A Wish List for China’s Third Plenum
IMF Blog, October 22, 2013
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- Authors: Anoop Singh
- Published: October 22, 2013
Financial markets — overview
- Author: Anoop Singh
- Date: October 22, 2013
- Context: IMF view that economic growth will slightly surpass this year’s official target, while identifying growing challenges that require accelerating reform ahead of the Third Plenum.
The challenges ahead
- Three decades of unprecedented expansion have raised nearly 500 million people out of poverty.
- Key pressures and vulnerabilities:
- Heavy reliance on capital accumulation and relocation of surplus labor from the countryside to urban factories.
- Stock of credit among the highest in the world and growing fast, particularly in the non-bank segment.
- In the past four years alone, the stock of credit as a share of GDP has risen from around 140 percent to 200 percent.
- Non-bank intermediaries mobilize short-term deposits to lend for longer maturities without the same capital buffers, provisioning, or regulatory rules that banks adhere to.
- Large buildup in debt, including at the level of local governments:
- Infrastructure spending by local governments used as a counter-cyclical tool since the global financial crisis.
- Because local governments are constrained in how they raise revenue and are not permitted to borrow directly from the markets, they channel infrastructure funding through off-budget financing vehicles.
- Augmenting reported public debt to include this additional infrastructure-related borrowing, IMF’s sense is that the general government debt is around 45 percent of GDP (twice the official number).
- This suggests less fiscal space to deal with unanticipated events than the reported headline number indicates.
- Capacity continues to be built well ahead of final consumer demand and returns to capital are diminishing.
- Demographic trend: surplus labor will be exhausted by around 2020, making it more difficult to offset diminishing returns by relocating surplus labor.
- Conclusion: The current growth model looks increasingly unsustainable.
What’s to be done? (policy recommendations)
- Financial sector reforms (main dimensions):
- Deposit rate liberalization.
- Elimination of perceived widespread implicit guarantees on financial products and intermediaries through:
- Introduction of deposit insurance.
- A formal resolution framework for failing institutions.
- Gradually move away from administrative guidance on credit allocation to adopting a policy rate as the main operating target for monetary policy.
- Objectives: contain the buildup of risks, enhance the efficiency of investment, and boost household capital income.
- Fiscal reforms:
- Give local governments authority over their own revenue sources more in line with their expenditure mandates.
- Shift the tax burden toward progressive and efficient forms of taxation.
- Channel dividend payments from state-owned enterprises to the budget.
- Objectives: address vulnerabilities in local government finances, reduce excess investment, and boost household consumption.
- Structural measures (the third broad area):
- Level the playing field within and across sectors through deregulation and easing barriers to entry (particularly in services).
- Raise resource prices to rationalize investment and protect the environment.
- Reform the hukou (household registration) system to improve labor market mobility and achieve a more efficient matching of workers to vacancies.
- Objective: enable a shift toward a growth model less reliant on capital accumulation and more dependent on the efficient use of resources (‘total factor productivity’ growth).
Eyes on the Third Plenum — timing and trade-offs
- Implementing significant reforms is a tall order and involves tough choices, including possibly accepting slower growth as the economy adjusts to the new path.
- Starting reforms now will allow China to sustain convergence to the level of higher income economies and deliver growth benefits more broadly and sustainably; delay increases the probability of stalled convergence.
- China’s leadership has indicated reform objectives; priority is to lay out and then implement concrete reform plans to manage the transition.
- Invoke of pragmatism: Deng Xiaoping’s maxim cited to underline expectation of far-sighted pragmatism at the Third Plenum.
Source: A Wish List for China’s Third Plenum (IMF blog post).
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