On behalf of my authorities, I would like to thank staff for their candid and thoughtful dialogue held during the Article IV mission. I would also like to express my authorities’ appreciation of this annual consultation with the Fund, which has been helpful in promoting a deeper understanding of the issues facing the Chinese economy.
Notwithstanding strong external and domestic headwinds, the Chinese economy continued to register solid growth, healthy labor market conditions, and subdued inflationary pressure, thanks to the support of a stable monetary environment and the targeted easing measures implemented. The banking sector also remains in good shape, and the financial supervisory and regulatory framework—including oversight of off-balance sheet and interbank and nonbank financing—has been strengthened further to ward off potential risks. Meanwhile, fiscal indebtedness remains at a moderate level, with local fiscal disciplines tightened, while differentiated policies, such as the housing mortgage policy, are enforced to safeguard the stability of the real estate market. Overall, the Chinese economy is on track to meet the 7.5 percent growth target this year, and my authorities will continue to implement macroeconomic policies in a forward-looking, targeted, and coordinated manner to maintain macroeconomic and financial stability.
At the same time, the Chinese economy continues to make progress on its structural adjustment and reform agenda. Manifesting a rebalancing in the economy, the role of private consumption and the tertiary sector in the economy continued to strengthen, while the current account surplus remained subdued. Meanwhile, notable progress has been made in deepening reforms along the lines of the Third Plenum reform blueprint, so as to give the market a decisive role in resource allocation. By striking a fine balance between stabilizing growth, on one hand, and adjusting the economic structure and promoting reforms, on the other, my authorities are confident that the Chinese economy will be able to settle on a more sustainable and balanced growth path, thus continuing to contribute to regional as well as global economic and financial stability.
Recent economic developments
The macroeconomic environment remains stable. After experiencing some moderation amidst the uncertain external environment, economic activities have stabilized recently on the back of targeted supportive measures. In particular, real GDP growth picked up to 7.5 percent in Q2 from 7.4 percent in Q1, while growth in retail sales, industrial value-added, and infrastructure investment strengthened respectively to 12.3, 8.9, and 25.7 percent from 12.0, 8.7, and 22.5 percent over the same period. Meanwhile, urban labor conditions continue to hold up well, with demand for labor staying firm and the unemployment rate remaining stable. Looking ahead, the purchasing managers’ index, particularly that for the service sector, indicated that the Chinese economy will continue to grow at a stable pace in the near term. That said, my authorities are vigilant to the downward pressures facing the economy, and will stand ready to deploy targeted measures to support growth and the labor market as appropriate.
Inflationary pressures remain mild, with the year-on-year CPI inflation rate moderating to 2.3 percent in the first half of this year from 2.6 percent in 2013. Meanwhile, the producer price inflation rate continued to stay in the negative territory, reflecting stable international commodity prices and overcapacity in certain industries. While inflation has stayed subdued, my authorities are vigilant to the price pressures stemming from agricultural products and rentals, as well as from resource pricing reform. Thus, my authorities will continue to guide inflation expectations so as to stabilize CPI inflation in 2014 at a rate of around 3.5 percent.
My authorities maintain a proactive fiscal policy stance in order to promote stable and inclusive growth. Social spending continues to be prioritized, with spending on education, social security employment, medical treatment, and health all registering robust growth in the first half of this year, so as to improve social welfare and sustain the decline in income inequality. For 2014 as a whole, my authorities set the budget deficit at about 2.1 percent of GDP, the same as the actual deficit in 2013, and agree with staff that a major stimulus is not warranted.
Notwithstanding the pickup in local government indebtedness in recent years, my authorities’ comprehensive audit indicated that the overall government debt level remained controllable at about 40 percent of GDP in mid-2013. In particular, the debt level remains comparatively moderate, and debts were incurred mainly to support infrastructure and social welfare spending. More importantly, the interest rate-growth differential and the government asset position of China remain very favorable.
In view of the increased prominence of the activities of local government financing vehicles (LGFVs) since the global financial crisis, my authorities have made devoted efforts in publishing comprehensive data on local government indebtedness consistent with international standards. Meanwhile, staff’s augmented estimates are subject to a high degree of imprecision, as staff had made many simplifying assumptions—such as the inclusion of debt obligations of LGFV for commercially viable ventures, which are neither part of government debt nor contingent liabilities, into the estimates—so as to compile a time series of local government finance. Thus, staff’s augmented estimates cannot reflect accurately the latest fiscal position and stance of China, and could pose the risk of market misperceptions.
Having said all that, my authorities agree that local fiscal disciplines have to be tightened, and have implemented a wide range of measures to improve the transparency and the sustainability of local indebtedness, including: (1) changing the performance assessment criteria of local governments; (2) enhancing private sector participation in infrastructure investment; (3) incorporating local government debt in the budgetary process; and (4) implementing a trial program to allow 10 local governments to issue their own bonds.
Going forward, my authorities will endeavor to establish an early warning system and adopt a medium-term fiscal plan, in order to strengthen fiscal management. My authorities will also continue to pursue fiscal reform in accordance with the Third Plenum blueprint, including better aligning responsibilities between the central and local governments, and undertaking tax reform. In this regard, my authorities aim to complete the value-added tax reform by the end of 2015, and will steadily push forward reforms in other areas of taxation.
Monetary conditions remain stable under a prudent monetary policy stance, with growth in M2 and RMB loans fluctuating at around 14.0 percent for most of the time since December 2013. With strong policy efforts on improving the credit structure and achieving social and development objectives, growth in lending to the rural sector and small and micro enterprises both outpaced that of total lending, whereas growth in medium- and long-term lending to industries with overcapacity declined. Meanwhile, the share of bank loan, bond, and equity financing in total social financing has picked up, while interbank liquidity conditions have remained largely stable, thanks to continued policy efforts on promoting direct financing, tightening supervision of nonbank and interbank financings, and strengthening liquidity management.
With strong determination to maintain a stable monetary and financial environment, my authorities will continue to adjust credit and macroprudential policies to ensure reasonable growth in money, credit, and social financing. In this regard, my authorities will recalibrate the housing mortgage policy and other prudential measures as necessary which, together with the ongoing urbanization and hukou reform, should help facilitate an orderly adjustment in the real estate market. Meanwhile, my authorities will continue to monitor liquidity conditions closely and conduct liquidity operations as needed, so as to maintain an appropriate level of liquidity.
While maintaining stable monetary conditions, my authorities continue to push forward market-based interest rate reform. Lending rates are now fully liberalized, while caps on small amount foreign currency deposit rates have recently been lifted in Shanghai, marking another step in deposit rate liberalization. A self-regulatory pricing mechanism was established to ensure discipline in pricing market interest rates, while the loan prime rate centralized quote and release mechanism and the issuance and trading of interbank certificates of deposit were launched to provide market-based references for pricing credit products and Shibor rates. My authorities will build on the progress achieved to set up an effective market interest rate system and improve the monetary policy framework and its transmission mechanisms.
The banking sector continues to perform well, registering sound capital level, stable return, subdued nonperforming loan ratio, strong loan-loss provisioning, and—according to the latest stress-testing results conducted by the CBRC—high resilience to adverse credit and macroeconomic shocks. Meanwhile, regulatory prudence has been exercised to ensure reasonable growth in nonbank financing to enhance market-based financial intermediation. In this connection, my authorities would like to point out that staff’s assessment of shadow banking has relied on the definition used by some market analysts, which is too broad and is not consistent with the Financial Stability Board’s definition. Much of the shadow banking activities, as analyzed by staff, involves little leverage and is placed under close supervision.
While the financial sector remains firm, my authorities continue to act preemptively to safeguard financial stability. In this regard, a joint ministerial conference on financial regulatory coordination was set up to provide a regular rule-based platform to promote coordination, while new rules were issued to further tighten oversight of trust, wealth management products, and interbank business. Credit risks of lending to local government financing platforms, the real estate sector, and the overcapacity industry have also been monitored closely.
At the same time, my authorities continue to make progress on aligning the regulatory framework with international standards. For instance, the overall capital regulatory regime was assessed by the Basel Committee to be compliant with the Basel III capital requirements, while the disclosure requirements for systemically important banks were enhanced. Financial reforms also continue to proceed, as manifested by the proposed establishment of five privately-owned banks to facilitate innovation and competition, and the permission to issue preferred stocks by eligible listed and nonlisted companies to promote direct financing.
Going forward, my authorities will endeavor to establish a crisis management and resolution framework, including setting up a deposit insurance scheme. These, coupled with the interest rate reform and ongoing efforts to reduce moral hazard and implicit guarantees of financial products, will help shift activity back to banks’ balance sheets and safeguard financial stability. My authorities will also strengthen the oversight of internet financing to ensure that the industry develops in a healthy and sustainable way to promote financial inclusion and innovation. Meanwhile, my authorities will continue the reform in financial institutions (i.e., commercial banks, policy banks, and asset management companies), while promoting capital market development under the guidelines released in May—including the registration reform of the new share offering system—so as to enhance the role of the market in allocating financial resources, thus better serving the real economy.
The current account surplus narrowed further from 2.6 percent in 2012 to 2.0 percent of GDP in 2013, and further to 0.3 percent of GDP in the first quarter of this year, as structural changes continue to proceed. Thanks to strong income growth, service imports continued to grow at a vibrant pace, dragging the service trade balance alongside. Growth in good exports did not register the same degree of resilience as growth in goods imports, in part reflecting the increasing share of final consumption goods in total goods imports. Meanwhile, the RMB exchange rate has become increasingly flexible, as more reform measures are in place. The daily trading band of the RMB/USD exchange rate was widened further in March, leading to more two-way movements as well as more divergent expectations of the rate since then. Banks have also recently been permitted for the first time to set the RMB/USD exchange rate freely in over-the-counter transactions, so as to further strengthen the market-driven nature of the rate. Looking ahead, the current account surplus is expected to remain moderate over the medium term amidst robust income growth and rising demand for services, and my authorities will continue to expedite reform of the exchange rate formation mechanism, in order to allow market forces to play the decisive role in driving the two-way movement in the exchange rate.
Regarding the external sector assessment results, my authorities continue to have strong concerns about the reliability and the soundness of the External Balance Assessment (EBA) methodology, given: (1) the arbitrariness and the lack of transparency in the setting of norms of policy and structural variables; (2) the continued presence of sizable unidentified factors in the estimated current account gaps in many countries; and (3) the inadequate consideration of the global implications of systemic economies’ monetary policies. Thus, we urge staff to strengthen their efforts on improving the EBA methodology.
Capital account convertibility and cross-border use of the RMB continue to develop, with investment quotas under the QDII, QFII, and RQFII schemes expanded, rules governing foreign exchange transactions of multinational firms eased, and the Shanghai Pilot Free Trade Zone and the Shanghai-Hong Kong Stock Connectivity Mechanism established. My authorities will accelerate the pace of capital account convertibility while, at the same time, monitoring cross-border capital flows closely against the backdrop of a volatile global monetary environment.
Reflecting the continuation of structural rebalancing in the Chinese economy, the size of the tertiary industry has exceeded that of the secondary industry since 2013. Meanwhile, labor income growth—including growth in per capita disposable income of urban household, per capita net income of rural household, and average monthly income of migrant workers—has been vibrant. Against such backdrop, the share of private consumption in GDP has continued to pick up over the past few years, with the growth contribution of final consumption expenditure surpassing that of gross capital formation during the first half of this year.
Substantial progress has been made in implementing reforms in other areas covered in the Third Plenum blueprint. Seeing the importance of urbanization and hukou reform in driving growth and promoting welfare, my authorities have set out a comprehensive urbanization plan which aims—in an environmentally and financially sustainable manner—to: (1) boost the urbanization ratios; (2) enhance social benefits, including the coverage of social housing, pension, and health in urban populations; and (3) implement hukou reform with reference to local circumstances. Plans on reforming medical care and integrating rural and urban pension schemes have also been announced. Meanwhile, my authorities have set up plans and measures to reduce energy consumption, carbon dioxide emission, and air pollution, and have amended the Environmental Protection Law in order to safeguard environmental sustainability. On the other hand, the one-child policy was eased in a number of provinces to counter the demographic pressure, while pilot programs of judicial reform—including the establishment of special intellectual property rights courts—have been approved to reform the court system and promote innovation. State-owned enterprise (SOE) reform also proceeds steadily to promote fair competition, with the dividend requirement for SOE enhanced, and some divestments of SOE made. By promoting structural adjustment and pushing forward reforms while—at the same time—supporting growth stability, my authorities are confident that China will transit smoothly to a sustainable, strong, and balanced growth path, thus contributing to regional and global monetary and financial stability.
Finally, my authorities will continue to enhance data standards in China, including revising the methodology of compiling GDP data in accordance with the System of National Accounts 2008, and actively considering the subscription to the Special Data Dissemination Standards and have been working with STA to conduct technical preparation.