China must reduce high levels of corporate debt and strengthen its banking sector if it wants to successfully transition to a new growth model, the International Monetary Fund (IMF) said in a report released Wednesday.
Speaking at the release of the Global Financial Stability Report (GFSR) here, Jose Vinals, the IMF's financial counsellor, directly addressed the "unprecedented but manageable challenges" China faces to move to "a new growth model and a more market-based financial system." China faces a "delicate balance" of transitioning to more consumption-driven growth without activity slowing too much, while reducing high debt levels through an orderly deleveraging, and moving towards a more market-based system, said Vinals, who is also the director of the IMF's monetary and capital markets department.
"This is a challenging set of objectives," he said. The GFSR said that, as the most important emerging market economy, China should take great care in how it manages this rebalancing and deleveraging process. This is not only important for China, given the impact any negative consequences in its own market would have on the global economy.
Central government debt is about 20 percent of China's gross domestic product (GDP), while 70 percent of local government debt takes the form of investment with expected returns, Chinese Premier Li Keqiang said last month during the Summer Davos Forum in Dalian, adding that China's government debt risks are "controllable."
Vinals said that while China has been successful in reducing the growth of credit, the stock of credit is still very significant. Furthermore, Vinals said that while the amount of non-profitable loans remains low in China's solid banking sector, a slowdown in Chinese growth will naturally lead corporate profits to drop and non-performing loans to increase.
Therefore, the IMF advises China to increase the resistance of banks so as to help them absorb these loans without major strains. In order to deleverage a heavily indebted corporate sector and enhance market discipline, China will have to accept "some corporate defaults, exits of non-viable firms ... and write-offs on non-performing loans, thus requiring a further strengthening of banks," Vinals said.
Vinals urged the government to act sooner rather than later, stating that "moving decisively will ultimately prove less costly than trying to grow out of the problem." On a related note, a senior Chinese official announced on Wednesday that China's official statistics would now comply with the Special Data Dissemination Standard (SDDS), an IMF mechanism created to ensure that the economic and financial statistics it receives from member countries meet a certain standard.
Speaking prior to the annual meetings of the World Bank Group and IMF here, Yi Gang, the deputy governor of the People's Bank of China, said that China and the IMF have been working together to improve China's statistics for many years and subscribing to the SDDS is "another milestone of this fruitful and important collaboration."
"We are committed to further strengthening our statistical system and enhancing transparency, as this is not only crucial for our own policy making, but also beneficial for a better understanding of the Chinese economy by the outside world," Yi said.
The IMF welcomed the move, calling it "an important advance." David Lipton, the first deputy managing director of the IMF, said the adherence to the SDDS showed "China's strong commitment to transparency as well as to the adoption of international best practices in statistics." Previously incorporated within the IMF's General Data Dissemination System (GDDS), China is the 65th country to join the SDDS, created by the IMF in 1996.
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