Weak recovery and continuing high unemployment in advanced economies will warrant a moderation of IMF's earlier optimistic forecast when it comes out with an updated world economic outlook in September prior to the annual fund-bank meetings. Meanwhile, IMF's Executive Board commending China's overall performance stressed the need for regulatory and supervisory vigilance to manage any deterioration in credit quality in the over-extended banking system and increased transparency in lending to local government financing vehicles. Pre-emptive action is also urged against a property bubble inflating in larger cities.

Making a detailed assessment of China's economy, which overtook Japan in the second quarter of 2010, the IMF report spells out a broad range of reforms for a sustainable shift toward a balanced economy, less dependent on exports and investment. China is committed to the G-20 framework for strong, sustainable and balanced growth in the world economy, and indeed claims to have effected “remarkable changes” in many areas to make the country less reliant on exports while further measures were being “carefully studied”. The authorities aver that, judged in an international context, China has moved at a faster pace toward the objective of rebalancing growth than others (G-20) but it realized the short-term economic and social difficulties in many of industrial countries.

IMF thinks China has to go much further toward moving to rebalancing growth. While transition from public stimulus to private sector-led growth is under way, measures to boost private consumption as principal driver of economic growth have to be put in place. These would include a stronger social safety net with increased basic pensions and social transfers, subsidies and incentives for purchase of smaller autos and motor cycles, and skill training for migrant workers entering urban areas. Welcoming the recent trend of rising wages as a healthy development, IMF report says it would raise household income and promote consumption leading to a more balanced economy.

Unlike India, China is not faced with inflationary pressures and though CPI is expected to peak by the middle of the year, the report assumes it would converge around 2 to 3 per cent, well within the official target, over the next two years. There has been some international concern over credit quality of the banking system and unwarranted growth in real estate prices. IMF says in the absence of alternative investment vehicles, residential real estate has become an attractive option for China's high domestic saving. Thus, a property bubble is “beginning to inflate in some of the larger cities and pre-emptive action is warranted”, the report said.

Chinese authorities have disagreed with some of IMF's assessments such as in regard to the pace of change in the pattern of growth, liberalization of the financial system, the exchange rate, and the call for appreciation of the renminbi, which has been one of the major areas of tension in Sino-US relations as Washington continues to record big trade deficits till July. On the “unprecedented expansion” of bank credit until recently (30 per cent of GDP in 2009) and resulting credit quality deterioration, IMF is making a financial stability assessment separately.

The Fund calls for greater reliance on interest reforms, open market operations and reserve requirements. Real interest rates now are close to zero and they have always been low in China, relative to the growth rate of the economy, and the low level creates perverse incentives within China, making household income lower and become a drag on consumption for households having less disposable income. At the same time, the low interest rates act as an incentive for investment as reflected in very high rates of investment in China, particularly in capital-intensive tradable industries, export-related industries.

It is on the exchange rate and IMF's prognosis of China reverting to current account surpluses that there is major disagreement. IMF contends the level of reserve accumulation (now at 2.5 trillion dollars) and the level of foreign currency intervention are both inconsistent with equilibrium in the balance of payments. The currency (renminbi) therefore is under-valued. Chinese authorities do not share IMF's view that once the global economy recovers and as the fiscal policy stimulus is unwound, the current account surplus will tend to reassert itself.

The staff report forecasts a return to current account surplus in the range of eight per cent of GDP. Chinese authorities maintain that reforms put in place are already resulting in structural change in saving and investment behavior. They view the renminbi level now much closer to equilibrium than at any time before. Also China is at such a stage of development where higher imports in domestic demand is likely to be an increasingly important factor.

In the discussions with IMF staff, China agrees that in some areas, reforms have to be pursued. IMF advocates further strengthening of social safety net particularly in health, education and pensions, investments in urban infrastructure, rural land reform and lifting remaining barriers to competition in service sectors.

China has made significant progress in near universal coverage of health insurance in urban areas and significantly expanded coverage for rural residents, IMF notes. China has planned to spend 2.5 per cent of GDP on health services over a three year period 2009-11. China has also achieved near universal enrolment and full public funding upto junior secondary education. The next step, IMF report suggests, should be universal public funding of education upto senior secondary level and improving the quality of education.

China which had de-linked from the dollar and shifted to a floating rate regime in July 2005 reverted to dollar-peg in July 2008 as a measure of protection during the global financial and economic crisis. Amid continuous pressure from USA and other leading trade partners, China on June 19 announced it would let its currency rise and fall according to supply and demand within a narrow margin. Virtually, there has not been any significant appreciation since then. Going forward, IMF says, the central bank (People's Bank of China)would need to avoid having modifications in real effective exchange rate determined by relative strength or weakness of US dollar, particularly given the very different cyclical conditions in the two economies (US and China).

Though the trade surplus was on relative decline in the aftermath of the crisis and export slow-down in 2009, China is regaining its export momentum. Given the current set of policies, IMF sees potential for current surpluses to reappear over the medium term. China does not agree with this view and maintains the surplus would continue to decline with a rise in imports and other changes taking place in several sectors of the economy. (IPA Service)