People’s Republic of China: Staff Report for the 2018 Article IV Consultation
Author: International Monetary Fund. Asia and Pacific Dept
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

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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

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Sources: Haver Analytics; and IMF staff estimates.

After adjusting for the local government debt swap.

Table 5.

China: General Government Fiscal Data

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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.