enterprises, of course owned by the government, to hand over their profits to their owner, the government, that the resources of that sector be used effectively in the economy.

And then, second, on the SDR and the renminbi, you know, we have a process that is underway for doing our review of the SDR basket. It's something we do every five years. We look at the currencies currently in the basket to see whether they still belong in the basket and what their weight should be in the basket and we look at other currencies to see if there are some where the data show that their importance has risen to the point where they belong in the basket.

And, of course, this year we will look at the renminbi, the growing internationalization of the renminbi. It's already a policy of the People's Bank of China to be enhancing the internationalization of the renminbi and the PBOC has plans to pursue that further this year. And it encompasses, I won't go through the details but it encompasses a range of steps that would make -- that would help to make the renminbi more freely usable both here in the country, in other markets for trade and for capital account transactions and all of those steps will be pertinent in our analysis.

But much more importantly, those will be steps that will be good for China because as China's economy grows, it'll be more and more important for China's growth prospects to be able to conduct both trade and capital transactions with your neighbors, with the rest of the world, and to do so in markets that are very -- that include renminbi markets that are very deep and very liquid.

QUESTIONER: My question is there are some signs that authority is shifting policy priority towards stabilizing the growth and some top authority has eased the condition for a local government financing vehicle to lend. And this, according to some observers, is a step back from a year ago when authorities said that the lending should not come from the financing vehicle but from the municipal bond issuance.

What do you think of the trend and how concerned are you about the increasing debt to GDP ratio in China? Thank you.

MR. LIPTON: I've said in my opening comments I do think there is a balance that has to be struck between promoting higher quality growth and maintaining the stability of the economy. And it is a fine balance. I don't think it's easy to strike. You know, as we've said, we believe that the policies that the government has set so far are appropriate that they strike this balance.

But as I mentioned on the particular issue of local government finance, there is the quite special additional factor that with the new budget law implementation, the transition in local government financing is very important. This is a major change and there's a need to calibrate local government spending and local government finance to make sure that it neither rises so quickly and involves projects that don't make sense, incurring debt without sufficient benefit nor that local government activities are constrained too much and provide a contractionary impulse in the economy.

I think the most important two requirements are that some balance is struck there so that the economy stays on a reasonable growth path and that this year is an important transition year towards a system of better financing mechanisms or reliance on municipal bond finance rather than on the kinds of financing vehicles that we used in the past. This, of course, is a transition so it can't necessarily be done immediately perfectly and it is important that there be some mid-course corrections to get to the right place.

QUESTIONER: My question's about the statement says that the renminbi rate is no longer undervalued. So my question is that how long have you been saying renminbi rate was undervalued and this is a problem? The second is can you explain a little bit more why did you change your decision this time?

MR. LIPTON: Yes. The current account surplus in China peaked at a very high level in the 2005 to 2007 period. And since that time, the renminbi has been appreciating in real terms and the current account surplus has been coming down. Now, as I mentioned in my opening comments, and I direct you to them for the details, the current account surplus, we think, still remains stronger than what we consider the norm to be.

But the exchange rate appreciation has been substantial and in particular, the exchange rate appreciation in the last 12 months has been significant. So our judgment is that there are -- there have long been many contributing factors to the current account surplus. The exchange rate being undervalued was one of them.

Now, the more important contributing factors to the current account surplus are the high level of savings, the fact that resources are -- so much of the resources of the country are dedicated to the credit investment and export channel. And we believe the rebalancing the economy towards a growth strategy of supporting household incomes and spending will boost national spending because households will have a proclivity to spend that will be an important contributing factor to eliminating the remaining gap on the external side.

QUESTIONER: Thank you, Mr. Lipton. I have two questions for you. The first is what do you think of the major risks facing China's economy right now? Is it property market or, you know, the debt overhang or something else? The second question is also about the renminbi and capital account liberalization.

PBOC Governor Zhou Xiaochuan said in April to the IMF that the strategy China is pursuing is not the traditional concept of full convertibility but a concept of a managed convertibility. What's your reaction to that? Do you think China can really make the RMB freely usable without relinquishing the controls over capital account? Thank you.

MR. LIPTON: Thank you. Good questions. First on the risks, you know, I haven't said much about the global economy but here are some risks from the global economy. We've said since our April world economic outlook was published that recovery in the global economy is underway but it's weak and uneven and that many emerging market countries are seeing their potential growth rates decline.

On top of that, the asynchronicity of money policy, the fact that the Fed is soon to be normalizing monetary policy while the European Central Bank and the Bank of Japan, are still forcefully implementing programs of quantitative easing, that has already led to exchange rate realignment with the dollar strengthening, the Euro and the Yen weakening and we don't know what the future holds in that regard.

But this is a global environment that China, like any other country but China especially because it's a very large economy, will have to take into account. So there's a need to be nimble in responding to those factors and the risks that there may be some further spillovers from the global economy to China.

The greatest domestic risk is the one that I have spoken about that the excesses in credit, in investment, have led to a situation where credit growth, credit levels in China are very high relative to GDP, where the performance of credit, meaning the non-performing loan performance is something to watch and where the lack of strong corporate governance, especially in the state enterprise sector but also in what governs local government infrastructure activities creates a possibility of poor use of resources, of inability to service debts to banks or bonds and that it's important to slow the growth rate of credit, the total social funding to take account of the non-performing loans that exist. Make sure that they are worked through, to institute better corporate governance.

I think those are the risks and responses that we see as most important. On the capital account liberalization, you know, the world has come around to capital account liberalization in different ways at different points in its history. Europe took quite a few years to decide to have liberal capital accounts themselves.

I think China's path is China's to choose but I think that what Governor Zhou is doing now to take important steps to put in place capital account convertibility will have benefits for China. It will mean that capital will flow in knowing that it can flow out. It will mean that Chinese companies, Chinese citizens will have more opportunities to diversity their own portfolios.

I was learning just this afternoon about the new mutual fund system connecting mutual funds in Hong Kong, mutual funds here that will allow Chinese citizens really for the first time, with limits still, but for the first time to put money in mutual funds in Hong Kong that could be holding a very diversified portfolio of stock and bonds from around the world. And so, where Chinese investors or Chinese business, Chinese individuals may have had in the past that principally the bank deposit is an asset and more recently some wealth management products or some stocks that the opening to the rest of the world will mean that portfolios can be diversified to include assets really around the world. And I think that'll be an important step.

It is also important that with capital account opening that the renminbi becomes the currency in which there are more financial market instruments that have depth and liquidity so that Chinese businesses and foreign businesses can borrow and lend reliably using these financial instruments. That will make Chinese -- that will provide all kinds of efficiencies for Chinese businesses that are either in the borrowing or lending business.

QUESTIONER: Mr. Lipton, you just suggest a policy priority of a (inaudible) one of implicit guarantees. How can policymakers better balance the reform and the risk in this area? Secondly, you mentioned that with the recent appreciation of RMB against a basket of currencies, RMB is no longer undervalued. Is this the first time for the IMF to use this term no longer undervalued? Thank you.

MR. LIPTON: Yes, I have said in my statement and we've been suggesting that it's important to eliminate implicit guarantees and to create corporate governance and better governance in a more decentralized way so that the many economic actors here, whether it's banks, state enterprises, local governments, are all taking responsibility for their borrowing, they're investing their own finances. I think that's something that will -- the more scarce resources are the more China has to look for quality growth, the more important that that is.

All I want to say about the appreciation of the renminbi is that first the -- we consider the external position still to be moderately stronger relative to fundamentals, relative to the norm. But with the movement in the exchange rate over a number of years but now especially the movement that's come in the last 12 months, we consider that it's no longer undervalued. That's a judgment about this moment.

As I said in my statement, we expect that in the future Chinese productivity will continue to grow and probably grow -- rise more rapidly than in the rest of the world. And, of course, every currency has to adjust to differentials in productivity and so, as Chinese productivity, if it does continue to grow more rapidly than in the rest of the world, there will be a continued need for appreciation to take account of that. So our judgment is about the present but we appreciate that in the future there may be -- there's likely to be appreciation in line with differentials and productivity growth.

QUESTIONER: China, the PBOC, has been easing monetary conditions for the past four or five months. Will these stall reform plans that have been implemented in the past two years?

MR. LIPTON: Well, clearly there are multiple objectives that have to be taken into account. We do believe that -- we have -- I've said today and we believe that it's important for China to reduce its vulnerabilities and where those have built up. The decline in the rate of growth of credit has been an important objective, an important accomplishment.

But at the same time, it is the obligation of the Central bank to keep an eye on the growth rate and the inflation rate which are their principle responsibilities. And so, there is a need to weigh and balance those two. And as I said, we think that the policies that have been chosen for -- by the Chinese authorities are appropriate to the macro economic circumstances right now.

Thank you all very much.

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