Is slower Chinese GDP growth better? Yes, says IMF

Slower Chinese GDP growth would be better for China and the world if comprehensive reforms are implemented and credit and investment growth is better controlled, says the International Monetary Fund (IMF).

After thirty years of spectacular growth, the Chinese economy has been growing more moderately. In order to secure a safer development path, the country must address vulnerabilities and implement the announced reform agenda.

In 2013, the Chinese economy grew by 7.7%. This year it is set to expand by approximately 7.5%, in line with the target set by the government, according to the IMF’s latest report on the state of the Chinese economy.

The authors say that much of China’s slowdown has been structural, “reflecting the natural growth convergence, but weak global growth has also contributed.”

The country’s reliance on credit and investment to fuel growth since the global financial crisis is losing its impact as investment efficiency has been in decline, resulting in resource misallocation and increasing vulnerabilities.

‘Web of rising vulnerabilities’

China’s current growth pattern has “created a web of rising vulnerabilities,” says the report.

Companies and local governments have borrowed both from banks and the so-called shadow banks to finance rapid investment growth, resulting in increasing local government and corporate indebtedness, “which is the flip side of the large increase in total credit since 2008.”

Several strands of the web of vulnerabilities run through the real estate sector.

Given China’s policy buffers, a drastic change in this trend is unlikely over the short term. The IMF warns that if this growth strategy persists, balance sheets will be weakened further, investment efficiency will dwindle, leaving China much more vulnerable to future shocks.

Comprehensive reform program

China must rapidly implement the reforms to transition, as it had previously announced, in order to secure a more sustainable growth path, the report emphasizes.

Reforms are urgently needed in the:

  • financial sector,
  • local governments,
  • exchange rate,
  • state-owned enterprises,
  • local governments.

As Chinese authorities had previously stressed, the reforms should aim to strengthen institutions, give the market a more pivotal role, and eliminate distortions.

The reforms would release a new source of productivity growth and make sure that resources are used more efficiently, the authors write.

The IMF writes:

“The reforms will also support both domestic and external rebalancing. While external imbalances have declined considerably, China’s external position is still moderately stronger compared with the level consistent with medium-term fundamentals and desirable policy settings.”

While the progress with moving the economy from an investment-led model to a consumption-driven one has been slow, implementing the reforms would help speed it up.

The authors add that government off-budget spending needs to be reduced, credit growth must slow down, as should investment growth. “While these measures would likely dampen activity somewhat, the report considers that vulnerabilities have risen to the point that containing them is a priority,” they write.

Short-term growth slowdown, long-term benefits

Implementing structural reforms and addressing vulnerabilities may reduce growth in the short term, but they will bring considerable benefits over time in terms of greater income and consumption.

Chinese authorities should accept slightly slower growth in the near term, and only consider a stimulus if economic activity slowed down well below their target. The IMF suggests a GDP growth target for 2015 of 6.5% to 7%.

China GDP various scenarios

Reforms would first slow growth but help make it more sustainable in the long run. (Data source: IMF)

The IMF writes:

“Faster implementation of reforms would have substantial benefits over the medium and long term not only to China, but also to the rest of the world. While spillovers to the global economy would reduce growth slightly in the short run, the benefits of a stronger and less vulnerable China dominate in the long run.”

After posting a record trade surplus in July, most economists are predicting export-led GDP growth for the rest of this year in China.