The International Monetary Fund (IMF), in its 2014 assessment of the Chinese economy, has advised the country to adopt lower growth targets and to put more emphasis on enacting reforms made public last November. Slower growth now will lead to higher, sustainable growth later, it said, adding that if reforms are not put in place, GDP growth may well plummet.
The IMF said that China’s currency, the renminbi, is still “moderately undervalued” by about 5 percent to 10 percent. It also warned of weakness in the real-estate sector and pointed to a credit bubble which, if not properly handled, could lead to grave problems.
While weaker growth in China would mean slower global growth, Markus Rodlauer, the IMF’s deputy director of the Asia and Pacific Department, said in a media conference call that “over time, the benefits from stronger demand in China will dominate, resulting from higher global output, and underscoring the positive spillovers to the rest of the world”.
In response, China’s representative to the world body, Zhang Tao, agreed on the need for sustainable development but voiced confidence in his government’s ability to take the necessary actions.
“By striking a fine balance between stabilizing growth, on the one hand, and adjusting the economic structure and promoting reforms, on the other, my authorities are confident that the Chinese economy will be able to settle on a more sustainable and balanced growth path,” he said.
The Chinese government is reluctant to accept lower rates of growth, which will result in fewer jobs being created and may lead to social unrest and political instability.
In their report, the fund’s executive directors noted that China’s rapid growth has been sustained by “heavy reliance on capital spending and credit” and, while this has provided “a welcome lift to the global economy”, growth prospects are now threatened by “declining efficiency of investment, a significant buildup of debt, income inequality and environmental costs”.
“The challenge is to shift gears, reduce the vulnerabilities that have built up, and transition to a more sustainable growth path,” the IMF concluded.
While expecting China’s growth in 2014 to reach the target of 7.5 percent, the fund suggested a substantially lower target for next year of 6.5 percent to 7.0 percent. If reforms are not implemented in a timely fashion, growth could drop to 3.5 percent by 2020 and even 2.5 percent after that, it warned.
At a press conference, Alfred Schipke, senior IMF resident representative in Beijing, said the key areas of rising risks were credit, shadow banking, local government finances and the real-estate sector. He warned against continuing to rely on a growth model that is credit driven.
The IMF report noted that “key reforms include further strengthening regulation and supervision, freeing up bank deposit interest rates, increasing reliance on interest rates as an instrument of monetary policy, and eliminating implicit guarantees across the financial and corporate landscape”.
It stressed “the need to reform state-owned enterprises with the aim of leveling the playing field between the private and public sectors” by opening up more sectors – particularly services – to competition.
Such suggestions are in line with reforms outlined at the Communist Party’s Third Plenum in November, which emphasized giving the market a decisive role in the allocation of resources.
Overall, the IMF report strikes a positive note even when discussing what it sees as potential problems. Thus, Steve Barnett, China division chief of the IMF’s Asia and Pacific Department, said the fund assumes “an orderly adjustment in the real estate market”.
Probably the key issue raised by the IMF is bank debt. As Forbes magazine reported recently, China’s total bank debt has risen “from $14 trillion in 2008 to $25 trillion today – more than double the total size of the US commercial banking sector”.
In the aftermath of the IMF report, The Wall Street Journal published an article under the headline “History Suggests China Is on Verge of Banking Crisis”.
“IMF economists looked at 43 countries over 50 years and found that just four had seen credit grow as rapidly as China had in the past five years – and all four faced banking crises within three years of such supercharged growth,” it reported.
Those countries were Brazil, Ireland, Spain and Sweden. Aside from Brazil, which had a banking crisis in 1994, the others all experienced a crisis in 2008. All saw debt grow by 75 percent to 100 percent of GDP over five years. The IMF estimates that China’s domestic debt increased by 73 percent of GDP during the last five years.
While history does not necessarily repeat itself, China should be aware of the abyss on whose edge it is poised.
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