After three decades of remarkable growth, China’s economy has been slowing. The country needs to implement the announced reform agenda and address vulnerabilities to secure a safer development path, says the International Monetary Fund (IMF) in a new paper.
China 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 6.5% to 7%.
China’s growth was 7.7% in 2013 and is expected to be around 7.5% in 2014, in line with the government’s target. Much of China’s slowdown has been structural, reflecting the natural growth convergence, but weak global growth has also contributed.
However, 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 mis-allocation and rising vulnerabilities.
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 non-bank 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.
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.
Future reforms should aim to eliminate distortions and implicit guarantees, strengthen institutions, and give the market a more decisive role, as the authorities emphasized.
In addition, 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 re-balancing.
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, say the IMF.