PEOPLE'S REPUBLIC OF CHINA: 2012 ARTICLE IV CONSULTATION

IMF Country Report No. 12/195 PEOPLE`S REPUBLIC OF CHINA July 2012 2012 ARTICLE IV CONSULTATION Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. In the context of the 2012 Article IV consultation with the People’s Republic of China, the following documents have been released and are included in this package:  Staff Report for the 2012 Article IV consultation, prepared by a staff team of the IMF, following discussions that ended on June 8, 2012, with the officials of the People’s Republic of China on economic developments and policies. Based on information available at the time of these discussions, the staff report was completed on July 6, 2012. The views expressed in the staff report are those of the staff team and do not necessarily reflect the views of the Executive Board of the IMF.  Informational Annex to the Staff Report of July 6, 2012.  Staff Statement of July 20, 2012  Public Information Notice (PIN) summarizing the views of the Executive Board as expressed during its July 20, 2012 discussion of the staff report that concluded the Article IV consultation.  Statement by the Executive Director for the People’s Republic of China. The policy of publication of staff reports and other documents allows for the deletion of market-sensitive information. Copies of this report are available to the public from International Monetary Fund  Publication Services 700 19th Street, N.W.  Washington, D.C. 20431 Telephone: (202) 623-7430  Telefax: (202) 623-7201 E-mail: publications@imf.org Internet: http://www.imf.org International Monetary Fund Washington, D.C. ©2012 International Monetary Fund PEOPLE`S REPUBLIC OF CHINA STAFF REPORT FOR THE 2012 ARTICLE IV CONSULTATION July 6, 2012 KEY ISSUES Context. The economy seems to be undergoing a soft landing, though global headwinds are increasing. Growth is expected to moderate to around 8 percent this year and inflation to drop to 3½ percent. Meanwhile, a political transition is underway. Focus. Near-term macroeconomic management challenges were a key focus of the consultation. The economy has been slowing partly as a result of policy action to moderate growth to a more sustainable pace, but a worsening of the euro area crisis poses a key risk to the outlook. The mission also discussed domestic risks related to the property sector, financial system, and local government finances. Another theme related to the medium-term priority of internally rebalancing the economy toward consumption. Finally, the mission also exchanged views on inward and outward spillovers, with particular attention to how China’s investment impacts the rest of the world. Macroeconomic policy advice. Policies should continue to be geared toward achieving this year’s growth targets. In the event of a worsening of the external outlook, China has ample room to respond forcefully, using fiscal policy as the main line of defense and with emphasis on measures that support China’s medium-term reform objectives. Internal rebalancing. The significant reduction in the current account surplus since its peak in 2007 is welcome, but this external rebalancing has been achieved at the cost of rising internal imbalances. China’s growth has become increasingly dependent on investment, a pattern that will be difficult to sustain. Therefore, there is a need to accelerate progress in transforming the economic growth model to be more reliant on consumer demand. Such a transformation would substantially boost living standards and make growth more balanced, inclusive, and sustainable. External assessment. The renminbi is assessed to be moderately undervalued, reflecting a reassessment of the underlying current account, slower international reserves accumulation, and past real effective exchange rate appreciation. 2012 ARTICLE IV REPORT Approved By Anoop Singh and Tamim Bayoumi PEOPLE’S REPUBLIC OF CHINA Discussions took place in Wuhan, Shanghai, and Beijing during May 29–June 8, 2012. The staff team comprised M. Rodlauer (Head), A. Ahuja, S. Barnett, M. Nabar, P. N’Diaye (all APD), M. Das (RES), I. Lee and M. Syed (resident representatives in Beijing), and A. Meier (resident representative in Hong Kong SAR). Messrs. Zhang, Xia, and Tao (OED) joined meetings in Wuhan and Beijing. The First Deputy Managing Director joined the mission on June 7–8. CONTENTS NEAR-TERM MACROECONOMIC MANAGEMENT ______________________________________________ 4 A. Near-Term Outlook______________________________________________________________________________4 B. Macroeconomic Policies _________________________________________________________________________4 C. Global Risks ____________________________________________________________________________________ 10 D. Domestic Risks ________________________________________________________________________________ 11 E. Financial Sector ________________________________________________________________________________ 14 FROM EXTERNAL TO INTERNAL REBALANCING: TRANSFORMING CHINA’S GROWTH MODEL ___________________________________________________________________________________________ 15 A. Progress with Rebalancing ____________________________________________________________________ 15 B. High Investment: Risks and Spillovers _________________________________________________________ 24 C. Toward Higher-Quality Growth ________________________________________________________________ 28 STAFF APPRAISAL ______________________________________________________________________________ 32 BOXES 1. Demographics—Has China Reached the Lewis Turning Point? __________________________________8 2. Recent Interest Rate Reform_____________________________________________________________________9 3. The Spillover Effects of a Downturn in China’s Real Estate Investment ________________________ 12 4. FSAP Follow Up: A Preliminary Assessment of Recent Reform Efforts and Pending Priorities _ 16 5. Roadmap for Financial Sector Reform _________________________________________________________ 17 6. Renminbi Internationalization _________________________________________________________________ 18 7. Analysis of the External Sector _________________________________________________________________ 21 8. China’s Rapid Investment, Capacity, and Output Gap _________________________________________ 25 9. Investment-Led Growth in China: Global Spillovers ____________________________________________ 27 10. Social Safety Net _____________________________________________________________________________ 30 2 INTERNATIONAL MONETARY FUND PEOPLE’S REPUBLIC OF CHINA 2012 ARTICLE IV REPORT FIGURES 1. Growth Appears Headed Toward a Soft Landing ________________________________________________5 2. Lingering Effects of the Last Stimulus ____________________________________________________________6 3. Current Account: Recent Trends and Prospects________________________________________________ 19 4. Exchange Rate _________________________________________________________________________________ 22 TABLES 1. Selected Economic Indicators __________________________________________________________________ 37 2. Balance of Payments ___________________________________________________________________________ 38 3. Indicators of External Vulnerability ____________________________________________________________ 39 4. Monetary Developments ______________________________________________________________________ 40 5. General Government Budgetary Operations ___________________________________________________ 41 6. Illustrative Medium-Term Scenario ____________________________________________________________ 42 7. Public Sector Debt Sustainability Framework __________________________________________________ 43 INTERNATIONAL MONETARY FUND 3 2012 ARTICLE IV REPORT PEOPLE’S REPUBLIC OF CHINA NEAR-TERM MACROECONOMIC MANAGEMENT A. Near-Term Outlook 1. Growth. Staff project growth to impulses from housing, and softer global moderate to 8 percent this year— ¼ percentage point lower than in the April WEO—the lowest in many years (Figure 1). This projection assumes that global activity is slightly weaker than envisaged in the April 2012 WEO and that the authorities continue to gear policies to achieving this year’s fiscal and monetary targets. Growth is expected to bottom out in the second quarter, and then accelerate in the second half of the year. Growth next year is projected to be 8½ percent. commodity prices have contributed to lower production costs. Inflation in China remains driven primarily by food prices, and barring further shocks to agricultural supply, inflation should stay in the 3–3½ percent range this year and fall to 2½–3 percent in 2013. 3. Authorities’ views. The authorities have been pursuing policies aimed at slowing the economy to a more sustainable pace. As a result, growth has been steadily moderating over the past five quarters. This managed slowdown, however, has run into stronger- 2. Inflation. Since peaking at than-anticipated headwinds from the 6½ percent last July, inflation has been on a downward path to 3 percent in May. Price pressures have eased across all major components of the CPI basket, led by declining food inflation that reflects the unwinding of agricultural supply shocks. Policy efforts to rein in the property sector have also helped to lower inflationary worsening of the euro area crisis. Measures to support growth are now being given more prominence and the authorities are confident that growth will be at least 7½ percent this year. Regarding inflation, they noted that ongoing reforms to increase factor prices could push inflation above staff’s 2013 forecast. B. Macroeconomic Policies 4. Fiscal policy. The 2012 budget strikes adjusted terms.1 Although revenues have a balance between unwinding the 2009-10 fiscal stimulus and providing support to the slowing economy (Figure 2). The overall deficit is expected to be 1¼ percent of GDP, unchanged from last year in cyclically been subdued this year, the full-year revenue targets remain achievable, as activity is expected to pick up in the second half of this year. To help support activity, implementation 1 This is based on staff definitions, which adjust the official figures for a few items, the main one being net transfers to the stabilization fund. 4 INTERNATIONAL MONETARY FUND ... - --nqh--