On July 22, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with the People’s Republic of China.

China is transitioning to a new normal, with slower yet safer and more sustainable growth. Growth last year fell to 7.4 percent and, this year, is forecast to slow further to 6.8 percent on the back of slower investment, especially in real estate. The labor market has remained resilient despite slower growth, as the economy pivots toward the more labor-intensive service sector. This, in turn, has supported household consumption. Inflation is forecast to remain at 1.5 percent, pulled down by the appreciation of the real effective exchange rate and falling global commodity prices.

Fiscal policy has been accommodative and continues to be impacted by off-budget activity. As of end-2014, augmented debt (general government plus off-budget activity) rose to around 57 percent of GDP. Monetary policy has remained broadly neutral, as interest rate cuts have matched the decline in inflation. Credit growth has decelerated significantly and shifted more toward conventional banking loans, as a result of stricter regulation on shadow banking. Growth in total social financing—a broad measure of funding—decelerated from the peak of 22 percent in May 2013 to 12½ percent in May 2015.

Considerable progress has been made in external rebalancing. The current account surplus fell to 2.1 percent in 2014 from the peak of around 10 percent in 2007, and the renminbi has appreciated by about 10 percent since last year in real effective terms. Further progress has also been made on domestic rebalancing, with consumption contributing 0.1 percentage points more to GDP growth than investment in 2014, and labor income gaining a larger share in GDP.

Executive Board Assessment²

Executive Directors commended the authorities’ success in implementing critical economic policies and reforms, evidenced by China’s remarkable development over the last 35 years. They observed that the reliance on credit-financed investment since the global financial crisis has created large vulnerabilities. In this regard, they welcomed the authorities’ commitment to move to a more sustainable growth model. They considered that a key challenge is to ensure sufficient progress in reducing vulnerabilities while preventing growth from slowing too much and advancing structural reforms.

Directors considered that reining in vulnerabilities is a priority. They welcomed the progress made in this regard, including by slowing down credit growth, especially in shadow banking; moderating investment, led by a slowdown in residential real estate; and passing a new budget law aimed at safeguarding fiscal sustainability. However, they agreed that more needs to be done to put vulnerabilities on a downward path, including a further decline in real estate investment, multi-year deleveraging, and medium-term fiscal consolidation.

Directors highlighted the challenge of managing the slowdown, and recommended that macroeconomic policies should be calibrated to achieve an orderly adjustment by aiming for GDP growth of 6½ to 7 percent this year and 6 to 6½ percent next year. They agreed that monetary policy should take a wait-and-see approach, especially as significant easing would risk exacerbating the credit and investment vulnerabilities. Meanwhile, a sharp contraction in local government spending that would reduce the augmented fiscal deficit should be avoided this year, in view of headwinds to growth from slowing credit and real estate investment. Directors considered it appropriate to start a gradual consolidation next year that lowers the augmented deficit to 8 percent of GDP by 2020 and puts public finances on a sustainable path.

Directors underscored that further structural reforms are needed to make the Chinese economy more open and market-based and promote further internal rebalancing. These include moving to a more market-based financial system and monetary policy framework, including completing interest rate liberalization and eliminating implicit guarantees; reforming state-owned enterprises; moving to an effectively floating exchange rate; and strengthening the fiscal framework, including local-central government relations, the social security system, and tax policy. They noted that these reforms are in the authorities’ agenda and welcomed the steps that have been taken. Looking ahead, they urged steadfast and timely implementation of the envisaged reforms.

Directors took note of the staff assessment that the external position in 2014 was moderately stronger than is consistent with fundamentals. They agreed that this highlights the need for continued reforms to further reduce excess savings and achieve a sustainable external balance. They also noted the staff assessment that the substantial appreciation of the renminbi in real effective terms this year has brought the exchange rate to a level that is no longer undervalued. A few Directors pointed out that further exchange rate adjustment could further facilitate external adjustment. Directors welcomed the steps taken to liberalize the capital account and recommended carefully sequencing these efforts.

Directors noted the authorities’ wide-ranging policy response to the recent equity market correction. They agreed that exiting these interventions in a timely manner would be consistent with the move toward a more market-oriented financial system. The focus should be on maintaining the liquidity of systemically important institutions and groups of institutions and strengthening the framework for market regulation, supervision, and crisis management.

Directors encouraged the authorities to continue to improve data quality, especially fiscal data, and welcomed their commitment to subscribe to the Special Data Dissemination Standard.