People’s Republic of China: Staff Report for the 2016 Article IV Consultation–Informational Annex

China continues its transition to a sustainable growth path. Rebalancing has progressed on many dimensions, particularly switching from industry to services and from investment to consumption, but less on reining in rapid credit growth. Reforms have advanced impressively across a wide domain, but lagged in some critical areas, and the transition to sustainable growth is proving difficult, with sizable economic and financial volatility. Vulnerabilities are still rising on a dangerous trajectory and fiscal and foreign exchange buffers, while still adequate, are eroding.

Abstract

China continues its transition to a sustainable growth path. Rebalancing has progressed on many dimensions, particularly switching from industry to services and from investment to consumption, but less on reining in rapid credit growth. Reforms have advanced impressively across a wide domain, but lagged in some critical areas, and the transition to sustainable growth is proving difficult, with sizable economic and financial volatility. Vulnerabilities are still rising on a dangerous trajectory and fiscal and foreign exchange buffers, while still adequate, are eroding.

Fund Relations

(As of May 31, 2016)

Membership Status: Joined 12/27/45; Article VIII (December 1, 1996)

General Resources Account:

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SDR Department:

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Outstanding Purchases and Loans: None

Financial Arrangements:

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Projected Payments to Fund (SDR million; based on existing use of resources and present holdings of SDRs):

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Exchange Arrangements:

China’s exchange rate regime has been classified as a crawl-like arrangement since June 21, 2010. De jure classification of the exchange rate is managed floating. On July 21, 2005, the People’s Bank of China (PBC) announced that the exchange rate of the renminbi against the U.S. dollar would be revalued upward by about 2.1 percent (from RMB 8.28/US$ to RMB 8.11/US$) and the exchange rate regime would move to a managed float in which renminbi’s value is set with reference to a basket of currencies. The stated intention of the Chinese authorities was to increase the flexibility of the renminbi’s exchange rate. The authorities indicated that they will not publish the currencies in the reference basket and their relative weight. The PBC indicated that it would adjust the exchange rate trading band as necessary to reflect market developments and financial and economic conditions. Under the new regime, the band around the daily trading price of the U.S. dollar against the renminbi was kept at ± 0.3 percent around the central parity published by the PBC while the trade prices of the non-U.S. dollar currencies against the renminbi were allowed to move within a certain band announced by PBC, which was initially set at ±1.5 percent and increased to ±3 percent in September 2005. In August 2005, the governor of PBC revealed that U.S. dollar, euro, Japanese yen, and Korean won were the main currencies included in the basket; and U.K. pound, the Thai baht, and the Russian ruble were among other currencies included in the basket. In May 2007, the band around the daily trading price of the U.S. dollar against the renminbi was widened to ± 0.5 percent. After maintaining the renminbi closely linked to the U.S. dollar between July 2008 and June 2010, the PBC announced on June 19, 2010 a return to the managed floating exchange rate regime prevailing prior the global financial crisis with the exchange rate allowed to move up to ±0.5 percent from a central parity rate to enhance the effectiveness of monetary policy. As of today, the band has been widened to 2 percent, allowing daily fluctuations relative to the central parity rate. The trading prices for the RMB against the euro, Japanese yen, pound sterling, Australian dollar, Canadian dollar, and New Zealand dollar float within a 3 percent range of the current day’s middle exchange rates for the RMB against these currencies. The trading prices against the Malaysian ringgit and the Russian ruble float within a 5 percent range of the current day’s middle exchange rates of the RMB against these currencies. The trading price of the RMB against the Thai baht in regional interbank markets floats within a 10% range of the reference price.

On January 4, 2006, over-the-counter (OTC) trading of spot foreign exchange was introduced with 15 banks initially designated as market makers. The number of market makers has since risen to 31 with all the banks approved as spot market makers, and 27 approved as forward and swap trading market makers by the end of 2014. The centralized spot foreign exchange trading system (CFETS) remains operative, but its central parity rate (renminbi against the U.S. dollar) is now based on a weighted average of CFETS and OTC transactions. Under the new system, CFETS first inquires prices from all market makers before the opening of the market on each business day, exclude the highest and lowest offers, and then calculates the weighted average of the remaining prices in the sample as the central parity for the renminbi against the U.S. dollar for the day. The weights for the market makers, which remain undisclosed, are determined by the CFETS using various factors, including the transaction volumes of the respective market makers in the market. The CFETS determines the middle rate for the renminbi against ringgit, yen, Hong Kong dollar, pound sterling, and ruble similarly.

China accepted the obligations of Article VIII, Sections 2, 3, and 4 of the Fund’s Articles of Agreement on December 1, 1996. There are repatriation requirements on proceeds from exports and from invisible transactions and current transfers. Starting on August 13, 2007, all enterprises (domestic institutions) having foreign exchange revenue from current operations may keep foreign exchange receipts according to their operational needs in their current foreign exchange accounts.

With SAFE approval or registration, domestic institutions may open foreign exchange capital accounts and retain foreign exchange revenues from capital transactions. Domestic institutions that had no current foreign exchange revenue may purchase foreign exchange for imports in advance based on documentary proof of the payment and deposit the funds into their foreign exchange accounts. Individuals may, also open foreign exchange savings accounts and deposit foreign exchange purchased in accordance with the relevant regulations. China maintains an exchange system free of restrictions on payments and transfers for current international transactions. However, China has notified measures to the Fund, pursuant to procedures under the Executive Board Decision 144-(52/51), which apply to measures imposed solely for national or international security reasons.

Exchange controls continue to apply to most capital transactions. Effective on July 1, 2006, quotas on foreign exchange purchases for foreign direct investment (FDI) were abolished, and domestic investors were allowed to purchase foreign exchange to finance pre-FDI activities. Since December 1, 2002, qualified foreign institutional investors (QFIIs) have been allowed to invest domestically in A shares, subject to certain restrictions, and all nonresidents have been allowed to purchase B shares, which are denominated in U.S. dollars or Hong Kong dollars. The overall investment limit for QFIIs was US$150 billion in 2016. As of the end of May 2016, a cumulative total of 273 QFIIs had been approved, with a total investment limit of US$81.098 billion. The Qualified Domestic Institutional Investor (QDII) scheme was introduced in 2004, and measures have since been taken to promote its development. Since May 1, 2006, residents can freely purchase up to US$20,000 foreign exchange and this limit was raised to US$50,000 in September 2006. Above this amount, purchases require relevant documents. In May 2007, the QDII scheme was expanded to allow qualified banks to invest retail funds in foreign equities. Effective July 5, 2007 the China Securities and Regulatory Commission extended QDII to securities and fund-management companies. The firms have to meet certain capital and other requirements. From April 2006, qualified insurance companies were also allowed to invest their own foreign exchange externally under the QDII scheme up to 15 percent of their total assets. QDIIs may also invest in foreign derivative instruments.

The use of renminbi in international transactions has been expanded. In 2010, international financial institutions were approved to raise funds domestically in renminbi for use offshore. Since August 2011, trade transactions between all provinces and cities in the Mainland with other countries may be settled in renminbi. Since August 17, 2010, eligible foreign institutions may invest in the interbank bond market in renminbi (CIBM). The eligible institutions include foreign banks engaged in cross-border trade settlements in renminbi, the Hong Kong SAR and Macao SAR region renminbi clearing banks, and foreign central banks and monetary authorities. These investments are subject to limits, but there is no minimum holding period. Starting from January 6, 2011, resident enterprises in 20 provinces and cities in the Mainland may use renminbi for outward FDI in those countries which accept such settlement. In December 2011, a new pilot scheme was announced to allow up to RMB20 billion in portfolio flows into the securities markets (through a renminbi Qualified Foreign Institutional Investor scheme), and in October, rules were published to allow overseas firms to invest renminbi raised offshore in the Mainland as foreign direct investment. Since 2012 all residents and nonresidents can use RMB for FDI. RMB qualified foreign institutional investors (RQFIIs) may invest in domestic securities markets. Under the expanded RMB qualified foreign institutional investors (RQFII) scheme, Hong Kong subsidiaries of Chinese financial institutions, as well as financial institutions registered and operated in Hong Kong SAR, may invest in domestic securities markets using RMB proceeds raised overseas. RMB clearing banks were or will be established in these countries/regions.

As of 2016, resident-associated companies of multinational corporations may directly lend to overseas-associated enterprises within a certain limit; they may also provide loans to overseas-associated enterprises through domestic banks. Foreign loans to domestic institutions, with a maturity of more than one year, are subject to NDRC approval. Short-term external borrowings are subject to the limits of SAFE approval.

Article IV Consultation:

China is on the standard 12-month consultation cycle. The 2015 Article IV mission was concluded on May 27, 2015 and the staff report was published on August 14, 2015.

Technical Assistance:

Technical assistance provided from 2001 through September 2016 is summarized in Annex V.

Resident Representative:

The resident representative office in Beijing was opened in October 1991. Mr. Alfred Schipke is the Senior Resident Representative and Mr. Waikei Raphael Lam is the Deputy Resident Representative,

World Bank-IMF Collaboration

(As of June 22, 2016)

1. The IMF China Resident Representatives held discussions with the World Bank team in June 2016 to exchange views on key areas of reform to ensure sustainable medium-term growth in China, minimize risks, and improve the inclusiveness of growth. The teams discussed their agendas for 2016-2017. The last such meeting was held during January 2016 in Beijing.

2. The teams agreed the focus of reform in China should be on shifting growth to a more balanced and sustainable path, along the line of the Third Plenum reform blueprint. Reforms should aim at preventing further buildup of risks stemming from rapid credit growth and quasi-fiscal spending, and move the economy to a more inclusive, environment-friendly, and sustainable growth path. Giving the market a more decisive role, eliminating distortions, and strengthening institutions will result in a more efficient use of resources, faster productivity growth, and rising living standards across the income spectrum.

3. Based on this assessment, teams identified the following reform areas as macrocritical:

  • Financial sector reforms. Further progress in financial sector reform is central to containing risks and boosting growth by facilitating better allocation of resources. Widespread implicit guarantees—of savers, intermediaries, and borrowers distort the pricing of risk and borrowing costs, resulting in misallocation of credit and inefficient investment. Key measures in this area include hardening budget constraint, enhanced debt restructuring mechanism to facility NPL resolution, as well as stepped-up supervision and regulation of the financial system. In particular, stronger measures to monitor and regulate the large shadow banking sector should be taken and regulatory arbitrage opportunities should be closed. Given the rising vulnerabilities, more effective mechanisms are needed to ensure a functional policy coordination framework is in place. There is also a need to upgrade the regulatory structure to ensure adequate supervisory cooperation and coordination.

  • Fiscal reforms. Off-budget spending, in infrastructure but also in other areas, undertaken by local government-owned entities have led to a significant buildup of debt. The new budget law aims to bring these projects on-budget and strengthen control over public financial management, but implementation would be key. Improving the fiscal framework is a priority for the medium term, including strengthening budget processes, data transparency, local government finances, and medium-term budget planning. Tax reforms should continue to modernize the current tax system and make it more progressive (e.g., relying more on direct taxes and allocating local governments revenues to match their spending responsibilities.

  • Reform of the social security system. Further strengthening the pension and health insurance systems—including by improving adequacy and expanding coverage—would have macro-benefits such as reducing precautionary household savings, but would need to be done with a careful eye to fiscal sustainability. It is crucial to improve benefit portability within and across provinces and economic sectors. Reforms should be done in a way that ensures the sustainability of the social security system, including through parametric changes (such as increasing retirement age, indexation, and so on) and structural reforms to the pension system (such as introducing the NDC approach, deepening the alignment of civil service and PSU pension schemes with the urban worker scheme, upgrading the pooling level, developing the medium and long term financing strategy, including for financing legacy costs outside the pension system), and strengthening the budget processes and administration for social security funds.

  • SOE reform. Reforms include opening up to full and fair competition activities currently reserved to SOEs, properly pricing finance and other factor inputs, requiring adequate dividend payments to the budget, and imposing hard budget constraints. Opening up the service sector to more competition will also be critical for generating the productivity gains necessary to fuel growth and for boosting household income, as services tend to be more labor intensive than industry.

  • Green growth. Air pollution, water quality and supply, soil contamination, and issues such as desertification, and degradation of grasslands, and dependence on coal and energy intensive economic options have social, health, and economic effects. Underpricing of energy and inadequate consequences for pollution has worsened these effects while contributing to China’s dependence on industry. Raising these factor costs to capture the cost of externalities, such as introducing a carbon tax and investing in green development including in renewable energy will make growth more sustainable and inclusive. This will also require mobilization of private capital and utilize the capital markets to support green investments.

  • Infrastructure. Investment in infrastructure has been a key driver of the Chinese economy, particularly during the slowdown around the Global Financial Crisis. However, the rapid pace of investment has in some cases left communities behind, and in other cases has led to excessive investment in projects with relatively low social or financial returns. Filling in the gaps of investment in social projects will make growth more inclusive while improving the overall social and financial efficiency of infrastructure investment. Measures to improve the process of approving new infrastructure projects will ensure that investments are focused in areas of the highest social return.

4. The teams agreed to the following division of labor.

  • Financial sector reforms. The Bank and the Fund will jointly conduct the 2017 FSAP; assess financial sector risks and needed reforms. The Fund will also continue to provide technical assistance to the Chinese authorities as needed.

  • Fiscal reforms. The Bank will continue to work with the Ministry of Finance (MOF) to help in implementing key reforms in public finance in the context of an ongoing fiscal technical assistance investment project. The Fund will continue its technical cooperation on the fiscal framework and budgetary preparation, including strengthening the medium-term macro and fiscal framework, enhancing local government borrowing monitoring, and modernizing accounting and treasury management. The Fund will also continue to discuss the near- and medium-term implications of China’s fiscal stance and policy choices on the broader economy as well as implications for global spillovers.

  • Social Security System. The Bank will continue to work with the Chinese authorities on reforms to improve the equity, sustainability, and portability of the social security system. This includes helping provincial governments in developing more integrated social security information systems. The Bank will also work with MOF to provide technical support on the overall reform and the pooling and financing strategies, and optimize fiscal risk management associated with social security liabilities through policy dialogue and engagement. The Fund will look at issues related to the how different social insurance schemes (including pensions and health care) fit into the medium-term fiscal and macroeconomic policy framework. The Fund will also review the balance between benefits and financing from different revenue sources, including social contributions and other revenue. Both the Bank and the Fund will continue to encourage the authorities to undertake regular and robust actuarial modeling of social insurance liabilities.

  • Green growth. The Bank’s focus on climate change and renewable energy as well as pollution reduction and prevention in China will continue to emphasize cutting-edge green technologies, scale-up of energy conservation and investments in energy efficiency, green transport and green building policies (for heat and energy efficiency). Engagements with a climate change focus will extend to expansion of distribution of electricity from natural gas generation, analysis of carbon capture and storage potential, and development of green finance, including carbon markets. The Fund will continue to discuss options to capture the cost of externalities through the use of fiscal policy such as better calibration of excise and introducing a carbon tax. It is ready to provide assistance on shifting the pricing and taxation of energy, and discussing the growth and fiscal implications of such a shift.

5. Teams have the following requests for information from their counterparts:

  • The Fund team requests to be kept informed of progress in the above macroeconomic structural reform areas, as milestones are reached and at least on a semiannual basis.

  • The Bank team requests to be kept informed of the Fund’s assessments of macroeconomic policies and prospects in the context of the Article IV consultation and staff visits, and at least semiannually.

The following table lists the teams’ separate and joint work programs for June 2016 to June 2017.

China: Bank and Fund Planned Activities in Macrocritical Structural Reform Areas

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Relations With the Asian Development Bank1

1. The Asian Development Bank’s (AsDB) partnership with the People’s Republic of China (PRC) has grown in many ways since the PRC became a member of AsDB in March 1986. The PRC is AsDB’s second largest shareholder among regional members and the third largest overall, as well as an important middle-income country client. By the end of 2015, the PRC’s cumulative borrowing from AsDB reached $29.2 billion with 226 loans for public sector projects. Of the total public sector loans, 55.7 percent was allocated to the transport sector, followed by agriculture and natural resources (12.6 percent) and water and other municipal infrastructure services (12.6 percent), energy (11.9 percent), industry and trade (2.3 percent), finance (2.3 percent), education (1.0 percent) and multisector (1.6 percent). Over the past 27 years, AsDB has helped finance 27 private sector projects in the PRC totaling $4.96 billion. AsDB also funds technical assistance for the PRC. By the end of 2015, AsDB had provided a total of $464.4 million for 802 technical assistance projects, consisting of $147.4 million for preparing projects and $317.0 million for policy advice and capacity development.

2. Overall, the PRC has demonstrated strong capabilities in implementing projects. The good performance shows the strong sense of project ownership among agencies involved in the design, implementation, and management of projects, as well as the rigorous screening process for development projects, particularly those proposed for external financing. Loan disbursement and contract award performance is good.

3. The PRC has demonstrated its strong partnership with AsDB by contributing to the Asian Development Fund, establishing the $20 million PRC Poverty Reduction and Regional Cooperation Fund (the PRC Fund), and replenishing another $20 million to the PRC Fund. The PRC Fund—the first fund established in AsDB by a developing member country—providing technical assistance projects to support subregional cooperation initiatives, particularly Central Asia Regional Economic Cooperation (CAREC) and Greater Mekong Subregion (GMS) programs.

4. The Asian Development Bank’s Country Partnership Strategy (CPS) 2016–2020 was endorsed by AsDB Board of Directors in February 2016. The CPS 2016–2020 is aligned with the priorities of the PRC’s 13th Five-Year Plan 2016–2020, the Midterm Review of AsDB’s long-term Strategy 2020, and AsDB’s approach to supporting upper middle-income countries. The CPS will support the government’s reform agenda by focusing on the following strategic priorities: managing climate change and the environment, promoting regional cooperation and integration, supporting inclusive economic growth focusing on the remaining poor, fostering knowledge cooperation, and supporting institutional and governance reform. AsDB’s sovereign and nonsovereign operations will support activities within these strategic priorities.

5. Projected public sector lending in 2016–2018 will total about $4.56 billion, of which 30 percent will support agriculture, natural resources, and rural development; 6 percent will support education; 8 percent will support energy; 5 percent will support health; 29 percent will support transport and 22 percent will support water and other urban infrastructure and services sectors. Over 90 percent of the projects are located in the western, central and north-eastern regions in line with the CPS’s priorities of promoting inclusive growth and environmentally sustainable growth.

6. AsDB’s technical assistance will complement the lending program to improve the sector policy environment, support governance and capacity development, and strengthen the knowledge base and innovative features of lending operations.

China: AsDB’s Commitments and Disbursements (Public Sector Loans), 1993–2015

(In millions of U.S. dollars)

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Refers to cumulative contract awards.

Refers to disbursements for the year.

Statistical Issues

(As of June 16, 2016)

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China: Table of Common Indicators Required for Surveillance

(As of June 15, 2016)

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Any reserve assets that are pledged of otherwise encumbered should be specified separately. Also, data should comprise short-term liabilities linked to a foreign currency but settled by other means as well as the notional values of financial derivatives to pay and to receive foreign currency, including those linked to a foreign currency but settled by other means.

Both market based and officially determined, including discount rates, money market rates, rates on treasury bills, notes and bonds.

Only 12-month growth rates are reported (price indices are not available).

Data on financing (foreign, domestic bank and domestic nonbank financing) is not available.

The general government consists of the central (budgetary funds, extra budgetary funds, and social security funds) and state and local governments.

Including currency and maturity composition.

Goods trade data are provided monthly. Services trade data are released with the current account statistics.

For real GDP, level data are available only on an annual basis (growth rates are available on a quarterly, cumulative basis).

Daily (D), Weekly (W), Monthly (M), Quarterly (Q), Annually (A); Irregular (I); Not Available (NA).

Interest rates change only infrequently; these changes are publicly announced.

Technical Assistance

China: Summary of Technical Assistance, 2001–16 1/

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The new Institute for Capacity Development (ICD) was formed from the merger of the former IMF Institute (INS) and Office of Technical Assistance Management (OTM) on May 1, 2012.

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Prepared by Asian Development Bank staff.