Millennium Post

Less fire in dragon breath

Unless the reforms aimed at rebalancing growth of the economy to which the new leadership is committed are carried out in accelerated fashion, China could get trapped in the middle-income tier of nations, according to IMF.

IMF expects China to grow 7.8 per cent this year and 7.7 per cent in 2014 and ADB projects sharper reductions to 7.7 per cent and 7.5 per cent for the two years. While China may have plenty of foreign currency reserves (3.44 trillion dollars by end-March) and fiscal room to avert any ‘hard landing’, IMF cautioned in its report that the current pattern of growth  based on state spending, credit expansion (‘shadow banking’) and investment is ‘not sustainable’ and is increasing domestic vulnerabilities.

The challenge for China now is to accelerate its transition to a more balanced and sustainable growth path with a decisive new round of reforms that addresses growing vulnerabilities in various parts of the economy and ‘unleash new sources of growth’, according to IMF officials.

The IMF report published on 17 July views with concern the credit boom, mainly, ‘the migration of activity to less regulated parts of the system’ and the banks remaining closely linked to the development of non-traditional finance, posing risks to the stability in the banking and non-bank financial sector. It emphasised that a more market-based and liberalised financial system is critical to prevent a further build-up of risks, achieve a more efficient allocation of investment, and boost household capital income. ‘Total social financing’ – a broad measure of credit including traditional banking and new forms of financial intermediaries to prop up economic growth – has increased from 130 per cent of GDP in 2008 to nearly 200 per cent of GDP, the report noted.

A priority is to rein in broader credit growth and prevent a further build up of risks in the financial sector. IMF said it would combine allowing greater room for market forces (such as liberalising interest rates in the ‘traditional’ banking industry) with strengthened oversight, governance and investor accountability.

China is yet to move to using interest rates as the primary tool of monetary policy. While the reforms proposed would lead to higher borrowing costs for many firms, IMF said it was critical to reduce the large-scale regulatory arbitrage and moral hazard evident in the current system, and to improve the allocation of credit essential to future growth and sound finance.
On the fiscal side, IMF has drawn attention to rising government debt, which it has put at 45 per cent of GDP, double the figure of 22 per cent of GDP in government statistics.

An IMF spokesman said this ‘augmented’ debt includes the build-up in borrowing by local governments through off-budget financing vehicles, particularly since 2009, and other off-budget funds. In this way, IMF has also calculated the fiscal deficit, which is ‘augmented’ to a level of 10 per cent of GDP, compared to the official data of two per cent.

This would limit available fiscal space. China has, however, made progress in external rebalancing with a reduction in its current account surplus and some reduction in its exchange rate which is now regarded as ‘moderately under-valued’. The higher fiscal deficit is attributed to a mismatch between expenditure mandates and revenue sources in local government finances. A byproduct of this, IMF report points out, is local governments’ reliance on land sales for financing, which creates distortions in the real estate market – the third category of domestic risks examined by an IMF team.
China has to address the enumerated priorities to secure a more balanced and sustainable growth path in a global environment that ‘will likely remain difficult for some time’.

Though it may entail a moderate slowdown in growth as the economy adjusts, it will be a tradeoff worth making for much higher income in the long run, Not only would success be good for China, it would also provide substantial benefits to the world economy, according to IMF which does not view latest official data on growth as indicating any significant slowdown.Growth estimated at 7.6 per cent in the first half of the year is on track with the authorities target of 7.5 per cent for 2013.
IMF officials discount any ‘hard landing’ for China’s economy though ‘formidable risks’ have to be addressed fairly urgently.

The reform directions and policy objectives proposed in the IMF report are congruent with government statements on the pattern of growth. But, they stressed, ‘timely and focused implementation will be crucial for success.’
Chinese Premier Li Keqiang said on 16 June that macroeconomic policies should be more scientific, forward-looking and targeted to promote continuous and healthy growth in the long run.
On growth moderation in the second quarter of 2013, he said it was inevitable to see economic fluctuations and a major task of macroeconomic control is ‘to avoid sharp fluctuations and keep economic growth within a reasonable range’.
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