People’s Republic of China: 2019 Article IV Consultation—Press Release; Staff Report; Staff Statement and Statement by the Executive Director for China
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International Monetary Fund. Asia and Pacific Dept
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Publication Date:
09 Aug 2019
eISBN:
9781513510460
Language:
English
Keywords:
ISCR; CR; People's Bank of China; PPI inflation; fixed asset investment growth; authority; exchange rate; real GDP; monetary policy; current account; FX market; Trade tensions; Global; private sector
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2019 Article IV Consultation-Press Release; Staff Report; Staff Statement and Statement by the Executive Director for China

Abstract

2019 Article IV Consultation-Press Release; Staff Report; Staff Statement and Statement by the Executive Director for China

Context: Navigating Headwinds and Uncertainty

1. Reform agenda – a pause in deleveraging. This is a critical year for the authorities’ planned pivot from “high-speed” to “high-quality” growth. The authorities’ made commendable progress on reducing financial sector fragilities and announced a lower growth target for 2019, a range from 6.0–6.5 percent. As economic activity slowed in the second half of 2018, however, the government shifted emphasis from deleveraging back to supporting growth. Structural reforms have continued in a number of areas but, while the principle of “competitive neutrality” has been put forward as a policy objective, its implementation remains at an early stage.

2. External headwinds – trade tensions and weak global demand… The trade conflict with the U.S. escalated since its start in spring 2018, and the outlook for the global economy in 2019 is weaker than previously expected. Two rounds of U.S. tariffs and counter-tariffs were implemented before a ‘truce’ and negotiations began in December 2018, which broke down in May and led to another round of tariff increases. At end-June, Presidents Xi and Trump agreed to temporarily keep tariffs at their current levels and to restart bilateral trade negotiations. The conflict goes beyond bilateral trade and extends to structural issues related to China’s foreign investment regime, intellectual property (IP) protection, technology transfer policies, industrial policy, cyber security, and, more broadly, the large economic role of the state. Progress on some of these dimensions, opening up in particular, would be consistent with previous staff recommendations and boost medium-term prospects, while other aspects of a potential U.S.-China agreement, such as on managed trade, could negatively affect the multilateral trading system.

uA01fig01

Tariff announcements

(Goods trade 2018, in USD billions; bubble size represents percent of GDP)

Citation: IMF Staff Country Reports 2019, 266; 10.5089/9781513510460.002.A001

Source: CEIC.
uA01fig02

Weaker domestic demand in advanced economies

(In percent)

Citation: IMF Staff Country Reports 2019, 266; 10.5089/9781513510460.002.A001

Source: IMF WEO database.

3. …leading to an uncertain and challenging environment. In the event a comprehensive and durable agreement is not reached, uncertainty is likely to persist and weigh on both the near and longer-term outlook as China’s access to foreign markets and technology may be significantly reduced.

Recent Developments: Weaker Growth Amid Regulatory Strengthening and External Headwinds

4. Growth slowed in 2018… In line with staff projections, growth moderated from 6.8 percent in 2017 to 6.6 percent in 2018, as a result of necessary financial regulatory reforms and tighter conditions for local government (LG) infrastructure funding. Trade tensions with the U.S. have weakened sentiment and heightened stress in financial markets. The authorities have responded with a wide range of policy measures, including import tariff cuts, tax cuts, monetary easing, and a marginal relaxation of the pace of regulatory strengthening.

5. …but stabilized in 2019 Q1, before being hit by another trade shock. Real GDP growth was 6.4 percent (y/y) in Q1, unchanged from 2018 Q4. Domestic demand weakened further, however, to 4.9 percent in Q1 compared to 6.7 percent in 2018 Q4, as net exports contributed 1.5 percentage points to growth due to contracting imports. Nominal GDP growth also decelerated further, from 9.1 percent in 2018 Q4 to 7.8 percent in Q1, driven by sluggish producer prices. High-frequency indicators still point to sluggish domestic and external demand as renewed trade tensions continue to weigh on market and business sentiment.

6. Core inflation moderated, while headline rose. Amid slowing activity, core CPI inflation fell just below 2 percent in mid-2018, and further to 1.6 percent in May. Headline CPI inflation rose to 2.7 percent in May, driven by rising food inflation. Driven by a global decline in commodity prices and weak infrastructure and construction, Industrial Producer Price Index (PPI) inflation fell sharply to below 1 percent in 2019, renewing pressure on corporate earnings and debt servicing capacity.

uA01fig03

PPI Inflation trends partially driven by common external factors

(In percent, year-on-year)

Citation: IMF Staff Country Reports 2019, 266; 10.5089/9781513510460.002.A001

Source: Haver Analytics.
uA01fig04

PPI inflation drops below CPI inflation

(In percent, year-on-year)

Citation: IMF Staff Country Reports 2019, 266; 10.5089/9781513510460.002.A001

Source: CEIC.
uA01fig05

Property market slowing since 2017

(In percent change, year-on-year 3mma)

Citation: IMF Staff Country Reports 2019, 266; 10.5089/9781513510460.002.A001

Source: CEIC and IMF staff estimates.

7. The property market trended down. Growth in real estate investment (excluding land purchases) was mostly negative in 2018, and both house price growth and sales growth slowed since late 2018. Housing inventories have started to build up in recent months, suggesting the housing cycle may still be in a downturn.

8. The current account (CA) continued to decline and capital flows moderated after strong inflows in early 2018.

  • Current account. The CA surplus has declined substantially relative to its peak of about 10 percent of GDP in 2007, reflecting strong investment growth, REER appreciation, weak demand in major advanced economies, technological upgrades in manufacturing, and a widening of the services deficit (see SIP). The CA surplus continued to decline in 2018, falling by about 1 percentage point, to 0.4 percent of GDP, driven by strong import growth. Export and import growth remained strong through most of 2018, partially due to frontloading of exports to the U.S. ahead of tariff imposition, before contracting from December. Driven by changing expectations about the outcome of U.S.-China trade negotiations, trade has been volatile so far in 2019, with nominal export growth near zero and imports contracting at 4 percent for the first six months of the year (y/y).

  • Exchange rate. The bilateral RMB/USD rate depreciated relatively rapidly from mid-June to early August 2018, when measures to counter depreciation pressure – the 20 percent reserve requirement for FX derivatives (a capital flow management measure (CFM)) and the countercyclical adjustment factor (CCAF) in the daily trading band’s central parity formation – were re-introduced. Despite the RMB/USD depreciation, the RMB was broadly stable against the basket and depreciated in real effective terms by about 2½ percent since the last Article IV. Estimates suggest little FX intervention by the PBC. At about US$3.2 trillion, China’s foreign currency reserves remain more than adequate to allow a continued transition to a floating exchange rate.

  • Capital flows. Capital inflows were strong in early 2018 and moderated through the year to small net outflows in 2018 Q4, but there were no significant outflow pressures. Capital inflows were supported by the inclusion of China A shares in MSCI equity indices and local currency government and policy bank bonds into the Bloomberg Barclays Global Aggregate Index. Staff estimates suggest these inclusions could result in sizeable additional inflows of around US$450 billion over the next 2–3 years.

uA01fig06

Significant potential inflows from index inclusions

(In USD billions)

Citation: IMF Staff Country Reports 2019, 266; 10.5089/9781513510460.002.A001

Source: GFSR (April 2019) and IMF staff estimates.
uA01fig07

China’s reserve coverage appears adequate

(In US$ billion)

Citation: IMF Staff Country Reports 2019, 266; 10.5089/9781513510460.002.A001

Source: CEIC, IMF staff estimates.

9. After slowing last year, debt accumulation accelerated in 2019 Q1. Overall debt of the nonfinancial sector grew by an average of 3½ percentage points of GDP in 2017 and 2018, considerably more slowly than in the decade prior, as corporate deleveraging partially offset government and household debt accumulation – but still reached 257 percent of GDP in 2018. Recent policy easing measures have led to a sharp increase in the pace of debt accumulation in 2019 Q1, with household and corporate debt growing by 1 and 3 percentage points of GDP, respectively.

uA01fig08

Household and government debt still rising

(In percent of GDP)

Citation: IMF Staff Country Reports 2019, 266; 10.5089/9781513510460.002.A001

1/ Excludes LGFV.Source: Haver Analytics and IMF staff estimates.

10. The build-up of risks in the financial sector has been contained, but vulnerabilities remain elevated and credit growth is picking up.

  • Financial deleveraging and reduced interconnectedness between banks and non-banks, as well as somewhat improved risk-differentiation, resulted from regulatory and supervisory reforms. Bank asset growth fell from 15 percent (y/y) in mid-2016 to 7 percent (y/y) in mid-2018, driven by a fall in claims on other financial institutions. Banks’ issuance of off-balance sheet investment vehicles, wealth management products in particular, was curtailed.

  • Credit growth slowed through 2018 but has begun to pick up in 2019. As a result of the contraction in shadow banking, total social financing (TSF) growth slowed more sharply than expected, from 15 percent (y/y) in early 2017 to under 10 percent at end-2018. Bank lending to the corporate sector continued to expand strongly, but banks favored SOEs over private enterprises, and lending to small and medium-sized enterprises (SMEs) in particular was curtailed. Growth in household lending moderated, but remained high, and short-term credit continued to expand rapidly, in part to circumvent restrictions on mortgage lending. TSF growth accelerated in 2019 to 10.6 percent in May, due to policy stimulus.

  • A recent takeover of a non-systemic mid-size bank. The government in May took over a medium-sized “zombie” bank with solvency and liquidity problems (Baoshang), the first public takeover in 20 years. The announcement that negotiated haircuts would be applied to large creditors’ claims raised concerns about counterparty risks and highlighted balance sheet weaknesses facing many small and medium-sized banks (joint-stock commercial banks, city commercial, and rural banks make up about 45 percent of total banking assets), including more than a dozen that have yet to release 2018 financial statements. These banks are reliant on interbank funding and also provide funding to non-bank financial institutions (NBFIs). Interbank funding tightened for some small banks and NBFIs, as negotiable certificate of deposit (NCD) issuance (about a tenth of small bank funding), fell sharply while funding costs for many NBFIs rose significantly. The PBC took steps to stabilize funding conditions by injecting liquidity and introducing a new credit support scheme for banks’ NCDs. Market sentiment has since stabilized, though borrowers with weaker balance sheets continue to face higher borrowing costs.

uA01fig09

Shadow banking contracted through 2018

(Stock, in RMB trillions)

Citation: IMF Staff Country Reports 2019, 266; 10.5089/9781513510460.002.A001

Sources: CEIC and IMF staff estimates.
uA01fig10

Asset management industry declined further in 2018

(In percent of GDP)

Citation: IMF Staff Country Reports 2019, 266; 10.5089/9781513510460.002.A001

Note: Insurance AM plans are excluded (2.5 trillion RMB at end 2017). Source: CEIC.
uA01fig11

Credit growth picks up

(In percent)

Citation: IMF Staff Country Reports 2019, 266; 10.5089/9781513510460.002.A001

Note: New definition includes ABS, loans write-offs, and special purpose bonds. Source: Haver analytics and IMF staff estimates.
uA01fig12

Drop in small banks and NBFI’s NCD issuance

(Actual NCD issued as percent of planned issuance amount)

Citation: IMF Staff Country Reports 2019, 266; 10.5089/9781513510460.002.A001

Source: WIND database.

11. Financial conditions, after tightening strongly in 2018, loosened in 2019.

  • Financial conditions tightened in the first half of 2018, driven by more stringent regulatory standards for banks and non-banks. Corporate credit spreads widened, more so for lower-rated borrowers, and corporate bond defaults rose from a low base, mainly for private corporates. Notwithstanding strong foreign inflows, China’s equity markets fell by 25 percent in 2018, more than other EMs, driven in part by margin calls and forced selling related to stock-pledged borrowings.

  • Financial conditions then eased somewhat after monetary policy loosened from summer 2018. Monetary policy easing led to a decline in short-term interest rates, but access to credit for private, particularly smaller, firms remained difficult. The stock market has rebounded by 19 percent so far in 2019.

uA01fig13

Financial conditions have loosened somewhat

(China financial conditions index, neutral = 0)

Citation: IMF Staff Country Reports 2019, 266; 10.5089/9781513510460.002.A001

Source: S&P Global.

12. Progress on rebalancing was mixed in 2018. External rebalancing resumed with net exports contributing negatively to growth, while internal rebalancing towards consumption accelerated. Internal rebalancing towards services progressed more slowly and, after a big improvement in 2017, credit efficiency did not improve further. Environmental rebalancing continued but progress was more limited in reducing inequality. While absolute poverty has fallen to less than 3 percent of the population— close to the authorities’ goal of eliminating it by 2020—still-high spatial and rural-urban inequality remains a challenge, as evidenced in the mission’s visit to villages in Guizhou province.

uA01fig14

Large variation in regional growth

(Real GDP growth rate, In percent)

Citation: IMF Staff Country Reports 2019, 266; 10.5089/9781513510460.002.A001

Source: CEIC.
uA01fig15

Mixed rebalancing progress in 2018

Citation: IMF Staff Country Reports 2019, 266; 10.5089/9781513510460.002.A001

Note: Refer to Table 7 for details.
Table 1.

China: Selected Economic Indicators

article image
Sources: Bloomberg, CEIC, IMF International Financial Statistics database, and IMF staff estimates and projections.

IMF staff estimates for 2017 and 2018.

Surveyed unemployment rate.

Not adjusted for local government debt swap.

Includes government funds.

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 budgetary 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

article image
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.

Shanghai Stock Exchange, A-share and B-share, and Shenzen Stock Exchange.

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

article image
Sources: Haver Analytics; and IMF staff estimates.

After adjusting for the local government debt swap.

Table 5.

China: General Government Fiscal Data

article image
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 government

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.

GDP in this table refers to expenditure side nominal GDP.