China: New Round of Reforms Needed for Continued Success

Reforms needed for more consumer-based, inclusive, sustainable growth

Rising domestic vulnerabilities in financial sector and local government finances

Economy expected to grow 7¾ percent this year, with downside risks

In their annual report on China’s economy, the economists emphasize the importance of reforms to secure more consumer-based and sustainable growth going forward.

Progress on external rebalancing, with rising domestic vulnerabilities

The resilience of China’s economy since the 2008 financial crisis has provided a welcome boost to global demand, and substantial progress has been made in rebalancing China’s external accounts, says the report.

But it warned that the pattern of economic activity in the world’s second largest economy has become too reliant on investment and credit, resulting in rising domestic vulnerabilities in the financial sector, local government finances, and real estate.

The Chinese authorities have announced a broad range of reforms and policy objectives for 2013 that are intended to contain risks and rebalance growth, but the priority now should be to devise specific action plans and implement them swiftly, says the report.

This will ensure a smooth continuation of the historic transformation of the past three decades in which bold reforms have helped China generate rapid growth and lift more than 500 million citizens out of poverty, it adds.

Nontraditional finance and the risk of credit crunch

Citing the rapid expansion of credit, the report cautions that while the development of nontraditional finance in the form of trust and securities companies marks a shift to more market-based intermediation, the migration of activity to less regulated parts of the system poses risks to financial stability. Banks remain closely linked to the development of nontraditional finance. The report noted that any worsening of credit quality related to the boom in nontraditional finance could potentially lead to a credit crunch and a large fiscal burden.

The expansion of nontraditional finance has accompanied a build-up in borrowing by local government through off-budget financing vehicles, particularly since 2009. Broadening the definition of government to include local government financing vehicles (LGFVs) and off-budget funds, the report estimates that in 2012 the “augmented” government debt was 45 percent of GDP (roughly double the headline general government debt figure) and the “augmented” fiscal deficit was around...