People’s Republic of China: Staff Report for the 2018 Article IV Consultation
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International Monetary Fund. Asia and Pacific Dept
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Publication Date:
26 Jul 2018
eISBN:
9781484370797
Language:
English
Keywords:
ISCR; CR; infrastructure fixed asset investment growth; bank asset growth; China; government; exchange rate; nominal GDP; foreign direct investment; monetary policy; market forces; Global
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2018 Article IV Consultation-Press Release; Staff Report; Staff Statement and Statement by the Executive Director for People's Republic of China

Abstract

2018 Article IV Consultation-Press Release; Staff Report; Staff Statement and Statement by the Executive Director for People's Republic of China

Context: An Historic Juncture

“What we now face is the contradiction between unbalanced and inadequate development and the people’s ever-growing needs for a better life.” (President Xi Jinping, 2017)

1. 2018 marks the 40th anniversary of China’s “reform and opening-up” policy. Four decades of reform have transformed China from one of the poorest countries in the world to now the second largest economy that accounts for one-third of global growth. Over 800 million people have been lifted out of poverty and the country has achieved upper-middle income status. China’s per capita GDP continues to converge to that of the United States, albeit at a more moderate pace in the last few years. A few provinces have already achieved advanced-economy income levels, though in most of the country per capita income is still a fraction of that in advanced economies, and there remains considerable room for China to continue catching up.

China’s rapid growth translated into rising living standards

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: CEIC, National Bureau of Statistics of China statistical yearbook.

GDP of advanced Chinese provinces greater than UK

(By World Bank 2016 country income classification based on GNI per capita)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: CEIC, IMF WEO database, World Bank.Note: Map excludes Hong Kong SAR, Macao SAR, and Taiwan Province of China.

2. The October Communist Party National Congress declared China’s entry into a “new era” and laid out a strategic vision for a “great modern socialist country” by mid-century. With the country’s main development challenge evolving from “meeting people’s basic needs” to their “ever-growing needs for a better life”, the authorities aim to transform the economy from high-speed to high-quality growth. Two key policy packages to achieve this are: (1) “Supply-Side Structural Reforms”—a host of measures aimed at tackling structural weaknesses such as overcapacity, excess housing inventory and high leverage; and (2) the “Three Critical Battles” of addressing financial risks (with a goal of stabilizing the debt/GDP ratio in three years), eliminating absolute poverty, and tackling pollution. These intentions signal a departure, at least in intent, from demand-side stimulus that has been driving China’s rapid GDP growth in the past. Also high on the government’s agenda is to foster new growth engines and promote national competitiveness through innovation, industrial upgrading and further opening-up.

3. Following the Party Congress, the authorities implemented major institutional restructuring to carry out the reform agenda. This includes forming Party “central committees” in key areas (such as structural reforms) and giving them a formal role in policy making and oversight, restructuring the financial regulatory framework with the newly established Financial Stability and Development Committee (FSDC) in charge of interagency coordination, merging the banking and insurance regulators, expanding the responsibility of the environment protection ministry, and setting up new government agencies for international aid and market regulation and supervision (including antitrust and intellectual property rights protection).

4. As the main contributor to global growth and trade, and an increasingly important and interconnected participant in global financial markets, China’s transition to a new model of development will significantly affect the global economy. China’s rising share in international trade and investment—as its fast-growing economy becomes more integrated with the rest of the world—underscores the importance of China in upholding the international trade system. China is also increasingly becoming a major international creditor, including through the Belt and Road Initiative (BRI), which could bring both opportunities for greater connectivity and growth, but also risks (e.g. debt sustainability).

Financial linkages: high dependence on Chinese bank lending among some Asian and African economies

(Color code based on Chinese banks’ claims as percent of counterparty annual GDP as of 2017Q4)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: IMF staff estimates (Cerutti and Zhou 2017).

Trade linkages: exports to China high among many commodity exporters and Asian economies

(Color code based on partner countries’ export to China as percent of their GDP in 2017)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: IMF DOT and WEO database.

Recent Developments: Stronger Growth, Slower Rebalancing

5. The momentum of the Chinese economy has remained strong. The year-on-year GDP growth rate has been in the range of 6.7–6.9 percent for eleven consecutive quarters. GDP growth reached 6.9 percent in 2017, the first annual acceleration since 2010, driven by a rebound in global trade, and the momentum continued into early 2018. Headline consumer price index (CPI) inflation remained contained at around 2 percent, while a strong pickup in the producer price index (PPI) since 2016 led to higher nominal GDP growth and corporate profits. The unemployment rate, as measured by the new survey-based indicator with expanded coverage, has fallen. China to date has not been significantly affected by the recent tightening in Emerging Market (EM) financial conditions.

PPI drives recovery in nominal GDP and industrial profits

(In percent, year-on-year growth)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Sources: CEIC and IMF staff estimates.

China and EM sell-off episodes: asset price changes and capital flows

(Change over one month after the event)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Note: Chart reflects changes within 1 month (22 working days) since the shock (EM selloff: 4/16/2018 – 5/23/2018).Source: Bloomberg, EPFR.

6. Favorable domestic and external conditions reduced capital outflows and exchange rate pressure. The RMB was broadly stable against the basket published by the China Foreign Exchange Trade System (CFETS) in 2017, but with more fluctuation versus the dollar, and it has appreciated by about 2 percent in real effective terms in the first half of 2018. The current account surplus continued to decline but, reflecting distortions and policy gaps that encourage excessive savings, the external position for 2017 is assessed as moderately stronger than the level consistent with medium-term fundamentals and desirable policies, with the exchange rate broadly in line (Appendix I). Addressing the policy gaps requires continued structural reforms, including improving the social safety net, further reducing entry barriers and accelerating state-owned enterprise (SOE) reforms, to avoid a resurgence of the current account surplus going forward. At US$3.1 trillion, China’s foreign currency reserves are more than adequate to allow a continued gradual transition to a floating exchange rate. Assessing reserve adequacy, however, is not straightforward since China is in transition to greater capital account openness and its exchange rate is not fully flexible. The IMF’s reserve adequacy metrics suggest that the level of reserves at the end of 2017 ranged between 100 percent and 260 percent. The authorities do not publish or provide intervention data, thus staff makes its own estimates. Based on staff estimates, there was minor net positive intervention (FX purchases) since the last Article IV; these estimates are subject to a margin of error which could include no intervention.

RMB broadly stable against the CFETS basket since 2016

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: Bloomberg.

China’s reserve coverage appears adequate

(In US$ billion)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: CEIC, IMF staff estimates.

7. Capital flow management measures (CFMs) were generally eased and made more transparent since the last Article IV consultation. Reserve requirement ratios for banks’ offshore RMB deposits and foreign exchange derivatives were lowered to zero, and restrictions on overseas direct investment were eased. The authorities introduced a new “macroprudential framework for capital flows.” Compared to the previous case-by-case and quota allocation system, the new framework aims to address risks arising from excessive cross-border financing and composition mismatches (e.g. currency and maturity) through a formula-based approach that is more predictable and transparent. In addition, the ceiling on entities’ cross-border financing (against their capital or net assets) is subject to a “macroprudential parameter” that can be adjusted under crisis or exceptional circumstances to address risks associated with capital flows.

Limited direct impact of announced tariffs

(Goods trade 2017, in USD billions; bubble size represents percent of GDP)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Note: The U.S. administration also stated that they would add tariffs to another $200 billion worth of Chinese goods if China responds to the U.S. action on the first $200 billion worth of Chinese goods.Source: CEIC.

8. Amid the trade tensions with the U.S., the Chinese authorities said they would respond to the U.S. tariffs with comprehensive measures, but they also announced new opening-up plans. These include lowering entry barriers on financial services and autos, reducing import tariffs for a wide range of consumer goods and autos, loosening sectoral restrictions on foreign investment through a shortened negative list, and seeking faster progress toward joining the WTO Government Procurement Agreement. The direct macro impact of tariffs announced to date appears limited, but could be amplified significantly through financial and investment channels, and further rounds of retaliation, raising downside risks (paragraph 61 and Appendix II).

9. Financial sector de-risking accelerated.

  • In line with the recommendations of the 2017 Financial Sector Assessment Program (FSAP, Appendix IV), regulators adopted a wide range of decisive measures to tackle the excessive expansion of the riskier parts of the financial system, such as interbank borrowing, wealth management products (WMPs) and banks’ off-balance sheet activities. Key measures included setting limits on the growth of WMPs and banks’ reliance on negotiable certificate of deposits (NCDs, a type of wholesale funding), more strict enforcement of the “look-through” principle (whereby the quality of the underlying assets is considered), and adjustments to loan provisioning requirements to encourage NPL recognition and disposal.

  • These measures reduced not only the size of the shadow banking sector but also the interconnections between banks and nonbanks. Banking sector assets grew by 8 percent in 2017, half of the rate in 2016, and total bank assets fell as a ratio to GDP for the first time since 2011. Funding costs rose somewhat reflecting the more appropriate pricing of credit risks, while greater risk differentiation also led to an increased (but still relatively low) number of defaults in corporate bond markets. The PBC maintained sufficient liquidity in the wholesale market to prevent any systemic liquidity risks. Although there are signs of some lending activity migrating to sectors less affected by the regulatory tightening thus far (such as money market funds and trust loans), these sectors are expected to be affected too as the full impact of the reform is phased in.

Intra-financial credit slowed significantly

(In percent, year-on-year)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: CEIC and Haver Analytics.

Bank assets/GDP ratio declined for the first time since 2011

(In percent)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: Haver Analytics.

10. The authorities recently announced important guidelines for the large (120 percent of GDP) asset management business. The sector has grown rapidly in recent years in response to liberalization of financial markets and China’s high savings rate, but the rapid expansion also reflects regulatory gaps that encouraged rampant arbitrage. In particular, banks relied on “channel” business to substitute bank lending with credit provision through off-balance sheet vehicles. Multiple layers of intermediation and products with complex and opaque structures were used to channel funds from investors to ultimate borrowers, causing significant maturity and liquidity mismatches. The new guidelines aim to harmonize regulations on all asset management products, irrespective of who issues them, by setting basic principles on product classification, investor suitability, conduct of business rules by managers/distributors, risk management, disclosure, valuation and reporting.

Size of asset management industry more than doubled since 2014

(In percent of GDP)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Note: Insurance AM plans are excluded (2.5 trillion RMB at end 2017).Source: CEIC.

11. Reforms also progressed in other key areas. Steel and coal capacity reduction continued, on track to meet the 2020 targets. Housing inventories in smaller cities declined considerably, due in part to social housing programs. House price growth moderated following the tightening measures since late 2016. Production of heavily-polluting industries was restricted during the winter to meet air pollution targets. Plans were published for the central government to take on some local government social spending responsibilities. The government articulated plans to strengthen protection of intellectual property rights for both foreign and domestic companies.

Capacity reductions on track to meet 2020 targets

(In percent of total capacity in 2015)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: CEIC.

Housing inventory ratios declined significantly

(In years)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: Local Housing Administrative Bureau (Fangguanju), Wigram Capital Advisors, IMF staff estimates.Note: Inventory is measured as floor space unsold. 2018 data is calculated as average from April 2017 to April 2018.

12. Restrictions on non-compliant local government borrowing were further tightened. In a series of documents, the government reinforced the ban on local government off-budget borrowing through local government financing vehicles (LGFVs), public-private partnerships (PPPs), and government guided funds (GGFs). They also stressed that government officials are accountable for non-compliant borrowing over their lifetimes. At the same time, the authorities raised limits on local government general and special purpose bonds, the formal channel for local government borrowing.

13. Nonfinancial sector debt growth slowed, but continued to increase as a share of GDP. Despite the sharp rebound in nominal GDP and industrial profits, total nonfinancial sector debt still rose significantly faster than nominal GDP growth in 2017. While the corporate debt to GDP ratio has stabilized, government and, especially, household debt is rising, driven by continued strong off-budget investment spending and a rapid increase in mortgage and consumer loans. And despite the stabilization of total corporate debt as a share of GDP and the still-strong aggregate balance sheet of the household sector, the average debt servicing capacity of listed companies did not improve and that of the household sector deteriorated further. This illustrates the magnitude of reform challenge, and that it may take determined actions over a long period of time to address the underlying vulnerabilities.

Government and household debt still rising as percent of GDP

(In percent of GDP)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: Haver Analytics and IMF staff estimates.

Corporate leverage still high and household leverage rising fast

(In percent)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Sources: WIND info, NBS, and IMF staff estimates.1/ Calculated as aggregate debt/aggregate EBITDA across all listed firms. Sample excludes outliers whose EBITDA/TA, EBIT/TA, EBITDA/Equity, EBIT/Equity, or ICR are above 95 percentile or below 5 percentilefor each year.

14. Rebalancing continued in 2017, but slowed in several dimensions. Growth became less dependent on credit, investment growth moderated, the current account surplus continued to decline, and the environmental clean-up campaign led to some improvement in air quality and energy efficiency. But many of the drivers behind the growth acceleration in 2017—external demand, domestic policy support and the PPI reflation—slowed rebalancing. Credit intensity improved in 2017, but this could be partly temporary due to the cyclical PPI rebound, and the stock of credit is still high and rising (Box 1). The contribution of consumption to GDP declined for the first time since 2013, and services’ share of GDP grew at a slower rate. Income inequality, one of the highest in the world, stopped falling.

Mixed Rebalancing Progress in 2017

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Note: Refer to Table 7 for details.
Table 1.

China: Selected Economic Indicators

article image
Sources: Bloomberg, CEIC, IMF Information Notice System database, and IMF staff estimates and projections.

IMF staff estimates for 2016 and 2017.

Surveyed unemployment rate.

Not adjusted for local government debt swap.

Average selling prices estimated by IMF staff based on housing price data (Commodity Building Residential Price) of 70 large and mid-sized cities published by National Bureau of Statistics (NBS).

Latest observation is for Q3 2017.

Adjustments are made to the authorities’ fiscal budgetary balances to reflect consolidated general government balance, including government-managed funds, state-administered SOE funds, adjustment to the stabilization fund, and social security fund.

Official government debt. Estimates of debt levels before 2015 include central government debt and explicit local government debt (identified by MoF and NPC in Sep 2015). The large increase in general government debt in 2014 reflects the authorities’ recognition of the off-budget local government debt borrowed previously. The estimation of debt levels after 2015 assumes zero off-budget borrowing from 2015 to 2021.

Expenditure side nominal GDP.

Augmented fiscal data expand the perimeter of government to include local government financing vehicles and other off-budget activity.

Table 2.

China: Balance of Payments

(In percent of GDP, unless otherwise noted)

article image
Sources: CEIC; IMF, Information Notice System; and IMF staff estimates and projections.

Includes counterpart transaction to valuation changes.

Includes foreign currency reserves and other reserve assets such as SDRs and gold.

Table 3.

China: External Vulnerability Indicators

article image
Sources: CEIC; Bloomberg; IMF, Information Notice System; and IMF staff estimates.

Estimates of debt levels before 2015 include central government debt and explicit local government debt (identified by MoF and NPC in Sep 2015). The large increase in general government debt in 2014 reflects the authorities’ recognition of the off-budget local government debt borrowed previously.

Shanghai Stock Exchange, A-share.

Includes foreign currency reserves and other reserve assets such as SDRs and gold.

Range for the ARA metric under different assumptions of exchange rate regime and capital controls.

Table 4.

China: Monetary and Credit Developments

article image
Sources: Haver Analytics; and IMF staff estimates.

After adjusting for the local government debt swap.

Table 5.

China: General Government Fiscal Data

article image
Sources: CEIC, Data Co. Ltd.; China Ministry of Finance; NAO; and IMF staff estimates and projections.

Includes central and local governments’ transfers to general budget from various funds, carry-over.

Includes adjustments for local government balance carried forward, redemption of local government bonds prior to 2014 and government bond issued under government managed funds.

Including only revenues/expenditures for the year, and excluding transfers to general budget and carry over.

Includes carry over counted as revenue, adjustments to local government spending, proceeding from issuing special purpose bonds, and net expenditure financed by land sales estimated by subtracting the acquisition cost, compensation to farmers, and land development from the gross land sale proceeds.

The overall net lending/borrowing includes net land sale proceeds as a decrease in nonfinancial assets recorded above the line.

Ministry of Finance debt only, excludes bonds issued for bank recapitalization and asset management companies.

Includes local government bonds and explicit debt.

10% of government contingent debt in 2014. Contingent debt in 2014 is estimated using LGFV total debt minus explicit LG debt of 15.4 Tr. Thereafter, 2/3 of new contingent debt are assumed likely to be recognized as general

Total social capital constribution to SCF and GGFs.

Includes only 2/3 of LGFV debt, being categoried as government explicit debt according to NAO report (2013), and excludes the rest 1/3, being categorized as government guaranteed debt or “possible to be recognized” debt.

Table 6.

China: Non-financial Sector Debt

article image
Sources: CEIC Data Co., Ltd.; Ministry of Finance; and IMF staff estimates.

LGFV debt recognized as LG debt as of 2014 (by the 2014 audit).

New LGFV borrowing estimate for 2015–17 is based on infrastructure fixed asset investment data.

Government guided funds (GGF) and special construction funds (SCF). Social capital portion only. Assumed to be included in corporate debt.

Table 7.

China: Rebalancing Scorecard

article image
Sources: CEIC and IMF staff estimates and projections. Note: The color coding is based on the change in each indicator from 2016 to 2017. Color coding: red if the changes go in the opposite direction of rebalancing; yellow if some progress was observed; and green if there was substantial progress in rebalancing. For indicators that are ratios, changes are measured in simple differences and are considered substantial if larger than 0.5 percentage points. For indicators that are indices and for the credit indicators, changes are measured in annual percent change and are considered substantial if larger than 5 percent

Credit Efficiency: Recent Development and Outlook

In 2017, credit growth—measured as Total Social Financing (TSF) adjusted for local government bond swaps—slowed to 13 percent, down 3.1 percentage points from 2016. Contrary to staff expectations, credit tightening did not translate into slower GDP growth in 2017. Consequently, credit intensity—measured as the amount of credit needed to generate 1 trillion of nominal GDP—improved. Several factors may explain the improvement in credit intensity in 2017.

Credit intensity improved in 2017 but continues to exceed pre-crisis levels

(In RMB trillions)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

1/ Scenarios defined in text below.Note: Credit intensity defined as credit to economy divided by nominal GDP.Source: CEIC and IMF staff estimates.

First, a strong pickup in nominal investment and producer price index (PPI) that helped boost nominal GDP seems to be the main factor behind the credit intensity improvement. After prolonged deflation, producer prices rebounded since mid-2016, growing 6.3 percent in 2017. The increase was potentially caused by: higher foreign demand, the government’s stimulus package supporting infrastructure investment and the real estate market, and—to a limited extent—capacity cuts in coal and steel sectors (APD REO 2018). Higher PPI raised the value of nominal investment and nominal GDP, leading to an improvement in credit intensity. To assess that impact, we analyze two scenarios:

  • Scenario 1. Remove the one-off surge in PPI from the 2017 investment deflator, substituting it with an average post-Global Financial Crisis investment deflator of 1.6 percent. That substitution lowers the 2017 nominal GDP growth by 1.4 percentage points. Credit efficiency still improves, but to a smaller extent than under the baseline scenario.

  • Scenario 2. Calculate real credit intensity (i.e., the amount of real credit needed to produce one trillion of real GDP). Credit is deflated using the investment deflator, an appropriate measure given that the majority of credit was used to finance investment, including household credit, which financed housing rather than consumer spending. The results indicate that credit intensity deteriorated even more between 2011 and 2016 than suggested by the nominal measure. The intensity improved in 2017, but remains high compared to the post-Global Financial Crisis levels.

Second, improvement in credit allocation among the SOEs. While SOEs remain significantly less profitable than private firms and carry more debt, since 2015 the share of loss-making SOEs declined from 28 percent to 24 percent, the ratio of their liabilities to profits has improved, and so did their ROA.

SOEs are performing better, but not as well as private firms

(In percent)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: IMF staff estimates.

Third, the shift towards the “new economy”. Growth has been rebalancing towards service sectors that are less credit intensive (Chen and Kang, 2018). Credit intensity has additionally improved in the “new economy” sectors such as IT and health and pharma.

Credit efficiency improved within new economy sectors

(Lower score means improvement in credit efficiency from 2007 to 2017)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: GFSR and Xie. P. (forthcoming).

The economy continues to shift towards services.

(Share in GDP, in percent)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: CEIC and IMF staff estimates.

What does that mean for China’s nonfinancial sector debt outlook in the medium-term?

  • While the rebalancing towards services is expected to continue, prospects for further improvements in credit efficiency at the firm level are uncertain. They will hinge on progress in SOE reforms and capacity cuts (both of which should result in an exit of the least efficient firms from the market), ensuring a level-playing field for private firms (both foreign and domestic), and allowing credit allocation to be more market-based.

  • Under staff’s baseline scenario, China’s credit intensity is expected to improve from 3.1 (trillion of credit needed to generate 1 trillion of nominal GDP) in 2017 to 2.6 in 2023. That improvement, however, will not be enough to stabilize the credit-to-GDP ratio. To achieve stabilization, staff estimate that credit efficiency would need to improve by at least 5 percent per annum (Scenario A). Such a scenario would require progress on SOE reforms and market-based allocation of credit to most efficient firms. An even bigger improvement in credit efficiency of the worst-preforming industrial sector by 10 percent per annum could allow the debt ratio to stabilize around 2020 and fall thereafter, without jeopardizing growth (Scenario B).

Evolution of credit intensity under alternative scenarios

(In percent of GDP)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: CEIC and IMF staff estimates.

Evolution of nonfinancial sector debt under alternative scenarios

(In percent of GDP)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: CEIC and IMF staff estimates.

Authorities’ Views

15. The authorities attributed the strong economic performance to strengthening fundamentals, supply-side structural reforms and recovering global trade. They noted that leverage had been brought under control, with growth of M2, bank loans and “TSF” (Total Social Financing—a measure of credit to the nonfinancial private sector) slowing significantly. A range of financial de-risking measures had been implemented to minimize regulatory gaps and contain systemic risks. These measures had effectively reduced the size and complexity of the shadow banking sector, and resulted in more appropriate pricing of credit risks. The recovery in industrial profitability reflected the authorities’ “supply-side” structural reforms, in particular, overcapacity reduction and cuts in corporate taxes and fees.

16. The authorities noted that the exchange rate for RMB had been increasingly determined by market forces. They stated that the PBC had not intervened in the FX market for more than a year and that RMB exchange rate flexibility versus the US dollar had increased to that of other Asian emerging market economies. They noted that the RMB had strengthened significantly against the US dollar as well as the basket this year. They disagreed with staff’s assessment of the current account norm, arguing that the norm should be positive given China’s economic fundamentals (as reflected by the previous estimates of the norm). The authorities also indicated that as capital flows became more balanced, they had eased CFMs.

Policies: Resolving Policy Tensions to Deliver High-Quality Growth

17. The authorities’ strategy to shift the policy focus more decisively from high-speed to high-quality growth is welcome. China has the potential to sustain safely strong growth over the long run by addressing the fundamental imbalances in the economy and making economic development more inclusive and greener. The government’s reform agenda contains many of the policies to achieve these goals, especially the renewed commitment to financial regulatory reforms, market-based resource allocation, further opening-up and innovation, and strengthening pollution control.

18. Staff, however, see some tensions. In particular, between the government’s stated development objectives and still-unsustainable debt growth, the pervasive role of the state in the economy, and the relatively restrictive trade and investment regime in some areas. If left unresolved, these tensions could threaten the authorities’ objectives, and a reversion to credit-driven stimulus would further increase vulnerabilities that could eventually lead to an abrupt adjustment. To reduce these tensions and achieve the desired higher-quality growth, two policy imperatives stand out—strengthening underlying drivers for sustainable growth and staying the course of reforms even in the face of a growth slowdown. In particular, the authorities should build on the existing reform agenda and take advantage of the current growth momentum to “fix the roof while the sun is shining” by:

  • Continuing to rein in credit growth

  • Accelerating rebalancing efforts

  • Increasing the role of market forces

  • Fostering openness

  • Modernizing policy frameworks

A. Continuing to Rein in Credit Growth

19. The authorities should stay the course on strengthening macro-financial settings and improving credit efficiency. Notwithstanding the improvement in credit efficiency in 2017, its current level implies that achieving the authorities’ annual and medium-term growth objectives would still depend on further substantial, and unsustainable, increases in debt. This underscores the need to further rein in credit growth and to continue improving credit allocation to reduce the drag on growth from slowing credit expansion. In this context, it is also important to de-emphasize the quantitative annual growth targets given the inherent incentive to rely on pro-stimulus policies that are inconsistent with longer-term development and reform objectives. The indicators used to evaluate the performance of government officials should be revised to reflect the focus on the quality of growth, such as deleveraging, green development and reducing income inequality.

20. Both supply and demand side measures are needed to slow credit expansion and improve its efficiency. On the credit supply side, the authorities should stay the course on strengthening financial regulations. For example, as financial institutions are required to unwind non-compliant asset management products by end-2020, the reintermediation of credit from these products to regular bank loans (which typically require higher capital risk weightings and additional loan-loss provisioning), should gradually weigh on banks’ capacity to extend credit and improve risk differentiation. To further improve the overall efficiency of credit allocation in the economy, harder budget constraints should be imposed on SOEs, especially local SOEs and LGFVs. Regulators should also consider tighter macroprudential settings to rein in the rapid increase in household debt, including more active use of debt service-to-income ratio caps, and widening them to include non-mortgage loans and borrowing via fintech channels.

Local SOE leverage ratio increased in 2017

(In percent)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: China Ministry of Finance, IMF staff estimates.

LGFV sales to cost ratios deteriorated further in 2017

(Density, in percent)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: Wind and IMF staff estimates.

21. Monitoring and formulating policy on deleveraging would be greatly helped by improving transparency on nonfinancial debt. An official series on debt by types of borrowers and creditors, channels of credit, and debt-servicing capacities would be useful in formulating more targeted deleveraging policies to avoid crowding out credit to the more productive parts of the economy. For example, private corporations may rely more on nonbank credit and could be more affected by the regulatory tightening. Care should also be taken to maintain the integrity of debt data as agents may seek to meet the government’s deleveraging objectives in form rather than substance.

22. Fiscal policy should support deleveraging and ease the transition to a new growth model.

  • Under the official, legal-based, definition of the government sector, the fiscal deficit stood at around 3 percent of GDP in 2017, and debt was relatively low (37 percent of GDP) and projected to increase only slightly. But under staff’s, economic-based (“augmented”) definition of the general government sector (including estimated off-budget investment spending), the deficit was around 11 percent of GDP in 2017, and debt was relatively high (68 percent of GDP) and projected to reach 92 percent by 2023.

  • Given that China still has some fiscal space (high savings, favorable terms, rapid growth, strong public assets and positive net financial worth), deficit reduction can be gradual and vary with cyclical conditions. Staff recommend that the augmented deficit be consolidated on average by ½-1 percent of GDP a year to gradually bring the primary balance to the debt-stabilizing level. This consolidation should be via lower off-budget investment, while on-budget deficits should be redirected to support rebalancing.

  • Resolving differences between official general government deficit and debt and staff estimates would boost transparency, policymaking and international comparability of fiscal data. Efforts to resolve these differences should be complemented by improved data on the government’s balance sheet (including government assets), which staff estimate to remain relatively strong.

23. The PBC should expect to gradually tighten monetary policy. Despite some recent tightening, monetary policy remains accommodative. The PBC’s 7-day repo rate has increased only slightly since mid-2017 and remains barely positive in real terms. CPI inflation is expected to pick up to around 2½ percent in 2018. The PBC should prepare to tighten gradually as inflationary pressures start to emerge, with the pace of tightening dependent on data as well as on the impact of other policy measures on inflation. Higher interest rates could also help reduce leverage and limit potential pressure on the exchange rate, but these considerations are secondary as interest rates should not be the primary tool for tackling financial stability concerns or stabilizing the exchange rate.

Current rates below estimated “neutral” levels

(In percentage point)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: IMF staff estimates based on Osorio-Buitron et al (forthcoming).Note: The estimated neutral rate is the real short-term rate consistent with a closed output gap and price stability.

Authorities’ Views

24. The authorities agreed with the need to de-emphasize growth targets. They viewed their growth targets as envisaged rather than binding, and agreed with the need to focus on the quality of development not the speed of growth. This focus would be reflected in public sector performance indicators. They also agreed with the need to stay the course on strengthening macro-financial settings, which was in line with their high priority on preventing major financial risks.

25. The authorities disagreed with staff’s assessment that the monetary policy stance was accommodative. Rather, they saw the current policy stance as neutral given stable growth, inflation and unemployment, and slowing credit expansion. As financial regulatory measures would continue to be effective in reining in credit growth over time, additional monetary tightening was not warranted. The authorities also noted that increased funding costs for financial institutions reflected more appropriate pricing of credit risks, but it did not necessarily lead to higher interest rates for the real economy as the de-risking measures reduced the layers of financial intermediation and the associated cost. They also explained that differentiated policies, such as the targeted reserve requirement ratio (RRR) cuts for inclusive finance last September, aimed to strengthen support for the real economy (e.g. micro and small enterprises and the agricultural sector).

26. While agreeing with the need to continue reining in local government off-budget (noncompliant) spending, the authorities disagreed with staff’s assessment of the fiscal position. They expected the fiscal deficit to fall slightly to 2.6 percent of GDP in 2018, despite cuts in taxes and fees for firms, as a result of continued strong economic growth coupled with greater expenditure control and efficiency. They continued to disagree with staff’s definition of the general government perimeter, noting that under the 2014 Budget Law, local governments did not bear any responsibility for the financial obligations of LGFVs, government-guided funds, or special construction funds. They also noted that local governments’ spending was bound by their revenue envelope and bond allocations while off budget investment was no longer allowed since 2011. They also pointed out that any illegally incurred debt would be borne by the firm and its investors, rather than the government. That said, they did see the need to continue strictly enforcing compliance with the law and preventing off-budget spending by local governments.

B. Accelerating Rebalancing Efforts

27. Slower rebalancing in 2017 underscores the need to accelerate structural reforms. While normalizing PPI inflation and external demand should support resumed rebalancing towards services and consumption, more decisive reforms would improve the quality of growth and prevent the external imbalance growing as investment slows.

China’s social spending is relatively low

(Social spending in percent of GDP)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: Expenditure Assessment Tool, CEIC, IMF staff calculations.

  • Deepening fiscal structural reforms (e.g. making personal income tax (PIT) more progressive, increasing spending on health, education and social transfers, and reforming intergovernmental relations to increase the resources available to local governments) to further boost consumption and reduce income inequality. In particular, the PIT should be reformed by widening the tax base, reducing the personal basic exemption, and removing imputed minimum earnings for social contributions to lower the effective tax rates for the working poor. Recent proposals by the authorities, however, raise the basic exemption and narrow the base by allowing mortgage interest deduction.

    Diverging provinces, 2017

    Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

    Note: A province is considered “diverging” when its per capita GDP in 2016 and per capita GDP growth in 2017 are both below (“lagging”) or both above the national average (“advancing”). The rest are considered converging provinces, excluding Macao SAR, Hong Kong SAR, and Taiwan Province of China.Source: CEIC, IMF staff estimates.

  • Addressing the urban-rural and spatial income inequality by removing barriers to labor mobility and strengthening equalizing fiscal transfers across regions.

  • Imposing a substantial carbon or coal tax to tackle air pollution and climate change. Although China launched a nationwide carbon emissions trading system in 2017 for large industrial users, combining it with a carbon or coal tax would substantially increase the environmental and revenue impact, for example, by including small-scale users.

28. Rebalancing efforts in general reinforce each other but there are also tensions across rebalancing dimensions that could usefully be addressed. For example, the government should increase targeted inter-government transfers to provinces most negatively affected by rebalancing policies such as overcapacity reduction and pollution control, and increase spending on social safety nets. A broader and more holistic approach to rebalancing and structural reforms would help address such tensions as well as the tradeoff between rebalancing and growth.

Policies to address tradeoffs in rebalancing

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

29. Digitalization has the potential to become a long-run growth engine, but emerging risks need to be addressed. The massive scale of the Chinese market and a supportive regulatory and supervisory environment in the early years of digitalization made China a global leader in frontier industries such as e-commerce and fintech. Leveraging existing social-media platforms, China’s fintech services have developed to include services such as third-party payments by non-bank digital providers, internet-based banking and insurance, digital wealth management and credit-ratings, which lowered the costs and broadened the reach of financial services. Notably, large, dominant fintech players in China have branched beyond their traditional niche to other areas of the finance supply chain, building an integrated ecosystem of financial services that link customers with businesses, but also posing regulatory/supervisory challenges. To maximize the long-run benefit of digitalization, the government will need to strike a balance between allowing innovation to develop and flourish, and playing an active role in addressing emerging risks such as privacy infringement and cyber-crimes, promoting competition (including with foreign firms), strengthening protection of intellectual property rights and anti-money laundering, and improving labor training to mitigate potential labor disruption.

China has more internet users than other major economies

(In millions of persons)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: WDI database.

Authorities’ Views

30. The authorities saw continued progress on rebalancing. The improvement in credit efficiency would be sustained, given continued financial de-risking and supply-side structural reform. Both the service sector and consumption contributed more than half of economic growth in 2017, household disposable income per capita accelerated, and the urban/rural income gap continued to narrow. The authorities would carry out more proactive policies to support consumption, employment and income growth, including accelerating personal income tax reform and improving the social security system. Recent reform initiatives on personal income tax, including higher income thresholds for PIT and tax deductions of household mortgage interest, had been submitted to the National People’s Congress. The authorities highlighted the plan to establish a comprehensive, equitable and unified pension system covering both urban and rural residents. They also believed that a carbon market was a good option in controlling greenhouse gas emissions, given China’s current development stage, and noted that the national carbon emissions trading system launched in 2017.

31. The authorities viewed digitalization as an opportunity to modernize China’s economic system. Digitalization had permeated every part of the economy and become a hallmark of China’s new innovation-driven development. To further support this development, policies would focus on expanding and deepening convergence of e-commerce and other areas of the economy, promoting online and offline synergies, developing smart cities, and consolidating resources for electronic government services.

C. Increasing the Role of Market Forces

32. Continued widespread, and from some perspectives increasing, state intervention threatens the goal of high-quality growth. Both direct intervention, via SOEs and government-backed investment funds, and indirect via administrative measures and moral suasion, can crowd out private investment, reduce allocative efficiency, reinforce the perception of implicit guarantees, and increase long-run policy uncertainty.

SOEs structurally less efficient than the private sector

(Return on assets, in percent)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Note: Private ROA is estimated using private industrial enterprises’ total asset and total profit.Source: CEIC, China Ministry of Finance.

SOE assets and share of investment rising

(In percent)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: CEIC.

  • SOE reforms have lagged. While the announced shift from managing SOE operations to managing state capital is welcome, recent measures seem more focused on supporting weak SOEs through debt restructuring, “mixed-ownership” reform (including some partial private sector ownership), and merging with stronger SOEs, rather than on operational restructuring. Despite the structurally weaker efficiency compared to private firms, SOEs’ assets and share of investment have increased.

  • Despite some measures to open healthcare and education to private investment and pilot land reforms to grant more property rights to rural residents, major distortions remain, especially in the services sector and in the markets for land, labor and capital.

  • Structural reforms have often relied more on administrative rather than market-based mechanisms. For example, capacity reduction may have disproportionately affected private firms in some sectors, and the campaign to reduce air pollution caused by coal consumption led to a surge in natural gas prices internationally in the winter of 2017. And while the shantytown renovation program was effective in improving living conditions for low-income households, it may have restrained the needed market adjustments to absorb the excessive housing inventories.

Natural gas price surged in winter 2017

(In RMB thousands per ton)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: CEIC and Bloomberg.

33. Boosting the role of market forces requires:

  • More decisive SOE reform. The focus on managing state capital should be accompanied by measures to keep state shareholders at arm’s length from SOE management, increase dividend payments to the budget, and complete the transfer of SOE social responsibilities to the government. Addressing the SOE debt overhang requires more decisive efforts to recognize underlying bad assets and force more “zombie” firms to exit, with the “flow” of SOE debt controlled by hardening budget constraints and phasing out preferential access to credit and implicit subsidies. Defaults of over-exposed SOEs should be allowed if market forces warrant. Reform of local SOEs could also be boosted by centralized data and monitoring.

  • Accelerating market liberalization. The dominance of the public sector in some “strategically key industries” should be balanced by further market liberalization, particularly in services, and ensuring competition policy is applied equally to state- and privately-owned firms. As reinforced by staff’s visit to the dynamic and prosperous city of Shenzhen, it is private, not public, firms that have driven China’s global leadership in frontier industries such as e-commerce, fintech and hi-tech consumer goods. Labor market flexibility should be improved by further intensifying “hukou” (household residency registration system) reform and enhancing access to social services. Advancing land use rights reform would help address the urban-rural development gap and the land demand-supply imbalance in the housing market.

  • More market-based overcapacity reduction. Reduction in steel and coal capacities has made progress, with significantly higher utilization and profitability, and positive global externalities. However, progress has relied on administrative measures and a more lasting solution would be to rely more on requiring loss-making firms to exit. Care should be taken to ensure that private and smaller firms are not unduly penalized. Greater transparency on data and policies would also help analysis and global understanding and co-operation (e.g. how overcapacity is defined, and targets set and allocated to individual firms). A more market-based approach to developing new industries would also help prevent the creation of new overcapacity in those industries.

  • A more sustainable housing market. The government’s “long-term mechanism for housing” appropriately focuses on addressing fundamental supply-demand imbalances. Ensuring long-run sustainability of the housing market requires increasing land supply for residential housing, promoting rental markets, and reducing the reliance of local governments on land sales. De-emphasizing growth targets would allow housing investment to be driven by long-run fundamentals, rather than the need to manage economic cycles. Staff’s projection indicates that residential investment, a key growth engine over the last decade, will decline as a share of GDP over the medium term as household income and consumption growth moderates.

Residential investment projected to decline to pre-crisis levels

(In percent of GDP)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: IMF staff estimates.

Authorities’ Views

34. The authorities underscored their commitment to allowing market forces to play a decisive role in resource allocation, and saw more progress than staff. On SOE reforms, they pointed out that corporatization of SOEs had been basically completed. Profitability of SOEs had improved significantly and the number of zombie firm bankruptcies had also increased. The authorities noted that all central SOE zombie firms would exit by the end of 2018, central SOEs’ social functions would be phased out by 2020, and overcapacity reduction was proceeding ahead of schedule. They pointed out that the Anti-Unfair Competition Law and the Anti-Monopoly Law applied equally to SOEs and POEs, and to Chinese and foreign companies. The Anti-Unfair Competition Law was recently revised to strengthen the protection of intellectual property, especially trade secrets.

35. The authorities stressed that their plan to develop strategic sectors would be market-based. They explained that the government’s plan to strengthen support for industrial manufacturing resembled those undertaken by governments in advanced economies. The authorities clarified that the government did not set mandatory targets for domestic content. Rather, the goal for self-sufficiency on key basic components and materials was mainly to address potential supply chain disruptions due to some advanced economies’ embargos and restrictions on certain exports to China. They emphasized that domestic and foreign companies would be treated equally in China’s effort to update its industrial sector, noting that industrial policies needed to be market-oriented.

D. Fostering Openness

36. While China has made progress in improving its trade and foreign investment regime, and this progress has accelerated recently, it still appears relatively less open than other G20 EM countries on service sector trade and investment.1

  • Trade in services. Service Trade Restrictiveness Indexes constructed by World Bank staff and by the OECD suggest that China’s restrictions on trade services are relatively high. For instance, the OECD index—which is more up to date—indicates that restrictions are higher for digital networks and transport and distribution supply chains, and mainly driven by restrictions on foreign entry and, to a lesser extent, by barriers to competition and regulatory transparency.

    Services trade restrictiveness has improved, but remains relatively high

    (Index; 1= closed)

    Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

    Note: The OECD Services Trade Restrictiveness Index (STRI) is a evidence-based index capturing services trade barriers in 22 sectors across 44 countries, representing over 80% of global services trade. Specifically, the STRI quantifies restrictions on foreign entry and the movement of people, barriers to competition, regulatory transparency and other discriminatory measures that impact the ease of doing business. The median index is reported taking a value between zero (complete openness to trade and investment) and one (total market closure to foreign services providers). See http://www.oecd.org/tad/services-trade/services-trade-restrictiveness-index.htm for further information.Source: OECD stat.

    FDI regulatory restrictiveness index has fallen in China

    (Index; 1= closed)

    Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

    Note: The FDI Regulatory Restrictiveness Index (FDI Index) measures statutory restrictions on foreign direct investment in 68 countries, including all OECD and G20 countries, and covers 22 sectors. The statutory restrictions cover the following areas: (i) foreign equity limitations; (ii) discriminatory screening or approval mechanisms; (iii) restrictions on the employment of foreigners as key personnel, and (iv) other operational restrictions (e.g., on branching, capital repatriation, or land ownership by foreign-owned enterprises). See http://www.oecd.org/investment/fdiindex.htm for further information.Source: OECD Stat.

  • Foreign direct investment (FDI). Despite some improvement in recent years, China’s FDI restrictions are higher than in other G20 EM countries according to the OECD FDI Regulatory Restrictiveness Index. The restrictions mainly affect the services sector (Figure 9). China’s FDI as a share of GDP has also fallen in recent years. Recent announcements to lower entry barriers for foreign investment in the financial and automotive sectors and loosen the “negative list” of sectors that are off-limits to foreign investors are welcome, but more is needed.

    China’s FDI is trending down and below EM average

    (In percent of GDP)

    Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

    Source: IMF WEO database.

Figure 1.
Figure 1.

Recent Developments and Outlook: Solid Growth Momentum

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Figure 2.
Figure 2.

Rebalancing: Uneven Progressy

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Figure 3.
Figure 3.

Credit: Credit Gap Narrows but Remains Large

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Figure 4.
Figure 4.

Monetary: Money Market Rates Rose

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Figure 5.
Figure 5.

Fiscal: Continued Loosening in 2017

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Figure 6.
Figure 6.

External: Outflow Pressure Abated

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Figure 7.
Figure 7.

Banking: Sharp Slowdown in Asset Growth

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Figure 8.
Figure 8.

Financial: Tighter Financial Conditions

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Figure 9.
Figure 9.

Cross-Country Comparison on FDI Regulatory Restrictiveness

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: OECD stat.Note: The FDI Regulatory Restrictiveness Index (FDI Index) measures statutory restrictions on foreign direct investment across 22 economic sectors in 68 economies. It gauges the restrictiveness of a country’s FDI rules by looking at the four main types of restrictions on FDI: 1) Foreign equity limitations; 2) Discriminatory screening or approval mechanisms; 3) Restrictions on the employment of foreigners as key personnel and 4) Other operational restrictions, e.g. restrictions on branching and on capital repatriation or on land ownership by foreign-owned enterprises. Restrictions are evaluated on a 0 (open) to 1 (closed) scale. The overall restrictiveness index is the average of sectoral scores. The discriminatory nature of measures, i.e. when they apply to foreign investors only, is the central criterion for scoring a measure. State ownership and state monopolies, to the extent they are not discriminatory towards foreigners, are not scored. The FDI Index is not a full measure of a country’s investment climate. A range of other factors come into play, including how FDI rules are implemented. Entry barriers can also arise for other reasons, including state ownership in key sectors. A country’s ability to attract FDI will be affected by others factors such as the size of its market, the extent of its integration with neighbours and even geography among other. Nonetheless, FDI rules can be a critical determinant of a country’s attractiveness to foreign investors. See http://www.oecd.org/investment/fdiindex.htm

37. China, as one of the main beneficiaries of the global trading system, has a strategic interest in playing a leading role in defending it. Doing so also means accelerating China’s opening-up, maintaining progress in reducing the current account surplus, and continuing to seek to resolve trade disputes through established mechanisms (e.g. World Trade Organization dispute settlement) or negotiation.

  • Accelerating opening-up. Faster opening-up would support China’s own high-quality growth agenda by increasing productivity via greater competition and foreign technology. This requires decisively addressing the distortions that still beset China’s economy and affect trade and cross-border flows, and promptly implementing, and going beyond, announced opening-up measures. The focus should be on a level playing field for domestic and foreign companies, including by reducing entry barriers, greater protection of intellectual property, and equal access to resources and treatment in regulations, government procurement and administrative approvals.

  • Further reducing the external imbalance. While the RMB in 2017 was broadly in line with economic fundamentals and desirable policies, the current account surplus was moderately stronger. This reflects structural distortions and policies that cause excessive savings, such as low social spending. Addressing these distortions and the resulting external imbalance would benefit both China and the global economy.

  • Mitigating trade tensions. All parties should seek a resolution that supports and strengthens the international trading system and the global economy. In this regard, avoiding exceptional measures and ensuring trade actions are well-grounded in WTO rules would help reduce the risk of escalation and undermining established dispute settlement mechanisms.

Authorities’ Views

38. The authorities reiterated China’s commitment to free trade and multilateralism, despite the trade tensions with the U.S. They indicated that it was in China’s own interests to further open the economy and increase imports, and they saw the U.S. trade actions against China a violation of the basic principles and spirit of the World Trade Organization (WTO). They added that unilateral trade moves would also impede the efficient operation of global value chains and result in welfare losses for all countries and consumers involved.

39. The authorities underscored China’s substantial and continuous opening-up, and disagreed that their trade and investment regime was relatively restrictive.

  • As a major contributor to global trade, China accounted for 24 percent of global goods imports growth and 20 percent of global services import growth over the last ten years.

  • China’s overall tariff level had declined from 15.3 percent before joining the WTO to currently 9.8 percent, far lower than that of many developing countries.

  • Trade facilitation had improved strongly, for example, with a “one-stop shop” for customs clearance and active implementation of the recent WTO Trade Facilitation Agreement.

  • Out of 160 sub-sectors of 12 broad sectors of the WTO General Agreement on Trade in Services, China has committed to opening 100 sub-sectors of 9 broad sectors, close to the advanced country average of 108 sub-sectors.

  • Recent measures included lowering many entry barriers for foreign investment, for example, in financial services, significant tariff reductions on autos and many consumer items, and pilot projects to develop services trade. Protection of intellectual property rights of foreign firms had been strengthened recently, for example, with concerted strikes against violators in Q4 2017. China’s commitment to further opening-up had recently been reaffirmed by President Xi in April.

40. The authorities did not support staff’s use of trade and investment restrictiveness indicators from the OECD. As China is not an OECD member, the authorities were not in a position to assess the methodology and source of such indicators, which they did not think reflected China’s recent opening-up efforts. They were also of the view that countries had different characteristics in their opening-up, which simple indicators would not fully represent. The authorities noted that these indicators were only in an IMF Working Paper which had not been formally discussed by or broadly consulted with the Executive Board of the IMF, and argued against using such indicators for surveillance.

E. Modernizing Policy Frameworks

41. Implementing the high-quality growth agenda requires modernizing policy frameworks. While there has been some progress, for example by abolishing quantitative monetary targets, merging the local and central tax administrations, and instituting a high-level financial oversight committee, there is still much reliance on administrative measures. Policies would benefit from more holistic, market-based and transparent policy frameworks.

A More Holistic Approach to Financial Regulation

42. The newly established FSDC should develop an ambitious agenda aimed at strengthening regulatory and macroprudential policy framework. The key priority is to foster and coordinate inter-agency efforts to assess the evolution of systemic risks. This requires the development of frameworks to identify and measure underlying mechanisms of risk transmission within the financial sector and between the financial sector and the real economy. While the recent reorganization of regulatory agencies can enhance supervisory effectiveness, care should be taken to ensure continued rigorous supervision, and the PBC will need to build its capacity to formulate regulations. Implementing the new regulations over asset management products will need to be closely coordinated across regulators to ensure that no gaps emerge. Banking system capital should be enhanced—in particular, there should be no further delay in identifying domestic systemically important banks and imposing an additional capital requirement.

43. A roadmap clearly laying out the sequence of reforms (in line with the FSAP recommendations) could help guide market expectations and an orderly repricing of risks. In particular, the authorities should design and implement a well-sequenced action plan to remove implicit guarantees, without which financial risks will eventually re-emerge. Also important is a transparent macroprudential framework to clearly define the design and activation of individual policy instruments depending on the type of systemic risks that needs to be brought under control.

Alignment of Recent Reforms with FSAP Recommendations

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

44. Fintech is developing rapidly and challenging financial regulators globally, with China at the forefront in many dimensions. The authorities have taken a range of actions to establish a comprehensive regulatory framework, including setting up a fintech committee to coordinate among regulators and industry, adopting a “substance over form” approach to close regulatory gaps, a centralized clearing house for third-party payments, and banning initial coin offerings. Given the transformative nature of fintech, regulators will need to stay nimble to head off emerging risks, for example, by strengthening data gathering/analysis and “know-your-customer” requirements for third-party payments.

Authorities’ Views

45. The authorities agreed with staff on the importance of staying the course on regulatory efforts. They were confident that the new institutional framework would ensure smooth coordination among the regulators. The guidelines to regulate the asset management businesses of financial institutions and the rules on liquidity risk management of commercial banks had been announced; phase-in periods were already locked-in and granted financial institutions the necessary time to adapt their business models to the new rules. In particular, banks would need to increase capital and change their funding modalities as they brought nonstandard credit assets previously channeled through asset management products back into their own balance sheets.

46. On fintech, the authorities saw the need to balance between regulation to prevent risk and promotion of innovation, but that currently their focus was on the former. Recognizing that China’s uniquely dominant hybrid technology/financial companies could have large spillovers to the financial system and the real economy, the authorities had embarked on a set of regulatory initiatives to streamline data collection and strengthen regulatory oversight. The regulatory framework was guided by the need for a level playing field for all payment service providers, the recognition of substance over form to ensure financial service provision fell under regulatory purview, and the desire that these services supported financial inclusion and did not jeopardize financial stability. Also, large fintech companies that posed systemic risks (e.g. to the payments system) would be treated as Systemically Important Financial Institutions (SIFIs).

A More Market-Based Monetary and Exchange Rate Policy Framework

47. China’s transition to a more market-based economy requires continued progress in modernizing the monetary policy framework. Recent progress, including dropping the quantitative M2 and TSF targets and further liberalization of bank deposit rates, should be built upon by giving the PBC operational independence and accountability around a clear inflation objective and an explicit policy rate and corridor, and dropping benchmark rates and window guidance. The framework would be strengthened by simplifying liquidity management so that policy actions are focused on the key policy rate―the seven-day interbank reverse repo rate―and policy rates for different tenors of open market operations and liquidity facilities are allowed to adjust automatically. The PBC’s intention, summarized in its recent public statement, to further increase its information disclosure and make its policymaking process more transparent is welcome―actions should include holding regular press conferences, publishing macroeconomic forecasts, and making available more information in English.

48. Two-way exchange rate flexibility should continue to increase and be supported by more concrete steps to deepen the foreign exchange market.

RMB volatility still low compared to other EM currencies

(Standard deviation of percent changes in exchange rates)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: Datastream and IMF staff calculations.Note: Chart shows the standard deviation of daily percent changes in the exchange rates for each month.

  • The central-parity mechanism for the daily trading band should be transparent and mechanical, with the exchange rate influenced by foreign exchange market intervention and public communication when necessary, rather than by administrative measures (e.g. the countercyclical adjustment factor introduced in May 2017).

  • Similarly, capital flow management measures, including the “macroprudential framework for managing cross-border flows”, should not be used to actively manage the capital flow cycle and substitute for exchange rate flexibility in line with the IMF’s Institutional View on capital flows. Necessary supporting reforms (effective monetary policy framework, sound financial system, reduced fiscal dominance, and exchange rate flexibility) should be prioritized to support the removal of CFMs and further capital account liberalization. At the same time, further capital account opening, especially for portfolio flows, while desirable over the medium term, should be carefully sequenced and targeted. CFMs should be consistently and transparently enforced and clearly communicated. Publishing information on PBC’s foreign exchange intervention (as is the practice in most other G20 countries) would improve market understanding and strengthen the credibility of the policy framework.

Authorities’ Views

49. The PBC argued that price stability was a primary, but not the only, objective of monetary policy. As China remained an economy in transition, price stability was given high importance when making monetary policy decisions, but other objectives had to be considered, including growth, employment, balance of payments, and financial stability. On monetary policy, the authorities indicated that they were making progress in moving to a market-based system where interest rates played an increasingly important role relative to quantities. For instance, the 2018 “Government Work Report” did not set a quantitative target on M2 growth. They indicated that the market-based system needed time to develop and that the dropping of benchmark rates should be done in a gradual and orderly manner. They also indicated that they would further improve transparency and communication along with continued reforms.

50. The PBC agreed that FX flexibility should continue to increase. They indicated that they would continue to improve the functioning of the FX market and further enhance exchange rate flexibility to keep the currency at a reasonable level consistent with equilibrium in the balance of payments. On the daily central parity mechanism, they explained that previously there were irrational and self-fulfilling depreciation pressures on the currency and the countercyclical factor had helped to better reflect macroeconomic fundamentals. However, the factor did not have a decisive role in determining the value of the currency and had been set back to zero.

51. The authorities agreed with staff that CFMs should not substitute for exchange rate adjustment. They noted they had made the CFM policy framework more transparent and price-based, and they intended to use CFMs as an additional macroprudential policy tool to address the buildup of systemic risks arising from capital flows, which they considered to be highly pro-cyclical. They also noted that systemic risks should be addressed with macroeconomic adjustment as the first line of defense, including by allowing the exchange rate to adjust. The authorities stated that CFMs should only be used under exceptional circumstances, and be promptly reversed after the exceptional circumstances disappeared. Meanwhile, they underscored that market forces could create major distortions over financial cycles (e.g. due to herding behavior), contributing to the buildup of financial stability risks associated with capital flows. In their view, these circumstances resembled those of the Asian Crisis where standard policy tools could not fully address the systemic risks.

Fiscal Structural Reforms

52. The announced measures to address the misalignment of center-local fiscal responsibilities are welcome, though the gap remains large. Additional measures should be considered, including greater assignment of revenue raising to local governments (e.g. a recurrent property tax), further sharing/transfer of spending responsibilities to the central government (e.g. pensions/employment insurance), and expanding rules-based transfers from the central government to support the least-developed and vulnerable regions.

Large local government revenue/expenditure gap remains

(In percent of GDP)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: CEIC.

53. Reforms to strengthen fiscal discipline should be deepened through a careful sequencing of policies. These should include: (1) identifying non-commercial off-budget local government investment (for example, financed by LGFVs and government guided funds) (2) moving such investment on budget with correspondingly larger local government bond allocations and (3) carefully dismantling implicit guarantees on the remaining projects. This should be accompanied by greater coordination between agencies on investment projects to ensure all government spending is done on-budget.

Authorities’ Views

54. The authorities noted that the recent Party Congress had set a comprehensive plan to modernize the fiscal framework. The plan had three important aspects: a clearer central-local fiscal relationship and responsibility that also fostered balanced regional development, a more transparent budget system (including a performance review system), and strengthening the tax system. Central-local fiscal relationship reforms were being carried through sequentially. Further sharing of fiscal and expenditure responsibilities between central and local governments and improving inter-government transfers were under discussion, and a property tax was also being considered.

The Belt and Road Initiative (BRI)

55. The BRI has great potential for both China and participating countries. It could fill large and long-standing infrastructure gaps in partner countries, boosting their growth prospects, strengthening global supply chains and trade, and increasing employment. In addition to more opening up by China, the success of the Initiative would be boosted by: a clearer overarching framework governing BRI investment, better coordination and oversight, more focus on debt sustainability of the partner countries, and a transparent mechanism for dealing with project disputes, non-performance and debt service problems, as well as more open procurement and greater transparency over contracts. Supporting capacity development in BRI participating countries (as is part of the agenda of the new China-IMF Capacity Development Center) would also help deliver the economic benefits of investment.

Governance indicators for BRI recipient countries, percentiles

(Number of BRI countries in each percentile of a given measure noted above bars; lower percentile indicates lower score for governance)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Note: Perception-based measures, summarizing the views of enterprises, citizens and expert survey respondents on the quality of governance in a country. The Control of Corruption measure compiled from survey institutes, think tanks, NGOs, international organizations and private sector firms drawing on a range of survey sources, subject to a margin of error.Source: http://www.govindicators.org and IMF staff estimates.

Authorities’ Views

56. The authorities agreed with staff on the potential benefits from the BRI and policies to maximize them while managing risks, but thought staff had overstated concerns. In their view, project selection and governance were decisions of market entities and were already strong, though they saw scope for further enhancing coordination among agencies and risk assessment.

Data

57. Data gaps should be urgently addressed. Recent efforts to improve data integrity, especially the plan to have the National Bureau of Statistics take over production of provincial economic data, are encouraging. However, major macroeconomic data gaps remain, including the lack of expenditure-side real GDP disaggregation, problematic deflation methods, and fiscal data that fall well short of international standards. These gaps undermine policymaking and credibility, IMF surveillance, and G20 commitments.

Authorities’ Views

58. The authorities agreed with the need to further improve data, while noting the recent progress. Full implementation of the System of National Accounts (SNA) 2008 was progressing as was the rollout of the system to make local-level statistics consistent with those at the national level. Data deficiencies on expenditure-side GDP made publishing details impractical at this time and could confuse the public. Therefore, production-side GDP remained the key gauge of aggregate activity.

Outlook and Risks

59. Growth is projected to moderate to 6.6 percent in 2018. The moderation reflects the lagged effect of regulatory tightening and the softening of external demand. Headline inflation is expected to rise gradually to around 2½ percent, while PPI inflation would moderate. The current account surplus is projected to narrow marginally to 0.9 percent of GDP in 2018, driven by deteriorating terms of trade.

60. Staff’s baseline assumes that the authorities remain committed to their 2020 GDP target, but would allow faster growth deceleration thereafter.

  • Reforms such as financial de-risking and environmental control will likely weigh on GDP, and productivity gains through structural reforms and digitalization will take time to materialize. The authorities will likely need to maintain strong credit growth to meet their growth targets, which would come at the cost of further increases in nonfinancial sector debt. Alternatively, if the authorities move more decisively to resolve the policy tensions now and focus on higher-quality growth and a greater role for the market, near-term growth would be weaker but longer-term growth would be stronger and more sustainable.

    Faster reform progress could pave the way for higher and more sustainable GDP growth

    (In percent, year-on-year growth)

    Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

    Sources: CEIC and IMF staff estimates and projections.

  • The illustrative “proactive” scenario features faster reform progress, particularly SOE reform and resolving zombie firms. Under such a scenario, growth slows in the near-term due to labor displacement but rebounds in the medium-term on the back of faster TFP growth by about 1 percentage point. Rebalancing from investment to consumption also accelerates. A temporary fiscal stimulus package with resources to support rebalancing could help cushion the near-term adverse impact.

61. Risks are tilted to the downside. On the positive side, growth could be stronger if previous reforms gain greater traction in enhancing productivity and the private sector proves more dynamic than expected. But a lack of decisive reforms in deleveraging and rebalancing would add to the already-high stock of vulnerabilities and worsen resource allocation, leading to more rapidly diminishing returns over the medium term. This scenario also raises the probability of a disruptive adjustment to Chinese demand which would result in a contractionary impulse to the global economy, as well as spillovers through commodity prices and financial markets. The major near-term risks are:

  • Financial. Uncoordinated financial and local government regulatory action could have unintended consequences that trigger disorderly repricing of corporate/LGFV credit risks, losses for investors, and rollover risks for financial institutions.

  • Trade and foreign investment. While the initial direct effects of tariff measures on Chinese exports announced by the U.S. seem limited, escalating tariffs and investment restrictions could disrupt supply chains, have knock-on effects on global financial markets, and weaken confidence and investment in China and the rest of the world. This could be coupled with a generalized rise of protectionism and an ensuing slowdown in global trade.

    Foreign debt outstanding by Chinese entities surged in 2017

    (In USD billions)

    Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

    Source: BIS.

  • Capital flows. Large outflows and pressure on the exchange rate could resume due to tighter and more volatile global financial conditions, especially a surging dollar. Investor sentiment towards emerging markets has recently weakened, and this could intensify, potentially spreading to China.

Authorities Views

62. The authorities broadly agreed on the outlook for growth, but were more sanguine on that for debt and associated risks. They were confident that the 2018 target of real GDP growth of around 6.5 percent was within reach, as was the target of doubling 2010 real GDP by 2020. CPI inflation would remain contained, despite the upward pressure due to rising commodity prices. They viewed downside risks in the near- to medium-term as mostly external in nature, especially heightened trade tensions with the U.S., a global rise in protectionism, and market volatility due to faster-than-expected monetary policy normalization in the U.S. and sharp dollar appreciation. Leverage had stabilized and should not pose major risks.

Staff Appraisal

63. The economy continues to perform strongly and reforms progressed in several key areas. Output growth picked up, CPI inflation remained subdued, corporate profits improved, and unemployment fell. Financial sector de-risking accelerated, with a wide range of decisive measures adopted; credit growth slowed; overcapacity reduction progressed; anti-pollution efforts intensified; and opening-up continued.

64. Rebalancing continued, but slowed in several dimensions. Growth became less dependent on credit and the current account surplus continued to fall, but exports rather than consumption drove the growth pick up. The external position is assessed as moderately stronger than the level consistent with medium-term fundamentals and desirable policies, due mainly to structural distortions, with the exchange rate broadly in line. Credit expansion remains excessive.

65. Risks are tilted to the downside. On the positive side, growth could be stronger if previous reforms gain greater traction in enhancing productivity and the private sector proves more dynamic than expected. On the negative side, key near-term risks include disorderly repricing of credit risks in the financial market, escalating trade tensions, and resumed pressure on capital outflows. The longer-term outlook depends on the policies deployed to achieve the authorities’ goals—determined market-based reforms could lead to sustained, stable, and still-strong growth, whereas continued state- and credit-driven policies will likely further build up risks, raising the likelihood of an eventual abrupt adjustment and dimming long-term growth prospects.

66. The authorities’ strategy to more decisively shift the policy focus from high-speed to high-quality growth is welcome. Its success requires addressing the policy tensions between, on the one hand, the stated goals of stabilizing leverage, allowing market forces a decisive role, and greater innovation and opening-up, and, on the other, still-unsustainable debt growth, the pervasive role of the state in the economy, and the relatively restrictive trade and investment regime in some areas.

67. The authorities should stay the course on tightening macro-financial settings to continue to rein in credit growth. Critically this includes following through on stated intentions to de-emphasize growth targets and not loosening credit if growth falls below target. Continuing financial regulatory reforms, curbing household borrowing and reining in off-budget local government investment would help deliver a more sustainable growth path.

68. Rebalancing efforts should be accelerated. Greater increases in health, education and social transfers, financed by taxes on income, property and carbon emissions, would support consumption, and reduce income inequality and pollution. A more comprehensive approach to structural reforms, such as increasing transfers to the regions most affected by overcapacity reduction or pollution control, could help address the tensions across rebalancing dimensions.

69. Market forces should be allowed to play a more decisive role. This means reducing the dominance of the public sector in many industries, opening up more markets to the private sector, and ensuring fair competition. Structural reforms should be more market based to increase their effectiveness.

70. To be an effective and credible leader of globalization, China should continue to address the distortions that still beset its economy and affect cross-border trade and investment. China would benefit from exposing sheltered sectors and firms to more domestic and foreign competition, ensuring a level playing field, and better protecting intellectual property rights. All parties should seek a resolution to trade tensions that supports and strengthens the international trading system and the global economy. In this regard, avoiding exceptional measures and ensuring trade actions are well-grounded in WTO rules would help reduce the risk of escalation and undermining established dispute settlement mechanisms.

71. Implementing the high-quality development agenda requires modernizing policy frameworks. Financial sector reforms have made strong progress recently—this should be continued, for example, by letting the new institutional structure of financial supervisors take a more holistic, forceful and coordinated approach. Monetary policy should continue to become more price-rather than quantity-based, and the exchange rate should continue to become more flexible. The central government should share more of local governments’ spending responsibilities while increasing their ability to raise their own revenues. Policymaking would also be improved by further strengthening China’s still weak macroeconomic data.

72. The exchange rate should continue to become more flexible, and reforms to support the removal of CFMs and further capital account liberalization should be expedited. CFMs should not be used to actively manage the capital flow cycle and substitute for exchange rate flexibility, and should be phased out over time as supporting reforms increase the economy’s ability to handle greater capital flow volatility. CFMs should be consistently and transparently enforced, and clearly communicated. Publishing foreign exchange intervention would improve market understanding and strengthen credibility of the policy framework.

73. The Belt and Road Initiative is a welcome and potentially transformative initiative. Its success will be enhanced by having an overarching framework, with better coordination and oversight, more open procurement and due attention to debt sustainability in partner countries.

74. China should urgently address macroeconomic data gaps to further improve data credibility and policy making.

75. It is proposed that the next Article IV consultation with China take place on the standard 12-month cycle.

Table 8.

China: SOE Performance

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Sources: WIND, NBS, Ministry of Finance.

Number of zombies refers to legal entities of central SOEs.

There are 98 central SOEs and 44000 legal entities affilicated to these SOEs by 2017.

Appendix I. External Sector Report

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Appendix II. Risk Assessment Matrix1

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Appendix III. Implementation of Main Recommendations of the 2017 Article IV Consultation

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Appendix IV. Implementation of Main Recommendations from the 2017 FSAP

The authorities launched comprehensive regulatory and institutional reforms that are closely aligned with the recommendations of the recent 2017 Financial Sector Assessment Program (FSAP). The reforms are all-encompassing and affect the organization, management, and oversight of the financial sector. Their main objectives are to improve interagency coordination, close regulatory and supervisory gaps, and contain systemic risks.

The reforms can be grouped into two broad categories. First, the government initiated an institutional reorganization that merged the insurance and banking regulators and transferred some regulatory formulation powers to the People’s Bank of China (PBC). The newly created financial stability and development commission (FSDC) will further enhance coordination, information sharing, and the monitoring of systemic risks. Second, significant new regulations on financial intermediaries and their activities are being phased in gradually, including the guideline on asset management business new bank liquidity requirements, and a new framework for the evaluation of insurance companies. Recent microprudential regulations are also aligned with FSAP recommendations and include measures to limit the growth of WMPs; measures aimed at reducing bank reliance on negotiable certificates of deposit; changes in loan loss provisioning rules and measures to facilitate disposal of NPLs; and other measures, such as those aimed at strengthening the management of entrusted loans.

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Appendix V. Debt Sustainability Analysis

Because of uncertainty about the perimeter of general government, the debt sustainability analysis assesses government debt under both official “budgetary” and staff’s estimated general government “augmented” definitions. While official budgetary government debt remains low and sustainable, “augmented” debt is high and on an upward trajectory. The results reflect a slight improvement of debt dynamics compared to last year’s DSA, but still suggest risks of debt stress at the augmented level. The risk of debt stress depends fundamentally on public investment via off-budget spending of local governments and LGFVs.

China’s public debt sustainability analysis (DSA) is based on the following assumptions:

  • Public debt coverage. Two definitions of debt are used. The main difference is the coverage of local government debt.

    • ○ The budgetary coverage scenario includes central government debt and “on-budget” local government debt identified by the authorities. For 2004–13, general government debt includes central government debt and local government bonds (issued by the central government). From 2014, general government debt includes central government debt and explicit local government debt (which consists of local government bonds and other recognized off-budget liabilities incurred by end-2014). The change of definition in 2014 is mainly a result of the change of official data coverage when 2/3 of LGFV debt was explicitly recognized as government liability.

    • ○ “Augmented” debt is used in the broad coverage scenario. It adds other types of local government borrowing, including off-budget liabilities borrowed by Local Government Financing Vehicles (LGFVs) via bank loans, bonds, trust loans and other funding sources, estimated by staff. It also covers debt of government-guided funds and special construction funds, whose activities are considered quasi-fiscal. The augmented deficit is the flow counterpart of augmented debt. Augmented data are staff’s best estimate of general government data. Data limitations mean some nongovernment activity is likely included, and some LGFV and funds may end up having substantial revenues. It is also possible that some general government activity takes place outside of staff’s augmented definition (e.g. PPPs).

  • Macroeconomic assumptions: The projection reflects a gradual slowdown of real GDP growth to 5.5 percent y/y by 2023 and GDP deflator growth of about 2.3 percent. The fiscal assumptions differ in the scenarios with budgetary government debt or augmented debt.

    • ○ Fiscal balance in the budgetary coverage scenario. This scenario assumes all spending is done within the confines of the budget, and thus that the new budget law is strictly implemented and off-budget public investment is sharply reduced. Under this scenario, primary fiscal deficits are assumed to decline from 3.0 percent of GDP in 2017 to 2.8 percent of GDP in 2023, driven chiefly by the assumption of a gradual decline in managed funds’ spending financed by land sales while the remaining on-budget primary balance remains flat.

    • ○ Fiscal balance in the augmented scenario. Off-budget local government spending is assumed to decline only marginally. The augmented primary deficit, which includes the on-budget fiscal deficit and off-budget spending financed by LGFV debt and government funds, is projected to decline from around 7.9 percent of GDP in 2017 to around 5.7 percent of GDP by 2023. Augmented expenditure to GDP ratio is projected to decline owing to: (i) lower expenditure financed by net land sales; and (ii) the authorities’ reforms to limit local government borrowing.

    • ○ Local government financing. While many local governments relied on net revenue from land sales and LGFV borrowing to finance their investment in the past, the DSA assumes that future financing needs will be increasingly met by bond issuance, in line with the authorities’ plan to replace all local government debt with bonds within three years.

    • ○ Interest rates and amortization. The interest rates for central government and local government bonds are assumed to be about 3–4 percent (in line with historical average). The interest rates of off-budget borrowing (only in the augmented scenario) are assumed to be about 6–7 percent (based on the yield differential between sovereign bond and LGFV bank loans and other short-term instruments). Staff assume all maturing debt will be rolled over, although we note a front loading of refinancing due to the ongoing swap3 of legacy LGFV loans for LG bonds.

In the narrow-coverage scenario, budgetary government debt is on a slightly increasing path.

  • Government debt under narrow coverage at 37 percent of GDP in end-2017 is on a slightly increasing path to 43 percent of GDP in 2023, to which a favorable growth-interest rate differential contributes. Off-budget local government spending is assumed to stop immediately after the implementation of the new budget law in 2015.

In the broad-coverage scenario, augmented debt continues to rise rapidly and consolidation would be needed to prevent it from stabilizing at a very high level.

  • Augmented debt rises to about 92 percent of GDP in 2023 from around 68 percent of GDP in 2017. This is because the broad-coverage scenario assumes that local-government off-budget spending continues after 2015 (although expected to decline gradually in the medium term).

China faces relatively low risks to debt sustainability for the budgetary government; however, off-budget activities pose large risks to debt sustainability in augmented debt.

  • In the narrow-coverage scenario, budgetary government debt remains relatively low at a still reasonable level in all standard stress tests except for the scenario with contingent liability shocks. A contingent liability shock in 2019 will result in a sharp increase from about 37 percent of GDP in 2017 to above 60 percent of GDP in 2019.4 While the budgetary debt level is still manageable, the authorities would potentially have to deal with an increase in gross financing needs that could be sensitive to market financing conditions and may entail rollover risks

  • In the broad-coverage scenario, the augmented debt level is also sensitive to macro-fiscal shocks. Combined macro-fiscal shocks would push debt to above 100 percent of GDP in 2023.

China’s debt profile will largely depend on the implementation of the new budget law and, more fundamentally, on efforts to reduce public investment.

  • Based on the projected debt dynamics under the narrow coverage, China’s debt profile is still manageable, especially given that it is mostly domestically financed.

  • However, the debt profile crucially depends on the off-budget activities. Implementation of the new budget law is crucial, as it determines whether debt dynamics will be closer to the narrow-coverage scenario or broad-coverage scenario. If the new budget law is strictly implemented and future LGFV borrowing will be completely on a commercial basis, debt-to-GDP will rise only gradually and stabilize. If local governments continue to incur off-budget liabilities, the debt profile will move closer to that in the broad-coverage scenario and the debt-to-GDP ratio will continue to rise in the medium term and only stabilize at very high levels. Fiscal risks may also arise from new financing avenues that have emerged, such as PPPs.

Figure 1.
Figure 1.

China: Public Sector Debt Sustainability Analysis (Budgetary Government Debt)

(In percent of GDP, unless otherwise indicated)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: IMF staff.1/ Public sector is defined as general government as per authorities definition.2/ Based on available data.3/ Long-term bond spread over U.S. bonds.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r − π(1+g) − g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r − π (1+g) and the real growth contribution as −g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).8/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.
Figure 2.
Figure 2.

China: Public DSA—Composition of Budgetary Government Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

1/ The contingent liability shock scenario also assumes that 10 percent of banking assets would turn into government liabilities.
Figure 3.
Figure 3.

China: Public DSA (Budgetary Government) – Realism of Baseline Assumptions

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source : IMF Staff.1/ Plotted distribution includes all countries, percentile rank refers to all countries.2/ Projections made in the spring WEO vintage of the preceding year.3/ China has had a cumulative increase in private sector credit of 41 percent of GDP, 2014–2017. For China, t corresponds to 2018; for the distribution, t corresponds to the first year of the crisis.4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.
Figure 4.
Figure 4.

China: Public DSA (Budgetary Government) – Stress Tests

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: IMF staff.
Figure 5.
Figure 5.

China: Public DSA (Budgetary Government) – Risk Assessment

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: IMF staff.1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white.Lower and upper risk-assessment benchmarks are:200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.4/ Long-term bond spread over U.S. bonds, an average over the last 3 months, 11-Jan-18 through 11-Apr-18.5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.
Figure 6.
Figure 6.

China: Public Sector Debt Sustainability Analysis (Augmented Debt: Broad Coverage)

(In percent of GDP unless otherwise indicated)

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: IMF staff.1/ Public sector is defined as the Augmented public sector.2/ Based on available data.3/ Long-term bond spread over U.S. bonds.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r − π(1+g) − g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r − π (1+g) and the real growth contribution as −g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).8/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.
Figure 7.
Figure 7.

China: Public DSA — Composition of Augmented Debt (Broad Coverage) and Alternative Scenarios

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Figure 8.
Figure 8.

China: Public DSA (Augmented Debt: Broad Coverage) – Stress Tests

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: IMF staff.
Figure 9.
Figure 9.

China: Public DSA (Augmented Debt: Broad Coverage) – Risk Assessment

Citation: IMF Staff Country Reports 2018, 240; 10.5089/9781484370797.002.A001

Source: IMF staff.1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white.Lower and upper risk-assessment benchmarks are:200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.4/ Long-term bond spread over U.S. bonds, an average over the last 3 months, 11-Jan-18 through 11-Apr-18.5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.

Appendix VI. Assessment of the Authorities’ Approach to Managing Capital Flows

Capital outflows moderated in 2017 following a surge in 2015–16. Capital flows management measures (CFMs) adopted to manage the surge have generally been eased. The authorities have also adopted a more transparent ‘macroprudential assessment’ framework to help deal with capital flows. The easing of CFMs since the last Article IV Consultation was broadly in line with the Fund’s Institutional View (IV) on capital flows given the progress made in the underlying supporting reforms. Implementing reforms that support the liberalization process remains a priority, but liberalization should be done gradually and cautiously. Capital flow pressures should be primarily dealt with by macroeconomic policies, including an effectively floating exchange rate. Standard micro/macro-prudential frameworks should continue to be strengthened to mitigate the procyclical build-up of systemic risk over the financial cycle, in line with FSAP recommendations. Transparent and consistent enforcement of CFMs, together with clear communication, is important to strengthen market participants’ confidence in the regulatory framework. CFMs should not be used to fine-tune capital flows, and should be phased out over time as the supporting reforms increase the economy’s ability to handle greater capital flow volatility.

Context

1. Capital outflows have abated since early 2017 after reaching record highs during 2015–16. Net capital outflows reached $640 billion a year in 2015 and 2016. These were driven by external debt repayments and a surge of overseas direct investments (ODI). Since then outflows slowed down, amounting to $73 billion in 2017, a trend that has continued into 2018. Most components in the financial account have contributed to this outcome. Errors and omissions—which mostly represent unrecorded capital flight—is the only item that remains persistently high.

2. The authorities’ response to capital outflows in 2015–16 included a mix of conventional policies as well as capital flow management measures (CFMs). The authorities intervened in the foreign exchange (FX) market, but also allowed the exchange rate to depreciate somewhat. In addition, they introduced CFMs and tightened the enforcement of existing ones as necessary supporting reforms had not kept pace with the capital account liberalization. The policy mix helped ease capital outflow pressures. Stronger domestic growth and external factors including a weaker dollar also contributed to this outcome. More broadly, interest and growth differentials, and relative policy uncertainties continued to remain key drivers of capital outflows.

Recent Developments

3. Since the last Article IV consultation, the authorities have mainly eased CFMs, and have introduced a macroprudential assessment framework for cross-border financing. The new framework is designed to manage risks associated with capital flows by influencing the overall volume and composition of capital flows in a counter-cyclical manner. The framework aims at mitigating currency and maturity risks, risks associated with off-balances sheet exposures and excess leverage. Prudential parameters address these risks—e.g., on exposures on currency, maturity, category risk, and excess leverage; and the so-called macroprudential adjustment parameter—by targeting single, multiple, or all financial or non-financial institutions. These parameters will be adjusted under crisis or exceptional circumstances (e.g. a surge of capital inflows). In addition, the authorities generally eased CFMs since the last Article IV consultation. Specifically, the authorities have taken the following actions:

  • The macroprudential assessment framework’s leverage ratio for non-financial enterprises’ cross-border borrowing was relaxed to align the framework with the overall volume of capital flows allowed under the previous administrative framework.

  • Reserve requirement ratios (RRR) for banks’ offshore RMB deposits and the RRR for foreign exchange derivatives were set to zero (September 2017).

  • Limits on overseas RMB withdrawal by payment cards were lowered from 100,000 yuan per card per year (individuals can hold multiple cards) to 100,000 yuan per year per person (December 2017).

  • Overseas direct investment (ODI) measure were overall eased: (i) the approval requirement for ODI above US$1 billion was abolished; ODI in non-sensitive projects is subject only to record-filing and, if above US$300 million, to submission of Non-sensitive Project Status Report; (ii) the coverage of sensitive industries was modified; and (iii) indirect investments by individuals through offshore entities was included in ODI coverage.

  • Financial institutions’ limit of overseas RMB lending was increased to 3 percent from 1 percent of the previous year’s end-year balance on all RMB deposits. A countercyclical factor was added to the framework, albeit without making changes to the limits.

  • The Qualified Domestic Limited Partnership (QDLP) scheme was resumed after a two-year halt. This allows foreign fund managers to raise money in China for investment abroad within the awarded quotas. Quotas were further increased to US$5 billion in April 2018.

  • The Qualified Domestic Investment Enterprises (QDIE) program in Shanghai and Shenzhen, which support domestic institutions carrying out outbound investments, was expanded for the first time since 2015. Its quotas increased to US$5 billion, up from US$1.3bn, in April 2018.

  • The Qualified Domestic Institutional Investor (QDII) scheme, which provides financial institutions with quotas for outbound investment, was also expanded in April 2018 for the first time since 2015.

  • The RMB Qualified Domestic Institutional Investor (RQDII) scheme, which provides financial institutions with quotas for outbound investment, was resumed, but saw a tightening of its reporting and enforcement requirements (May 2018). The authorities also indicated that the scheme is linked to “macroprudential” measures for overseas investment on cross-border capital flows, off-shore RMB market liquidity, and RMB product development.

  • The dollar-denominated Qualified foreign institutional investor (QFII) and the RMB Qualified Foreign Institutional Investor (RFQII), were modified to ease restrictions on foreign institutional investors’ outflow of funds from China. Specifically, the three-month capital lock-up period and the 20 percent monthly repatriation limit for the QFII and the RQFII were eliminated, and FX hedging on onshore investment was allowed (June 2018).

Assessment

4. Staff assesses that recent easing of CFMs is in line with the Fund’s IV. Following past advice, staff supports a cautious approach for further liberalization, including through the removal of some targeted measures. Therefore, setting the RRR on FX derivatives to zero, is appropriate as it supports the development of the derivatives market by improving hedging operations to manage currency-related risks. Setting the RRR on bank’s off-shore renminbi deposits to zero also removes a discriminatory practice. Moreover, measures that gradually ease constraints on outbound investment, such as the measures on ODI, or the quota schemes such as QDLP, QDIE, QDII and RQDII are appropriate and in line with the gradual and cautious liberalization process. This is also the case of measures affecting quota schemes such as QFII and RQFII, which eliminate a discriminatory restriction on capital outflows by foreign investors. The adjustment to the leverage ratio was also appropriate as it aligned the new framework with the overall level of capital flows allowed under the previous administrative framework (January 2018). The change in limits of overseas RMB withdrawals by payment cards, which was a CFM tightening, may be appropriate on AML grounds, although further analysis will be conducted in the context of the next AML/CFT Review on China.1

5. The new framework is an improvement over the previous ad-hoc system of case-by-case approval and quota allocations, but using it to actively manage the capital flow cycle would be inconsistent with the Fund’s IV. The framework is more predictable and transparent, and addresses risks arising from excessive cross-border financing and mismatches (e.g., currency, maturity, on/off balance sheet). The framework also includes a macroprudential adjustment parameter. The framework could be in line with the Fund’s IV if the parameter is adjusted only in crisis or exceptional episodes to address potential risks associated with capital flows and the measure does not substitute for warranted macroeconomic adjustment. Nonetheless, adjusting the parameter to actively manage cross-border financing in the absence of well identified risks would deem the measure inconsistent with the Fund’s IV.

6. In line with previous Fund advice, consistent and transparent enforcement remains a challenge. Regulations remain “confidential” or are not always readily available to the market. Transparent and consistent enforcement of CFMs’ together with a clear communication is important to strengthen market participants’ confidence in the regulatory framework.

7. The authorities should thus prioritize the implementation of reforms that support the liberalization process, while primarily relying on macroeconomic policies to deal with risks associated with capital flows. Some CFMs may be appropriate as reforms are being phased in, which is consistent with the liberalization of the capital account being gradual, carefully sequenced, and paced with supporting reforms.
1

Based on findings of Cerdeiro and Nam (2018), A Multidimensional Approach to Trade Policy Indicators (IMF Working Paper 18/32). This is a factual analysis of openness and not an assessment of China’s compliance under WTO rules or vis-à-vis any other forum or agreement.

1/

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Nonmutually exclusive risks may interact and materialize jointly. “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

1

Highest, near-term action (H, NT); Highest, medium-term action (H, MT); Medium (M).

2

Information as reported by the authorities, with IMF staff providing translation.

3

In 2014, around RMB 14 trillion of LGFV borrowing was recognized as explicit LG debt. And the government embarked on a three-year debt-to-bond swap program for LG to exchange the LGFV loans into LG bonds from 2015. By the end of 2017, RMB 10.9 trillion LG borrowing was exchanged, which saved RMB 1.2 trillion in interest payments and mitigated debt refinancing risks, according to the authorities. Another RMB 1.73 trillion of debt needs to be swapped by August 2018.

4

Mechanically, the standard contingent liability shock in the IMF’s DSA toolkit assumes that 10 percent of non-government banking system assets would turn into government liabilities. Non-government banking system assets were about 220 percent of GDP in 2016. It also assumes that the real GDP growth in 2018 and 2019 would be 2–2.5 percent lower (a one standard deviation shock).

1

For example, there were reports of a surge of ATM withdrawals in Hong Kong SAR by $HK 20 billion per month as Macau SAR introduced a facial recognition technology in its ATMs (South China Morning Post – January 26, 2018).

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Cover IMF Staff Country Reports
People’s Republic of China: 2018 Article IV Consultation-Press Release; Staff Report; Staff Statement and Statement by the Executive Director for the People's Republic of China
Author:
International Monetary Fund. Asia and Pacific Dept
Volume/Issue:
Volume 2018: Issue 240
Publisher:
International Monetary Fund
ISBN:
9781484370797
ISSN:
1934-7685
Pages:
120
DOI:
https://doi.org/10.5089/9781484370797.002
  • View in gallery

    China’s rapid growth translated into rising living standards

  • View in gallery

    GDP of advanced Chinese provinces greater than UK

    (By World Bank 2016 country income classification based on GNI per capita)

  • View in gallery

    Financial linkages: high dependence on Chinese bank lending among some Asian and African economies

    (Color code based on Chinese banks’ claims as percent of counterparty annual GDP as of 2017Q4)

  • View in gallery

    Trade linkages: exports to China high among many commodity exporters and Asian economies

    (Color code based on partner countries’ export to China as percent of their GDP in 2017)

  • View in gallery

    PPI drives recovery in nominal GDP and industrial profits

    (In percent, year-on-year growth)

  • View in gallery

    China and EM sell-off episodes: asset price changes and capital flows

    (Change over one month after the event)

  • View in gallery

    RMB broadly stable against the CFETS basket since 2016

  • View in gallery

    China’s reserve coverage appears adequate

    (In US$ billion)

  • View in gallery

    Limited direct impact of announced tariffs

    (Goods trade 2017, in USD billions; bubble size represents percent of GDP)

  • View in gallery

    Intra-financial credit slowed significantly

    (In percent, year-on-year)

  • View in gallery

    Bank assets/GDP ratio declined for the first time since 2011

    (In percent)

  • View in gallery

    Size of asset management industry more than doubled since 2014

    (In percent of GDP)

  • View in gallery

    Capacity reductions on track to meet 2020 targets

    (In percent of total capacity in 2015)

  • View in gallery

    Housing inventory ratios declined significantly

    (In years)

  • View in gallery

    Government and household debt still rising as percent of GDP

    (In percent of GDP)

  • View in gallery

    Corporate leverage still high and household leverage rising fast

    (In percent)

  • View in gallery

    Mixed Rebalancing Progress in 2017

  • View in gallery

    Credit intensity improved in 2017 but continues to exceed pre-crisis levels

    (In RMB trillions)

  • View in gallery

    SOEs are performing better, but not as well as private firms

    (In percent)

  • View in gallery

    Credit efficiency improved within new economy sectors

    (Lower score means improvement in credit efficiency from 2007 to 2017)

  • View in gallery

    The economy continues to shift towards services.

    (Share in GDP, in percent)

  • View in gallery

    Evolution of credit intensity under alternative scenarios

    (In percent of GDP)

  • View in gallery

    Evolution of nonfinancial sector debt under alternative scenarios

    (In percent of GDP)

  • View in gallery

    Local SOE leverage ratio increased in 2017

    (In percent)

  • View in gallery

    LGFV sales to cost ratios deteriorated further in 2017

    (Density, in percent)

  • View in gallery

    Current rates below estimated “neutral” levels

    (In percentage point)

  • View in gallery

    China’s social spending is relatively low

    (Social spending in percent of GDP)

  • View in gallery

    Diverging provinces, 2017

  • View in gallery

    Policies to address tradeoffs in rebalancing

  • View in gallery

    China has more internet users than other major economies

    (In millions of persons)

  • View in gallery

    SOEs structurally less efficient than the private sector

    (Return on assets, in percent)

  • View in gallery

    SOE assets and share of investment rising

    (In percent)

  • View in gallery

    Natural gas price surged in winter 2017

    (In RMB thousands per ton)

  • View in gallery

    Residential investment projected to decline to pre-crisis levels

    (In percent of GDP)

  • View in gallery

    Services trade restrictiveness has improved, but remains relatively high

    (Index; 1= closed)

  • View in gallery

    FDI regulatory restrictiveness index has fallen in China

    (Index; 1= closed)

  • View in gallery

    China’s FDI is trending down and below EM average

    (In percent of GDP)

  • Figure 1.
    View in gallery
    Figure 1.

    Recent Developments and Outlook: Solid Growth Momentum

  • Figure 2.
    View in gallery
    Figure 2.

    Rebalancing: Uneven Progressy

  • Figure 3.
    View in gallery
    Figure 3.

    Credit: Credit Gap Narrows but Remains Large

  • Figure 4.
    View in gallery
    Figure 4.

    Monetary: Money Market Rates Rose

  • Figure 5.
    View in gallery
    Figure 5.

    Fiscal: Continued Loosening in 2017

  • Figure 6.
    View in gallery
    Figure 6.

    External: Outflow Pressure Abated

  • Figure 7.
    View in gallery
    Figure 7.

    Banking: Sharp Slowdown in Asset Growth

  • Figure 8.
    View in gallery
    Figure 8.

    Financial: Tighter Financial Conditions

  • <sup><xref ref-type="fig" rid="RA01fig09">Figure 9.</xref></sup>
    View in gallery
    Figure 9.

    Cross-Country Comparison on FDI Regulatory Restrictiveness

  • View in gallery

    Alignment of Recent Reforms with FSAP Recommendations

  • View in gallery

    RMB volatility still low compared to other EM currencies

    (Standard deviation of percent changes in exchange rates)

  • View in gallery

    Large local government revenue/expenditure gap remains

    (In percent of GDP)

  • View in gallery

    Governance indicators for BRI recipient countries, percentiles

    (Number of BRI countries in each percentile of a given measure noted above bars; lower percentile indicates lower score for governance)

  • View in gallery

    Faster reform progress could pave the way for higher and more sustainable GDP growth

    (In percent, year-on-year growth)

  • View in gallery

    Foreign debt outstanding by Chinese entities surged in 2017

    (In USD billions)

  • Figure 1.
    View in gallery
    Figure 1.

    China: Public Sector Debt Sustainability Analysis (Budgetary Government Debt)

    (In percent of GDP, unless otherwise indicated)

  • Figure 2.
    View in gallery
    Figure 2.

    China: Public DSA—Composition of Budgetary Government Debt and Alternative Scenarios

  • Figure 3.
    View in gallery
    Figure 3.

    China: Public DSA (Budgetary Government) – Realism of Baseline Assumptions

  • Figure 4.
    View in gallery
    Figure 4.

    China: Public DSA (Budgetary Government) – Stress Tests

  • Figure 5.
    View in gallery
    Figure 5.

    China: Public DSA (Budgetary Government) – Risk Assessment

  • Figure 6.
    View in gallery
    Figure 6.

    China: Public Sector Debt Sustainability Analysis (Augmented Debt: Broad Coverage)

    (In percent of GDP unless otherwise indicated)

  • Figure 7.
    View in gallery
    Figure 7.

    China: Public DSA — Composition of Augmented Debt (Broad Coverage) and Alternative Scenarios

  • Figure 8.
    View in gallery
    Figure 8.

    China: Public DSA (Augmented Debt: Broad Coverage) – Stress Tests

  • Figure 9.
    View in gallery
    Figure 9.

    China: Public DSA (Augmented Debt: Broad Coverage) – Risk Assessment

China’s rapid growth translated into rising living standards

GDP of advanced Chinese provinces greater than UK

(By World Bank 2016 country income classification based on GNI per capita)

Financial linkages: high dependence on Chinese bank lending among some Asian and African economies

(Color code based on Chinese banks’ claims as percent of counterparty annual GDP as of 2017Q4)

Trade linkages: exports to China high among many commodity exporters and Asian economies

(Color code based on partner countries’ export to China as percent of their GDP in 2017)

PPI drives recovery in nominal GDP and industrial profits

(In percent, year-on-year growth)

China and EM sell-off episodes: asset price changes and capital flows

(Change over one month after the event)

RMB broadly stable against the CFETS basket since 2016

China’s reserve coverage appears adequate

(In US$ billion)

Limited direct impact of announced tariffs

(Goods trade 2017, in USD billions; bubble size represents percent of GDP)

Intra-financial credit slowed significantly

(In percent, year-on-year)

Bank assets/GDP ratio declined for the first time since 2011

(In percent)

Size of asset management industry more than doubled since 2014

(In percent of GDP)

Capacity reductions on track to meet 2020 targets

(In percent of total capacity in 2015)

Housing inventory ratios declined significantly

(In years)

Government and household debt still rising as percent of GDP

(In percent of GDP)

Corporate leverage still high and household leverage rising fast

(In percent)

Mixed Rebalancing Progress in 2017

Credit intensity improved in 2017 but continues to exceed pre-crisis levels

(In RMB trillions)

SOEs are performing better, but not as well as private firms

(In percent)

Credit efficiency improved within new economy sectors

(Lower score means improvement in credit efficiency from 2007 to 2017)

The economy continues to shift towards services.

(Share in GDP, in percent)

Evolution of credit intensity under alternative scenarios

(In percent of GDP)

Evolution of nonfinancial sector debt under alternative scenarios

(In percent of GDP)

Local SOE leverage ratio increased in 2017

(In percent)

LGFV sales to cost ratios deteriorated further in 2017

(Density, in percent)

Current rates below estimated “neutral” levels

(In percentage point)

China’s social spending is relatively low

(Social spending in percent of GDP)

Diverging provinces, 2017

Policies to address tradeoffs in rebalancing

China has more internet users than other major economies

(In millions of persons)

SOEs structurally less efficient than the private sector

(Return on assets, in percent)

SOE assets and share of investment rising

(In percent)

Natural gas price surged in winter 2017

(In RMB thousands per ton)

Residential investment projected to decline to pre-crisis levels

(In percent of GDP)

Services trade restrictiveness has improved, but remains relatively high

(Index; 1= closed)

FDI regulatory restrictiveness index has fallen in China

(Index; 1= closed)

China’s FDI is trending down and below EM average

(In percent of GDP)
Figure 1.

Recent Developments and Outlook: Solid Growth Momentum
Figure 2.

Rebalancing: Uneven Progressy
Figure 3.

Credit: Credit Gap Narrows but Remains Large
Figure 4.

Monetary: Money Market Rates Rose
Figure 5.

Fiscal: Continued Loosening in 2017
Figure 6.

External: Outflow Pressure Abated
Figure 7.

Banking: Sharp Slowdown in Asset Growth
Figure 8.

Financial: Tighter Financial Conditions
Figure 9.

Cross-Country Comparison on FDI Regulatory Restrictiveness

Alignment of Recent Reforms with FSAP Recommendations

RMB volatility still low compared to other EM currencies

(Standard deviation of percent changes in exchange rates)

Large local government revenue/expenditure gap remains

(In percent of GDP)

Governance indicators for BRI recipient countries, percentiles

(Number of BRI countries in each percentile of a given measure noted above bars; lower percentile indicates lower score for governance)

Faster reform progress could pave the way for higher and more sustainable GDP growth

(In percent, year-on-year growth)

Foreign debt outstanding by Chinese entities surged in 2017

(In USD billions)
Figure 1.

China: Public Sector Debt Sustainability Analysis (Budgetary Government Debt)

(In percent of GDP, unless otherwise indicated)
Figure 2.

China: Public DSA—Composition of Budgetary Government Debt and Alternative Scenarios
Figure 3.

China: Public DSA (Budgetary Government) – Realism of Baseline Assumptions
Figure 4.

China: Public DSA (Budgetary Government) – Stress Tests
Figure 5.

China: Public DSA (Budgetary Government) – Risk Assessment
Figure 6.

China: Public Sector Debt Sustainability Analysis (Augmented Debt: Broad Coverage)

(In percent of GDP unless otherwise indicated)
Figure 7.

China: Public DSA — Composition of Augmented Debt (Broad Coverage) and Alternative Scenarios
Figure 8.

China: Public DSA (Augmented Debt: Broad Coverage) – Stress Tests
Figure 9.

China: Public DSA (Augmented Debt: Broad Coverage) – Risk Assessment