Overview of the IMF’s AnnualOverview of the IMF s Annual Consultation with China

September, 2016 1

Overview Economy becoming more balanced in many areas and reforms progressing

But critically, credit growth remains excessive and SOE reforms have lagged

Which clouds the outlook, threatening growth and financial stability

And which requires urgent action to address: And which requires urgent action to address:

• Tackle the corporate debt problem

• Stop credit/investment stimulus and allow growth to slow

• Guard against financial risks

• Continue to an effectively floating FX regime

• Strengthen transparency (communications and data)

2

Mixed Progress on Rebalancing

Rebalancing Scorecard

Internal EnvironmentExternal Income Distribution

Current acc. Net exports contrib. Cons/Inv Industry/Services Credit Energy Air pollution Labor income ratio Income inequality

3

Reform Progress on Many Fronts

0.6

Std of CFETS Index

RMB Increasingly Referencing a Basket 1/

PBC's

0 3

0.4

0.5Std of CFETS Index Daily Change announcement

of CFETS basket

0.1

0.2

0.3

Std of CNY/USD Parity Rate Daily Change

0Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16

Sources: Bloomberg LP; and IMF staff calculations.1/ Standard deviation caculated on a 30-business-day forward rolling window.

• Monetary framework• Fiscal framework• Urbanization

New 5 year plan has the right goals

4

• New 5-year plan has the right goals• Also plans to reduce overcapacity/zombie SOEs

But Policy has at Times Also Obstructed Reform and Rebalancingand Rebalancing

Real Fixed Asset Investment Growth 1/(In percent, year-on-year)

Credit: High and Rising 1/(In percent year-on-year growth)

21

29

21

29

( p , y y )

Non-SOESOE

190

220

30

40Credit (Adjusted for LG debt swap)

(In percent, year on year growth)

Credit to GDP ratio (Unadjusted, RHS)

Credit to GDP ratio (Adjusted, RHS)

5

13

5

13Total

100

130

160

0

10

20

Nominal GDP

-3-32013 2014 2015 2016 July-16

1/ Deflated by FAI prices; authorities publish quarterly index and staff estimates monthly index.

10002009Q1 2010Q1 2011Q1 2012Q1 2013Q1 2014Q1 2015Q1 2016Q1

Sources: CEIC Data Company Ltd.; and IMF staff estimates.1/ Total social financing stock.

2016Q2

• Traditional stimulus – from mid 2015• Uneven reform progress – especially on governance, SOEs, corporate debt,

opening up• Lack of policy clarity – reform or growth? Eg equity market response/ role of

5

Lack of policy clarity reform or growth? Eg equity market response/ role of private sector

Rising Vulnerabilities… Hard Landing in Overcapacity/RegionsOvercapacity/Regions

T d E

20

25

Two-speed Economy(In percent, year-on-year growth)

10

15

Nominal growth of services sector

Nominal GDP growth

0

5

10Q1 11Q3 13Q1 14Q3 16Q1

Nominal growth of industrial sector

16Q2

Sources: CEIC Data Company Ltd.; and IMF staff estimates.

6

…High Corporate Debt and Weakening FundamentalsFundamentals

Ireland

SwedenChina 15 1/

150

200

pora

tes

Corporate Credit: High vs. Peers(Selected economies, 2014)

25

30

1y, ICR < 2

China Listed Companies' Potentially Impaired Loans 1/(In percent of debt)

Australia

Brazil

DenmarkEuro area Finland

Germany

Greece

Hungary

India

Italy

JapanKorea

Malaysia

Netherlands

PolandRussia

Singapore

South Africa

Spain

Thailand Turkey

United Kingdom

United States

China 15 2/

50

100

t to

non-

finan

cial

corp

(per

cent

of G

DP)

China 09 1/

China 09 2/

10

15

20

1y, ICR < 1.5

1y, ICR < 1

ArgentinaIndonesiaMexico

South Africa

00 10 20 30 40 50 60 70

Cred

it

GDP per capita (USD thousand)Sources: Bank for International Settlements (BIS); and IMF staff estimates.1/ Calculated as total social financing minus equity and household loans. 2/ Calculated as total social financing minus equity, LGFV borrowing and household loans.

0

5

2010 2011 2012 2013 2014 2015 E

1/ Estimated impaired loans on each ICR standard as a share of total loans in the sample. The sample is from the S&P Capital IQ database. / g q y, g

7

…Large Credit “Gap” and Increasing Credit Intensity of GrowthIntensity of Growth

200

230

Fast Credit Growth and Wide Credit Gap 1/(In percent of GDP)

JapanSpain

3

4

Credit Intensity Rising Further 1/(New credit per unit of additional GDP)

110

140

170

Thailand

China 1

2

3Post-crisis average

50

80

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 20132015Sources: Bank for International Settlements (BIS); and IMF staff estimates.1/ Total credit to the private nonfinancial sector Dotted lines represent the credit trend

China

2015

0

1

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015Sources: Bank for International Settlements (BIS); World Economic Outlook (WEO) and IMF Staff estimates.1/ Pl tt d 3 lli

Pre-crisis average

1/ Total credit to the private nonfinancial sector. Dotted lines represent the credit trend. 1/ Plotted as 3-year rolling average.

8

…Increasingly Large, Leveraged, Interconnected and Opaque Financial Systemand Opaque Financial System

300

32040

Commercial Bank Balance Sheets Expanding Rapidly(In percentage points of GDP, year-on-year growth)

52Corporate loans

Shadow Products in a Credit System Context, 2015(In trillion of RMB)

220

240

260

280

0

20Total assets (stock, % of GDP, RHS)

89

89

67

52

24

18

40

15

Other credit products

Less: Overlap

Shadow products

Corporate bonds

180

200

-2007 08 09 10 11 12 13 14 15

Foreign and reserve assets Claims on government and central bankClaims on other depository corporations Claims on other finanical institutions

133

123

113

27

10

10

Retail loans

LGFV loans

Policy bank loans

Claims on nonfinanical institutions Claims on other residential sectorsOther assets Total assets

Sources: Haver Analytics; and IMF staff estimates.

0 50 100 150 200

Note: Segments highlighted in red are high-risk, yellow indicates medium-risk, and green is low-risk. Segments in gray are outside the scope of analaysis or assumed to be zero-risk.

9

…A Propensity for Asset Price Booms

Booming Tier 1 House Prices(In percent, year-on-year growth, 3mma)

50

65

50

65Tier I

20

35

20

35 Tier II

Tier III or IV

-10

5

-10

5

NBS: Floor space selling price

-25-252008 2009 2010 2011 2012 2013 2014 2015 2016June-16

Sources: Fangguanju; and IMF staff estimates

10

Sources: Fangguanju; and IMF staff estimates.

…Significant Capital Outflows

Financial Acount and Errors and Omissions(In billion of US dollars)

50

150

-50

50

-150

-2502011Q1 2012Q1 2013Q1 2014Q1 2015Q1 2016Q1

Non-reserve flows Errors and Omissions

11

Risks

80s Credit Booms Tend to End Badly(In percentage points)

Ireland

Spain

ArgentinaUruguay60

80

e in

five

yea

rs

China 2/

United KingdomBelgiumDenmark

Italy

NorwaySweden

Finland

GreecePortugal

Spain

Brazil

UruguayMalaysia

Philippines

Thailand

40

ratio

cha

nge China 2/

0

20

10 8 6 4 2 0 2 4redi

t-to

-GD

P

Followed by banking crisis 3/

-10 -8 -6 -4 -2 0 2 4Cr

GDP growth change 1/ Source: IMF staff estimates.1/ Average growth differential between 5-year post-boom and 5-year pre-boom periods. 2/ No growth change as China's boom has not ended.

12

3/ Banking crisis is identified following Laeven and Valencia (2012).

Outlook—Benign Near-term but Increasingly W k M di t ith t R fWeak Medium-term without Reform

7

8

GDP Growth: Illustrative Scenarios(In percent, year-on-year growth)

ProactiveNo-reform

230

Credit Ratio: Illustrative Scenarios 1/(In percent of GDP)

No-reform

4

5

6

7

Projection range

Proactive

Baseline

170

200

Proactive

Baseline

2

3

4

2012 2015 2018 2021

S CEIC D t C Ltd d IMF t ff ti t

1402014 2015 2016 2017 2018 2019 2020 2021

Sources: CEIC Data Company Ltd.; World Economic Outlook (WEO) and IMF staff estimates.1/ Nonfinancial private debt calculated as total social financing stock adjustedSources: CEIC Data Company Ltd.; and IMF staff estimates. 1/ Nonfinancial private debt, calculated as total social financing stock adjusted for local governemnt debt swap minus equity financing and LGFV borrowings.

13

Buffers still High, but Shrinking Fast

182

200200

Reserves Still Adequate(In percent of IMF Reserve Adequacy Metric)

Fixed With Capital Controls Fixed Without Capital Controls

60

70

60

70

Gross Government Debt ...Not High(In percent of GDP)

75

113

94 80

120

160

80

120

160

43

65

20

30

40

50

20

30

40

50

75

0

40

0

40

2016Q1 EM Average (ex China)

2016Q1 EM Average (ex China)

31

0

10

0

10

China 2015 1/ EM 25th percentile EM 75th percentile

Sources: World Economic Outlook (WEO); and IMF staff estimates.1/ Including all explicit government (central and local) liabilities and part of the contingent

Sources: Assessing Reserve Adequacy; IMF Policy Papers; February 14, 2011. / g p g ( ) p g

liabilities that the government might be responsible for.

14

What were Beijing’s Views?

Outlook: saw 6 ½ - 7 as sustainable, infrastructure spending was needed,

quality of growth improving

External: commodity prices to recover, tourism increase, current account 2-

3% GDP in medium term, outflows to moderate

Risks:

• External: uncertainty/weak investment in some EMs; sluggish recoveryExternal: uncertainty/weak investment in some EMs; sluggish recovery

AEs; rising geopolitical tension

• Domestic: corporate debt (but manageable); financial sector (limited

and supervisors reacting)

15

Spillovers

6

Contribution to Global Growth: Still Large(In percentage points)

BRAZAFTUR

Financial Amplifier

Exchange rate depreciation

Spillover Channels and Countries

2

4

HKGMNG

COLRUS CHL

KAZZMB

IRN

MYSBHRAZEBRNARENGAQAT

TURMEXIDN

Exchange rate depreciation between Jun 10 and Sept 28 > 10 percent

-2

0

2000 2003 2006 2009 2012 2015

China United StatesJapan Euro areaRest of World World

KORTHA

AUSSAUVENOMN

QNORISLUKRPERGHA

Trade Channel

Exports to China (2013-14 average) > 5 percent of GDP

Commodity Channel

Net commodity exports > 5 percent of GDP

Sources: World Economic Outlook (WEO); and IMF staff estimtes.Source: IMF staff estimats.

16

Policies – (1) Tackle Corporate Debt Problem

• High level – political – decision to let

30000

Insolvency Little Used(Number of cases, 2014)

g p

weak firms go

• Harden budget constraints

10000

15000

20000

25000

• Triage: good, bad and the ugly

• Recognize losses

• Share the burden

0

5000

USA Germany England & Wales China

Sources: China Court; Sinotrust; Euler Hermes; US Trust Offices; Credireform; and UK

• Share the burden

• Out of court debt restructuring /

distressed debt marketSources: China Court; Sinotrust; Euler Hermes; US Trust Offices; Credireform; and UK Insolvency Service.

• Social costs

• Facilitate market entry

17

Policies – (2) Accept the Slowdown

30Monetary Policy Looser than Implied 1/

Policy stance index 55

Consolidated general

Fiscal Deficit Remains Large, But More on Budget(In percent of GDP)

0

10

20

Tigh

ter

-5

0

-5

0

Consolidated general government balance

-20

-10

2003 2004 2005 2007 2008 2009 2011 2012 2013 2015

LooserTaylor-rule implied policy index

Mar-2016Source: IMF staff estimates.

-15

-10

-15

-10

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Augmented balance

1/ The monetary policy stance index is constructed on the basis of a short-term interest rate, reserve requirement ratio, open market operations and credit growth. The implied policy index is estimated with a simple Taylor rule that includes inflation and output developments.

Proj.

Sources: CEIC Data Company Ltd.; Authorities; and IMF staff estimates.

• Move away from growth targets

• Slow credit growth—tackle at source

• Interest rates—eventually/gradually rise

18

• Fiscal—reduce augmented deficit, switch from off budget investment to on-

budget pro-rebalancing, introduce substantial carbon/coal tax

Policies – (3) Guard against Financial Risks( ) g

• Banks: proactive recognition of losses; build

Current Regulatory Structure

State Council

capital; improve funding quality

• Shadow products: holistic/aggressive

h i i

CBRC CSRC CIRC

PBOC

SAFE

• Monetary policy

• Financial

approach to supervision

• Capital markets: orderly functioning, not

intervention• Commercial banks

•Financial asset management companies

•Trusts

• Securities

• Futures

• Insurance

Financialstability

• Other financial regulations

• Foreign exchange management

• Cross border payments and capital flows

• Property: restrict demand in Tier I; restrict

supply in lower tiers•Trusts

•Other depository FI

• FX reserve• Crisis preparedness: prepare for potential

idiosyncratic and systemic stress

• Regulatory structure: no best practice but

19

• Regulatory structure: no best practice, but

major upgrade in effectiveness needed

Policies – (4) Move to Effective Float( )

d ff l b h ld• Transition difficult but should continue—

effective float ideally by 2018

• Couple with short-term management to 8

Narrowing Corridor around 7-day Repo Rate

PBC standing lending facilityp g

avoid excessive volatility

• RMB broadly in line with fundamentals, 4

6

PBC standing lending facility

Interbank 7d repo (fixing rate)

but should respond to market conditions

• Support with move to more market-based

monetary framework 0

2

PBC interest on excess reservesPBC 7d reverse repo (OMO)

monetary framework

• Caution with further capital account

liberalization

0Jan 14 Jun 14 Nov 14 Apr 15 Sep 15 Feb 16 Jul 16

Sources: CEIC Data Company Ltd.; and People's Bank of China.

Aug 16

20

Policies – (5) Enhance Transparency( ) p y

• Data: progress made but major gaps

• Communications: clear authoritative consistent• Communications: clear, authoritative, consistent

21

What were Beijing’s Views?j g

• Corporate debt: part of 5-year plan; progress being made; but has to be

gradual and market driven

• Macro policies: expected credit growth to slow, but will also need to be

gradual; do not recognize “augmented” deficit fiscal to remain “proactive”gradual; do not recognize augmented deficit, fiscal to remain proactive

• Financial stability: disagree with debt at risk estimates; taking action on

shadow products; funding diversification natural and stable; no need for

countercyclical buffer

• FX: pressures eased, progressing to more market based system by allowing

i l l f k f hil bi h iprogressively more role for market forces while curbing overshooting.

Capital account to be gradually liberalized.

• Transparency: data quality being upgraded, recognize importance of

22

Transparency: data quality being upgraded, recognize importance of

communications but also constraints

Key Takeawaysy y

• Significant progress made on rebalancing and reform

• But lagging in critical areas: reining in rapid credit growth and SOE reform

• As a result, vulnerabilities continue rising on a dangerous trajectory

• Buffers still adequate but eroding• Buffers still adequate, but eroding

• Thus hard landing unlikely in near term, but risks rising and timing uncertain

• Challenges manageable, but urgent action needed to ensure they remain so

• Many reforms ongoing and planned but focused and more forceful action

needed in critical areas

23

Check out the Reportsp

• Staff Report http://www.imf.org/external/pubs/cat/longres.aspx?sk=44181.0

• Selected Issues http://www.imf.org/external/pubs/cat/longres.aspx?sk=44182.0

• Project Syndicate Op-ed by David Lipton https://www project-• Project Syndicate Op-ed by David Lipton https://www.project-

syndicate.org/commentary/china-corporate-debt-problem-by-david-lipton-

2016-08

• Video http://www.imf.org/external/mmedia/view.aspx?vid=5080114876001

• IMF Survey Interview with James Daniel

h f lhttp://www.imf.org/en/News/Articles/2016/08/11/14/40/NA081216-Proactive-

Reforms-Critical-to-China-Medium-Term-Growth-Prospects

24

Annex—Spillovers to U.K.

2

Domestic Value-Added for China's Final

Share of Domestic Value-added Used for China's Final Demand (In percent of GDP)

0

Change of Value-Added Exports from China's Rebalancing:(Change in value-added exports, in percent of total exports, due to 5 ppt increase/ decrease in consumption-to-GDP/investment-to-GDP ratio)

1.2

1.6Consumption

Domestic Value-Added for China's FinalInvestment

-0.3

-0.2

-0.1

0

0.4

0.8

-0.6

-0.5

-0.4

World Asia AE EM-Com EM LATAM UK Euro0World Asia LATAM UK Euro Area

Source: IMF staff estimates.

Others Area

Source: IMF staff estimates.

25

Annex—Spillovers to Euro Area

1.6Domestic Value-Added for China's Final Consumption

Share of Domestic Value-added Used for China's Final Demand (In percent of GDP)

0.20

Change of Value-Added Exports from China's Rebalancing:(Change in value-added exports, in percent of total exports, due to 5 ppt increase/ decrease in consumption-to-GDP/investment-to-GDP ratio)

0.8

1.2Domestic Value-Added for China's Final Investment

-0.20

-0.10

0.00

0.10

0.0

0.4

AUT

BEL

CYP

DEU ES

PES

T

FIN

FRA

GRC IR

L

ITA

LTU

LUX

LVA

MLT

NLD PR

T

SVK

SVN

Are

a

-0.50

-0.40

-0.30

AUT

BEL

CYP

DEU ES

PES

TFI

NFR

AG

RC IRL

ITA

LTU

LUX

LVA

MLT

NLD PR

TSV

KSV

NAr

ea

Euro

Source: IMF staff estimates.

Euro

Source: IMF staff estimates.

26

THANK YOUTHANK YOU

27