I.M.F. Tells China of Urgent Need for Economic Change

“Since the global crisis, a mix of investment, credit and fiscal stimulus has underpinned activity,” the I.M.F. said in a major annual assessment of the Chinese economy. “This pattern of growth is not sustainable and is raising vulnerabilities. While China still has significant buffers to weather shocks, the margins of safety are diminishing.”

The report emphasized downside risks to the Chinese economy, touching on familiar themes though imparting more of a sense of urgency than it has in the past.

The country still has large foreign currency reserves and plenty of room for new government spending to buffer against any unexpected shocks, said Markus Rodlauer, the I.M.F.’s China mission chief, in an interview. But he said the Chinese economy was looking more and more vulnerable, with changes getting harder to make as time goes on.

The I.M.F. — along with a range of international economic officials, research groups, academics and financial market participants — has raised concern that money is pouring into mispriced real estate and infrastructure investments in China that are increasing growth in the short term but might do little for the Chinese economy down the road.

For decades, a cheap currency, cheap labor and huge infrastructure investment fueled enormous growth in the Asian nation. China has made “substantial” progress on rebalancing its trade deficits with the rest of the world, the I.M.F. said, and its current-account balance as a share of its total economy is less than a quarter of its precrisis peak.

The fund described the Chinese currency as “moderately” undervalued, as it has for about a year after a long stretch of describing it as “significantly” undervalued — a policy maneuver that helped increase China’s exports but angered many foreign countries whose goods became relatively less competitive.

But imbalances in China’s domestic economy “remain large,” the I.M.F. warned, as Chinese consumers fail to take over for consumers from the United States, Germany and other countries who helped stoke China’s growth for years. Consumption rates have barely budged from last year. But net purchases of physical assets like roads, hospitals and commercial buildings grew further as a share of the economy.

“A decisive shift toward a more consumption-based growth path has yet to occur,” the I.M.F. said. “Accelerating the transformation of the growth model remains the main priority.”

The I.M.F. focused on a few spots of acute risk in the Chinese economy.

One is the financial system. The country has experienced a huge boom in lending through “less regulated” parts of its financial system, it said. The report raised concerns about the adequacy of the country’s regulatory controls, and about the quality of underwriting and the pricing of risk.

The formal banking sector might not be as strong as it looks, either, the I.M.F. warned. “Based on reported data, bank balance sheets appear healthy and loan books show only a modest deterioration in asset quality,” it wrote. “However, banks remain vulnerable to a sharper worsening of corporate sector financial performance.”

Another issue is a proliferation of debt-financed spending by local governments without adequate tax bases, often through “local government financing vehicles” that have long been fingered as a weak spot in China’s markets. “Further rapid growth of debts would raise the risk of a disorderly adjustment in local government spending,” the I.M.F. warned.

Finally, it also cautioned about the possibility of sharp price drops in the real estate markets, which remain “prone to bubbles,” the I.M.F. said, in no small part because many Chinese savers do not earn interest on their deposits and thus push money into the housing markets.

Bettina Wassener contributed reporting from Hong Kong.

Article source: http://www.nytimes.com/2013/07/18/business/global/imf-tells-china-of-urgent-need-for-economic-change.html?partner=rss&emc=rss