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Even The Ever-Optimistic IMF Frets Over China-US Trade Tensions

THE INTERNATIONAL MONETARY FUND has cut its forecast of China’s 2019 GDP growth by 0.2 percentage point to 6.2% because of the expected impact of tariffs imposed as a result of its trade dispute with the United States. In its newly published World Economic Outlook, the Fund also projects 6.6% growth for this year, down from 6.9% in 2017 as the policy measures to slow credit growth and deleverage the economy take effect.

However, the IMF expects China to apply domestic stabilisation measures that will boost growth in 2019 by 0.5 percentage points to offset the impact of the tariffs, which the Fund estimates to cut growth by 0.7 percentage points potentially.

The Fund’s baseline forecast takes account of tariffs announced by mid-September. Maurice Obstfeld, the director of the IMF’s Research Department, says he is less optimistic about a resolution to the trade dispute with the United States than he was six months ago. In one scenario modelled by the Fund, an escalation of trade restrictions could cut 1.6% of China’s GDP in 2019.

Obstfeld, who retires soon, also took what by the IMF’s diplomatic standards was a hugely political swing at ‘America First’ unilateralism. He concluded what will be his final forward to the Outook with this paragraph.

Multilateralism must evolve so that every country views it to be in its self-interest, even in a multipolar world. But that will require domestic [Obstfeld’s italics] political support for an internationally collaborative approach. Inclusive policies that ensure a broad sharing of the gains from economic growth are not only desirable in their own right; they can also help convince citizens that international cooperation works for them. I am proud that during my tenure, the IMF has increasingly championed such policies while supporting multilateral solutions to global challenges. Without more inclusive policies, multilateralism cannot survive. And without multilateralism, the world will be a poorer and more dangerous place.

Dealing with one aspect of ‘America First’, the US-China trade dispute, the People’s Bank of China has again just eased monetary policy, reversing its recent stance to rein in credit growth and address financial risks though deleverage.

The Fund says applying domestic stimulus will be at the long-term cost of delaying tackling China’s internal financial imbalances. It has advocated for some time that China should de-emphasise the quantity of growth and think more about the quality of growth and the economy’s resilience to financial instability — the shadow banking sector and over-leveraging in local government financing being two of the most glaring point of vulnerability.

“It will be important, despite growth headwinds from slower credit growth and trade barriers, to maintain the focus on deleveraging and continue regulatory and supervisory tightening, greater recognition of bad assets, and more market-based credit allocation to improve resilience and boost medium-term growth prospects,” the Fund says.

In its Financial Stability Report, issued the day after the World Economic Outlook, the IMF says:

In China, financial conditions have remained broadly stable, with an easing in monetary policy largely offsetting the impact of external pressures. China’s equity markets have weakened on rising trade tensions. Tighter liquidity resulting from earlier regulatory efforts to de-risk and deleverage the financial system has led to pockets of stress in corporate bond markets, which prompted Chinese authorities to ease monetary policy. The central bank injected liquidity via cuts to the required reserve ratio and through lending facilities. The exchange rate weakened further, down 7 percent against the U.S. dollar (and down 5 percent compared with a basket of 24 currencies) since mid-June, prompting authorities to reintroduce a 20 percent reserve requirement for foreign exchange forwards.

The trade-off between growth and stability is a difficult one for policymakers in any country. In China, that will always lean towards stability, which will likely mean a more accommodative macro policy stance and only fine-tuning to deleverage.

Hence the IMF repeats its mantra:

Despite a growing emphasis in China on the quality rather than the speed of growth, tensions persist between stated development goals and intentions to reduce leverage and allow market forces to play a larger role in the economy.

An overarching priority is to continue with reforms, even if the economy slows down, and to avoid a return to credit- and investment-driven stimulus. Key elements of the reform agenda should include:

  • strengthening financial regulation and tightening macroprudential settings to rein in the rapid increase in household debt;
  • deepening fiscal structural reforms to foster rebalancing (making the personal income tax more progressive and increasing spending on health, education, and social transfers); tackling income inequality by removing barriers to labor mobility and strengthening fiscal transfers across regions; and
  • more decisively reforming state-owned enterprises; and fostering further market liberalization, particularly in services.

Addressing the distortions that affect trade and cross-border flows is also needed.

All of which, as ever, is more about domestic political priorities than economic policymaking.

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Trade Tension And A Less Certain Outlook Cloud China’s Economy

THE INTERNATIONAL MONETARY FUND has held its growth projections for China unchanged even as it warned of growing downside risks to the global outlook.

The newly published July update to its World Economic Outlook puts its forecast GDP growth at 6.6% for this year and 6.4% for next. It cites softening world demand and regulatory and financial tightening as the reasons why.

The Fund’s forecast is in line with official figures for the second quarter released today by the the National Bureau of Statistics showing the economy growing by 6.7% year-on-year in the second quarter, the twelfth consecutive quarter of 6.7-6.9% growth.

Rebalancing, evidenced by private and public consumption contributing a record 78.5% of January-June GDP growth, continues as does excess-capacity reduction; mining sector output grew by at less than a quarter of the pace of overall industrial output.

Net export volumes shaved 0.7 of a percentage point off first-half growth as exporters and importers raced to beat the imposition of US tariffs. The effect of those are likely to be felt more severely in the second half of this year.

For its part, the IMF notes:

The recently announced and anticipated tariff increases by the United States and retaliatory measures by trading partners have increased the likelihood of escalating and sustained trade actions. These could derail the recovery and depress medium-term growth prospects, both through their direct impact on resource allocation and productivity and by raising uncertainty and taking a toll on investment.

To trade tensions, the Fund adds rising US interest rates and commodity prices, notably oil, as among the most concerning downside risks to the global economy.

The Fund’s prescription that ‘avoiding protectionist measures and finding a cooperative solution that promotes continued growth in goods and services trade remain essential to preserve the global expansion’ may find more resonance in Beijing that Washington these days, as will its call to preserve global economic integration under an open, rules-based multilateral trade system.

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IMF Sees China’s Economy With Momentum To Face Headwinds

IN ITS LATEST World Economic Outlook, the International Monetary Fund has left its forecast for China’s growth this year and next unchanged from January’s 6.6% and 6.4% respectively.

Both numbers are one-tenth of a percentage point higher than the Fund’s forecast in October last year. They are also in line with the most recent forecasts from the World Bank and the OECD.

Faster than expected global growth and domestic policy support has sustained the economy in the form of resurgent net exports and healthy private consumption, giving it some momentum to propel it into the challenging headwinds of America First protectionism and still-risky domestic overleverage.

Thereafter, the IMF provides a familiar refrain:

Over the medium term, the economy is projected to continue rebalancing away from investment toward private consumption and from industry to services, but nonfinancial debt is expected to continue rising as a share of GDP, and the accumulation of vulnerabilities clouds the medium-term outlook.

And its obligatory silver lining:

Tighter regulation of nonbank intermediation in China, where nonfinancial corporate sector debt is still rising, is a welcome start of a needed policy response to contain the accumulation of vulnerabilities.

But it also highlights a missed opportunity:

Fiscal policy has played a vital part in shoring up short-term growth at the expense of eroding valuable policy space. Gradual consolidation, together with a shift of spending back onto the budget and away from off-budget channels, would help improve sustainability.

The Fund’s accompanying Global Financial Stability Report goes into greater depth about the elevated risks posed by what it says is the large-scale, tight and opaque linking of the banking system to the shadow banking sector (see diagram below) through its exposure to off-balance-sheet investment vehicles largely funded through the issuance of some 75 trillion yuan ($12 trillion) of investment products.

One-third of those by value are directly managed by the banks, who are seen as implicitly guaranteeing the products. A key challenge for authorities will be phasing out those implicit guarantees, which will require banks to improve their liquidity and capital buffers as there are large maturity mismatches between the products’ assets and liabilities.

Diagram of linkages within China's financial system. Credit: IMF Global Stability Report, April 2018

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Putting Financial Stability Ahead Of Growth

IN THE SIX years since the International Monetary Fund last published a Financial System Stability Assessment of China, credit has boomed, spreading shadow banking has added complexity to the system, and moral hazard has grown as belief in the implicit state guarantee to firms and investors has remained unshakeable.

In short, financial instability risks have grown rapidly.

Within the constraint of maintaining growth and employment, authorities have responded to mitigate the risk and to put the expanding financial system on the right footing to support the ‘rebalancing’ of the economy from being led by infrastructure investment and export manufacturing to being more consumption and service driven.

There is much more to do, however, as the Fund outlines in its latest assessment.

Some of that will be politically challenging, notably allowing firms to fail, markets to fall and investors to lose money, which will be the consequences of removing the implicit guarantee that the state stands behind financial loans and products. They will also require detailed technical work on bankruptcy procedures, financial education and even social security safety nets.

Political priorities will also need to be adjusted to put financial stability ahead of economic growth. That is already starting to happen as job losses, particularly in heavy industry and primary production, and slowing economic growth more generally shows. However, the tolerance for both is greater at the higher levels of government than at the local one, where the expectation among officials that promotion depends on creating good economic growth numbers is proving hard to break. The massive task of reforming local government finances is probably a multi-decade, not just multi-year endeavour.

China Financial System Growth

Improving the supervision of the financial sector is an easier piece to bite off, and authorities have been systematically expanding that for banks, insurance companies and securities firms in recent years. The Fund recommends setting up an umbrella regulator focusing solely on financial stability to coordinate the oversight of systemic risk across sectors.

This regulator, which would be an institutional version of the recently established Financial Stability and Development Committee, will need authority and independence over the sector supervisors and an improved flow of data given the scale and complexity of the country’s financial system, especially in some of the murkier areas of shadow banking. As was seen in the West with the 2008 financial crisis, failure to monitor risks outside the regulatory perimeter can be the most damaging failure of all.

The Fund also suggests that the well-advertised rapid growth of debt requires banks to hold a plumper cushion of capital, and particularly at the larger banks that are systemically important. Greater capital reserves would not only provide a buffer in the event of a sudden or severe economic downturn, but also against the particular risk with Chinese characteristics of the extensive off-balance-sheet borrowing, notably for wealth management products, that the banks implicitly guarantee.

In the same vein, banks and financial institutions should be nudged through lending rules to stop using short-term borrowing to finance their investments and instead both lend and fund longer-term. Should it come to it, and a financial institution goes under, regulators should have their powers expanded in line with international standards to let the firm to ‘fail safely’ rather than prop it up with public funds.

Another area that the Fund urges oversight is digital finance, or fintech, which as expanded significantly in China as elsewhere. Existing oversight frameworks are often ill-fitting for the innovation that comes with fintech, though the need for systemic safety and soundness is not diminished.

The Fund calls China ‘the global centre of fintech’, noting the growth of peer-to-peer lending and the emergence of payment systems run by internet retailers such as Alibaba that are competitors to the banks’. Smartphone app WeChat’s WeBank is already a competitor to banks’ lending.

The scale of this is still small compared to the overall size of the banking system and thus not a systemic risk — yet. Nonetheless, they will need to be brought into the regulatory and supervisory scheme of things. This is starting to happen following the State Council last year launching an overhaul of internet finance oversight.

 

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IMF Again Warns China Off Growth For Growth’s Sake

THE IMF’S NEWLY published World Economic Outlook projects a 0.1 percentage point increase in GDP growth this year over last, to 6.8%. That is an upward revision of 0.1 percentage point to its July forecast, based on policy easing and stimulus to domestic demand earlier in the year.

However, the Fund sees the glide path of managed slowing growth resuming next year, with GDP growth forecast at 6.5% in 2018 (again up 0.1 percentage point from July’s forecast, and up 0.2 percentage points from its April forecast) and thereafter slowing further to 5.8% by 2022.

By that point, the IMF expects China to be growing more slowly than the emerging and developing Asia average, forecast at 6.3%. That would a phenomenon not seen since China started its double-digit growth spurt.

That, in its way, would be a mark of success for the rebalancing of the economy towards being more consumption-driven and less dependent for growth on infrastructure investment and exports. The IMF is projecting that China’s current account balance will have shrunk to $28.8 billion by 2022, against $196.4 billion last year, and almost one-tenth of the level it was a decade ago. As a percentage of GDP, the effect will be even more dramatic: a projected 0.2% in 2022 against 4.7% in 2009.

All neat projections, but realizing them is not without risk, most notably in managing debt:

Over the medium term, dealing with financial sector challenges will be essential. Minimizing the risk of a sharp slowdown in China will require the Chinese authorities to intensify their efforts to rein in the credit expansion.

The conundrum is that 6%-plus growth is necessary for China to have met its target of doubling real GDP between 2010 and 2020. To make sure it does, Beijing will be in no hurry to withdraw its stimulus.

However, as this Bystander and others have noted before, delay comes at the cost of further increases in debt, making the issue more difficult to resolve through the necessary measures of tighter supervision, reined-in expansion of credit and writes down of the underlying stock of bad assets.

This, in turn, would slow rebalancing and reduce the policy space available to respond in case of an abrupt shock to the system, internal or external.

Such shocks are not difficult to imagine, and are detailed by the Fund:

a funding shock in the short-term interbank market or the funding market for wealth-management products; the imposition of trade barriers by trading partners; or a return of capital outflow pressures because of a faster-than-expected normalisation of US interest rates.

The political dimension to this, unaddressed by the IMF, not surprisingly given its sensitivity, is whether President Xi Jinping will emerge from next week’s Party Congress in a sufficiently strong position to be able deemphasize near-term growth targets and implement more reforms that would enhance the sustainability of growth. Without doing so, he will be unable achieve his long-term goal of maintaining the Party’s monopoly grip on power while transforming China’s economy to its next phase of development.

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China’s ‘Achilles’ Heel’ Of Debt

THE IMF’S LATEST Article 4 consultations report on China’s economy retraces some well-trodden ground. While edging up its projections for China’s growth projections, the Fund again underlines the growing risk from debt in the medium term.

Arguably this is the greatest macroeconomic risk that China faces and which the Fund says needs to be addressed now if sustainable growth is to be sustained. It summarises that risk in a supplementary note to the main report thus:

International experience would suggest that China’s credit growth is on a dangerous trajectory with increasing risks of disruptive adjustment and/or a marked growth slowdown.

Managing the debt issue is inseparable from rebalancing the economy, away from infrastructure investment and export-led growth to domestic consumption.

Progress in rebalancing, the Fund acknowledges, is being made, particularly in reducing industrial overcapacity. Borrowing by local governments is being made more transparent, and regulators have started to address financial sector risks.

The Fund, though, calls, as it has repeatedly done in the past, for the pace of reforms to accelerate, taking advantage of the relatively robust growth the economy is now enjoying.

Its check list of five action points will be familiar:

  • boost consumption by increasing social spending by the government and making the tax system more progressive;
  • increase the role of market forces by reducing implicit subsidies to state owned enterprises and opening up more to the private and foreign sectors;
  • deleverage the private sector by continuing the recent regulatory tightening in the financial sector and greater recognition of bad assets in the financial sector;
  • ensure macroeconomic sustainability by focusing more on the quality of growth and less on quantitative targets; and
  • improve policy frameworks so that the economy can be better managed.

The fund particularly recommends accelerating the reform of state owned enterprises by moving social functions away from them and opening their protected sectors to more private and foreign competition.

There will be a cost to that which will strain the financial system. Bankruptcies will rise with the elimination of blanket state guarantees and lenders that have made uncreditworthy loans will get into trouble. The political concern is that strain on the financial system turns into social stress.

IMF China reforms scorecard August 2017

As this Bystander has noted before, policymakers have been steadily if cautiously managing down the GDP growth rate for several years, mostly by reducing too high investment and too rapid credit growth. They have been less active in opening up replacement sources of growth, notably by opening up to the private sector.

The fund also lays great importance on the need to liberate private savings for consumption by increasing public spending on health, pensions and education, three areas in which its spending is well below the OECD average, and by increasing social transfers to the poor, who are disproportionately greater savers than the poor in other countries,

Again as this Bystander and many others have noted before, the longer China delays tackling the structural underpinning of its debt load, the longer resolving them will take and the greater the risk of not doing so becomes.

This is an opportune moment from an economic point of view to do so. Growth in the first half of the year was more robust than expected with both the global economy and financial conditions being benign. Domestically, the effects of cutting industrial capacity are starting to work through, bolstering profits and areas of the private sector where state-owned enterprises are largely absent, such as e-commerce are showing exemplary dynamism.

Also, balance-of-payments and exchange-rate management have been adept while some old-school fiscal stimulus six to nine months ago has also kicked in.

Markus Rodlauer, deputy director of the IMF’s Asia and Pacific Department, put it this way:

The situation at this point right now…should be used as an opportunity…to bear down and to buckle down and continue with this financial sector adjustment, which is really the Achilles’ heel now of the economy.

Once the 19th Party Congress due to be held in October or November is out of the way, and assuming it has not changed politics appreciably, that may happen more visibly.

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IMF Sees Increases In China’s Growth And Debt

THE INTERNATIONAL MONETARY Fund (IMF) has upgraded both its economic growth forecast for China in 2018 and the downside risks of debt.

In its July update to its World Economic Outlook, the Fund says its projections reflect the strong first quarter growth this year and expectations of continued fiscal support.

It now says it expects growth next year to be 6.7%, the same as this year and in 2016, and 0.1 percentage point higher than previously forecast. Growth in 2018 is expected to slow by 0.2 percentage points less than previously projected, to 6.4%.

This the Fund believes will be because authorities will sustain high public investment to achieve the target of doubling in real terms 2010’s GDP by 2020. This, in turn, implies that debt levels will not be attacked as actively as needed and financial reforms delayed.

The National Financial Work Conference, the high level policymaking agency chaired by President Xi Jinping that concluded its quinquennial meeting on July 15, emphasized that policymakers’ priority was to deleverage state-owned enterprises (SOEs) within its focus on limiting systemic financial risk.

First, though, Xi has to get through the forthcoming Party plenum, which should provide clues to the strength of his position to tackle the politically powerful interests that control the SOEs.

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