IMF Nudges Up China Growth Forecast, Cajoles On Reform

THE INTERNATIONAL MONETARY Fund has nudged up its growth forecasts for China over the next couple of years. The latest update to its World Economic Outlook says the Fund expects growth to be 6.5% this year and 6.2% next, both 0.2 percentage points higher than its January forecast, which in turn had been unchanged from last October’s.

These are both lower growth rates than 2015’s 6.9%, however. The Fund identifies policy stimulus as the reason for its revision, but adds:

A further weakening is expected in the industrial sector, as excess capacity continues to unwind, especially in real estate and related upstream industries, as well as in manufacturing. Services sector growth should be robust as the economy continues to rebalance from investment to consumption. High income growth, a robust labor market, and structural reforms designed to support consumption are assumed to keep the rebalancing process on track over the forecast horizon.

The Fund forecasts inflation to remain low at about 1.8% in 2016, reflecting lower commodity prices, the real appreciation of the renminbi, and somewhat weaker domestic demand.

It also notes the challenges of rebalancing and says with some understatement that the transition “has been bumpy at times”.

Slowing growth has eroded corporate profitability, which in turn, hinders firms’ ability to service their debt obligations, raising banks’ levels of nonperforming loans:

The combination of corporate balance sheet weakness, a high level of nonperforming loans, and inefficiencies in bond and equity markets is posing risks to financial stability, complicating the authorities’ task of achieving a smooth rebalancing of the economy while reducing vulnerabilities from excess leverage.

It also says:

Limited progress on key reforms and increasing risks in the corporate and financial sectors have led to medium- term growth concerns, triggering turbulence in Chinese and global financial markets. Policy actions to dampen market volatility have, at times, been ineffective and poorly communicated.

The risk is that:

A sharper-than-forecast slowdown in China could have strong international spillovers through trade, commodity prices, and confidence, with attendant effects on global financial markets and currency valuations.

That would be felt in both emerging market and advanced economies. On the upside well-managed rebalancing would ultimately lift global growth and reduce tail risks.

The Fund says the international community should therefore support Beijing’s efforts “to transit to a more consumption–and service–oriented growth model while reducing the vulnerabilities from excess leverage bequeathed by the prior investment boom”.

To that end, strengthening the influence of market forces in the Chinese economy, including in the foreign exchange market, is a key objective.  However:

Further structural measures, such as social security reform, will be needed to ensure that consumption increasingly and durably takes up the baton from investment. Any further policy support to secure a gradual growth slowdown should take the form of on-budget fiscal stimulus that supports the rebalancing process. Broader reforms should give market mechanisms a more decisive role in the economy and eliminate distortions, with emphasis on state enterprise reforms, ending implicit guarantees, reforms to strengthen financial regulation and supervision, and increased reliance on interest rates as an instrument of monetary policy.

The Fund notes the progress in financial liberalization and in laying the foundations for stronger local-government finances, but says, again, that the reform for state-owned enterprises needs to be more ambitious, clearly laying out and accelerating a substantially greater role for the private sector and hard budget constraints.

Easier to say than politically to execute. Little progress is being made on dismantling the clientelist structure of state-owned enterprises, as a reading between the lines of what this state media report on the recent meeting of the Leading Group for State-Owned Enterprises Reform doesn’t say highlights.