BOFIT Viikkokatsaus / BOFIT Weekly 2017/41

In its World Economic Outlook (WEO) released this month, the IMF has slightly raised its projected growth for the Chinese economy. IMF analysts now expect China's GDP to grow by 6.8 % this year and 6.5 % next year. The revised forecast reflects higher-than-expected growth in the first half of this year and strength in China's export markets. The 2018 forecast assumes that the Chinese government will continue to support economic growth, especially through public investment in order to meet the government's target of doubling real GDP between 2010–2020. Achieving of the GDP growth target, which was set by the party leadership in 2012, requires that GDP growth average about 6.5 % p.a. in coming years.

The increase in the IMF's growth prognosis is not so much an indication of strong economic conditions, but a foreshadowing of increased economic problems in coming years. Debt-fuelled stimulus policies partly account China's recent high growth. This has eroded room to manoeuvre in the fiscal policy sphere and slowed progress in structural reform of the economy. In conjunction with the WEO's release, the IMF issued a longer-term projection that sees Chinese GDP growth slowing very gradually while public-sector debt as a share of GDP rises from the current level of 48 % to over 60 % in 2022. However, China's public-sector liabilities are actually even greater than that.

The IMF would like to see China shift its policy focus from annual GDP growth targets to reforms that support sustainable growth and tuning of fiscal policy so that the broadly defined budget deficit (about 10 % of GDP) is gradually reduced to stabilise the debt-to-GDP ratio. The monetary stance should be gradually tightened. Monetary policy could be made more effective by phasing out monetary targets, increasing exchange rate flexibility and improving communications. China could also strengthen its financial market supervision and impose measures to make banks deal with non-performing loans. Expanding the role of markets in the economy should be a central priority. This means, for example, opening of China's tightly closed service sector and allowing state-owned enterprises to face harder budget constraints.

As earlier, the IMF warned of postponing efforts to restrain mounting indebtedness and structural reforms as it could lead to a sharp slowdown in the economy. A crisis could be triggered by a sudden drying up of access to financing on the interbank market or the wealth management product market, barriers to trade imposed by trading partners or increased pressure to move capital out of the country due e.g. to a faster-than-expected rise in US interest rates.

A rapid slowdown in Chinese economic growth would also be reflected in the volume of trade with other nations, a drop in global commodity prices and uncertainty over global growth prospects. The latest WEO notes that China accounts for over half of the world demand for metals. A tightening of China's lending policies or a substantial reduction its overcapacity in metals production could have profound downward or upward price implications in global commodity markets.