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IMF Warns China of Reliance on Credit, Other Imbalances

Posted by hkarner - 14. August 2016

Date: 13-08-2016
Source: The Wall Street Journal

Multilateral agency urges country to deal with its economic problems while they are still manageable

China’s heavy reliance on state funding threatens to crowd out private companies—a risk noted by the IMF—and thereby set back the Chinese government’s planned transition to a services and consumption-led economy.

BEIJING—China needs to reduce its reliance on credit-fueled investment, and deal with rising corporate debt and other imbalances while those problems are still manageable, the International Monetary Fund urged Friday in its annual review of the world’s second-largest economy.

The IMF said Beijing is relying excessively on credit to reach “unsustainably high growth targets.” The multilateral agency’s to-do list includes tackling corporate debt, reforming bloated state enterprises and strengthening the financial system to reduce distorting effects on China’s economic performance.

The IMF cited growing risks of disorderly corporate defaults, protracted lower growth and a “hard landing” in regions suffering from industrial overcapacity if Beijing failed to act quickly to overhaul its economy. China’s main economic agencies and regulators didn’t respond to requests for comment.

James Daniel, IMF’s mission chief for China, said Beijing has made progress in encouraging growth in the services sector and spurring private consumption. But they have lagged in critical areas, especially in reforming state-owned-enterprises and tackling excessive corporate debt, he said.

“As a result, vulnerabilities are still rising on a dangerous trajectory” Mr. Daniel said. And while budget and foreign exchange reserves are still adequate, they are eroding, he said.

Some economists have warned that Beijing’s attempts to prop up growth at relatively high levels is leading to more wasteful investment and financial risks that could ultimately further weigh on China at a time the global economy is in a slow-growth rut. The IMF suggests Beijing target a lower near-term growth rate closer to 6%. But Chinese leaders have moved cautiously in overhauling the economy out of concern about labor unrest and market turmoil ahead of a leadership change next year.

The Shanghai World Financial Center. China in recent months has sent a wash of credit through its financial system to cushion its economic downturn.

“China’s economic transition will continue to be complex, challenging, and potentially bumpy, against the backdrop of heightened downside risks,” the IMF said in the report following a two-week consultation with Chinese officials.

China in recent months has sent a wash of credit through its financial system to cushion its economic downturn and hit its growth targets of 6.5% to 7% this year and an average of 6.5% over the next five years.

That heavy reliance on state funding threatens to crowd out private companies—a risk noted by the IMF—and thereby set back the Chinese government’s planned transition to a services and consumption-led economy. Private investment declined in June for the first time since China started releasing statistics in 2004 and worsened in July.

Part of the problem lies with the massive state-owned enterprises, which account for around 55% of corporate debt but only produce 22% of economic output. The IMF called for Beijing to move faster in reforming state-owned companies. It suggested curtailing their preferential access to credit and markets and liquidating or restructuring zombie firms—unprofitable, debt-laden companies kept alive by credit.

Failure to move promptly to overhaul the economy could halve the country’s growth rate to around 3% in the next several years and spur a surge in already-high credit levels, the IMF said. That could wreak havoc on markets overseas and sap global growth, the IMF warned.

Many of the IMF’s reform prescriptions are largely on President Xi Jinping’s agenda, though he has called for state companies to remain a core part of the economy and his government has been criticized for moving too slowly to tackle their problems.

The IMF review also renewed its alarm about corporate debt levels, which are at an estimated 145% of China’s gross domestic product, up from around 100% in 2007. In June, the IMF said China’s corporate liabilities were “high by any standard,” adding that they “must be addressed immediately.”

According to the IMF, Chinese authorities told them they were making progress on reducing debt, carrying out structural reform, giving markets a more decisive role in the economy and that state companies are “increasingly competing on an equal footing with private firms.”

In the review, the IMF also urged Beijing to address looming vulnerabilities in the financial sector even if this results in slower economic growth. Banks should recognize loan losses and strengthen their capital ratios, it said, and Beijing should tighten control over off-book financial products.

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