IMF warns debt driven high growth raises risk of hard landing for the Chinese economy

In its annual Article IV consultation country report for China, the IMF team sees government efforts to cling to high growth targets as harmful to the Chinese economy. The IMF expects China to use all means possible in achieving its target of real doubling of 2010 GDP by 2020. Achieving this goal calls for extensive debt-fuelled fiscal stimulus policies and increased public investment that thwart efforts to rebalance the economy away from investment-driven growth to increased emphasis on consumption and services. Holding tightly to specific target numbers has fuelled a rapid increase in public and private borrowing, which in turn exposes many sectors to increased levels of risk. China's debt-to-GDP ratio is expected to rise another 60 percentage points by 2022.

The IMF would like to see China move from numerical growth targets to committing to economic reforms as it is the only way to sustain relatively robust economic growth over the long term. Growth needs to be supported through productivity gains, which would require rapid implementation of major reforms. Critical elements in reform of the corporate sector include decommissioning of unprofitable zombie firms, reform of state-owned enterprises that are less efficient than their private-sector counterparts and reduction of overcapacity. While these painful measures will lower growth over the short term, the IMF believes China can get growth on a sustainable basis over the long term. Other major areas for economic reform mentioned by the IMF include increasing the role of markets in the economy to improve resource allocation and levelling the playing field between private (including foreign) firms and state-owned or state-associated firms.

In the monetary policy sphere, the IMF sees the current stance of monetary policy accommodative and exchange rate broadly in line with fundamentals. The authorities have recently cracked down on capital outflows and increased administrative controls over the exchange rate, which are moves away from the needed shift to a market-based and ultimately floating exchange rate regime. While more flexible exchange rate, financial market stability and more effective price-based monetary policy framework would allow further relaxation of capital controls, the IMF cautions China to carefully sequence reforms in the current circumstances.

The emphasis in fiscal policy needs to shift from overinvestment to policies that support private consumption, including increased income transfers, progressive income taxes and government spending on education and healthcare. With such changes, households would be able to devote a larger share of their income to consumption rather than saving. China's very high savings rate helps sustain excessive domestic fixed investment that erodes productivity and sustains global imbalances. China's ratio of private consumption to GDP is still below 40 % (world average around 60 %), reflecting the high household savings rate (23 % 0f GDP, world average 8 %).