China Would Benefit from Slower but Safer Growth

Successful implementation of comprehensive reform agenda will secure more balanced, sustainable growth

Slower credit and investment growth are required to contain risks

Slower but safer growth path is good for China and the world

China’s growth was 7.7 percent in 2013 and is expected to be around 7½ percent in 2014, in line with the government’s target, the IMF said in its most recent report on the state of the Chinese economy. Much of China’s slowdown has been structural, reflecting the natural growth convergence, but weak global growth has also contributed.

In their annual assessment, the report’s authors emphasize that China’s heavy reliance on investment and credit to drive growth since the global financial crisis is running out of steam as investment efficiency has been declining. The result has been resource misallocation and rising vulnerabilities.

Web of vulnerabilities

The report says that the current growth pattern has created a web of rising vulnerabilities. To finance rapid investment growth, firms and local governments borrowed from both banks and nonbank financial entities (the so-called “shadow banks”). This has resulted in rising corporate and local government indebtedness, which is the flip side of the large increase in total credit since 2008. In addition, many strands of the web run through the real estate sector.

While an abrupt adjustment in the near term is unlikely, given China’s policy buffers, repeated use of this growth strategy would further weaken balance sheets, reduce investment efficiency, and leave China more vulnerable to shocks in the future.

Comprehensive reform agenda

The report’s main message is that China needs to quickly implement the announced reforms to transition to a more sustainable growth path. Priority reforms are in the following areas: financial sector, state-owned enterprises, exchange rate, and local governments. Reforms should aim to eliminate distortions and implicit guarantees, strengthen institutions, and give the market a more decisive role, as the authorities emphasized.

The report indicates that implementing these reforms would unleash new sources of productivity growth and ensure that resources are used more efficiently. The reforms will also support both domestic and external rebalancing. While...