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China OutlookEconomic Developments and Prospects

Markus Rodlauer, October 2016 1

Overview

2

The Broader Picture – Rebalancing and Reforms?

Key Issues

Size and Quality of Credit Growth

Increasing Complexity of Financial System

Frequency of Asset Bubbles

Recent Capital Outflows

Exchange Rate

Outlook

Policy Advice

The Goal: A New Structure and Quality of Growth

3

External Internal

Environment Income Distribution

Rebalancing

Scorecard

▪ Current account

▪ Net exports contribution

▪ Cons./Investment

▪ Industry/Services

▪ Credit

▪ Energy

▪ Air pollution

▪ Labor income ratio

▪ Income inequality

Rebalancing is Underway but Causing Uneven and Slower Growth

4

0

5

10

15

20

25

10Q1 11Q3 13Q1 14Q3 16Q1

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

Nominal growth of

industrial sector

Nominal growth of

services sector

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

Nominal GDP growth

16Q2

Slowdown has Prompted a Return to Higher Stimulus

5

• Traditional stimulus – from mid-2015

• Uneven reform progress – SOEs, corporate debt, opening up

• Policy uncertainty – reform/growth? market/state?

-3

5

13

21

29

-3

5

13

21

29

2013 2014 2015 2016

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

July-16

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

Non-SOE

SOE

Total

100

130

160

190

220

0

10

20

30

40

2009Q1 2010Q1 2011Q1 2012Q1 2013Q1 2014Q1 2015Q1 2016Q1

Credit (Adjusted for LG

debt swap)

Nominal GDP


1/ Total social financing stock.

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

Credit to GDP ratio

(Unadjusted, RHS)

Credit to GDP ratio

(Adjusted, RHS)

2016Q2

Three Main Concerns. First, High Corporate Debt.

6

Argentina

Australia

Brazil

Denmark

Euro area Finland

Germany

Greece

Hungary

India

Indonesia

Ireland

Italy

Japan

Korea

Malaysia

Mexico

Netherlands

Poland

Russia

Singapore

South Africa

Spain

Sweden

Thailand Turkey

United Kingdom

United States

China 15 2/

China 15 1/

0

50

100

150

200

0 10 20 30 40 50 60 70

Cre

dit

to

no

n-f

inan

cial c

orp

ora

tes

(perc

en

t o

f G

DP)

GDP per capita (USD thousand)

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

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.

China 09 1/

China 09 2/

Second, Rapidly Growing Credit.

7

United Kingdom

BelgiumDenmark

Italy

NorwaySweden

Finland

Greece

Ireland

Portugal

Spain

Argentina

Brazil

Uruguay

UruguayMalaysia

Philippines

Thailand

0

20

40

60

80

-10 -8 -6 -4 -2 0 2 4Cre

dit

-to

-GD

P r

ati

o c

han

ge in

fiv

e y

ears

GDP growth change 1/

Followed by banking crisis 3/

Credit Booms Tend to End Badly(In percentage points)

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.

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

China 2/

50

80

110

140

170

200

230

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 20132015

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

Japan

Thailand

Spain

Sources: 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

8

0

5

10

15

20

25

30

2010 2011 2012 2013 2014 2015 E

1y, ICR < 2

1y, ICR < 1.5

1y, ICR < 1

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

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.

0

1

2

3

4

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Sources: Bank for International Settlements (BIS); World Economic Outlook (WEO) and IMF Staff

estimates.

1/ Plotted as 3-year rolling average.

Pre-crisis average

Post-crisis average

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

Third, Questions about Quality of Credit

Meanwhile, the Financial System Becomes Increasingly Complex due to Shadow Products…

9

133

123

113

89

89

67

52

52

27

10

10

24

18

40

15

0 50 100 150 200

Retail loans

LGFV loans

Policy bank loans

Other credit products

Less: Overlap

Shadow products

Corporate bonds

Corporate loans

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

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.

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

2010 2011 2012 2013 2014 2015

Trust companies Securities companies Asset managers

Shadow Products(In billion of RMB)


10

…and a Sharp Rise in Short-term Intra-financial Sector Lending

180

200

220

240

260

280

300

320

-20

0

20

40

07 08 09 10 11 12 13 14 15

Foreign and reserve assets Claims on government and central bank

Claims on other depository corporations Claims on other finanical institutions

Claims on nonfinanical institutions Claims on other residential sectors

Other assets Total assets

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

Sources: Haver Analytics; and IMF staff estimates.

Total assets (stock, % of GDP, RHS)

High Savings/Capital Controls leave China

Exposed to Asset Price Volatility

11

-25

-10

5

20

35

50

65

-25

-10

5

20

35

50

65

2008 2009 2010 2011 2012 2013 2014 2015 2016

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

June-16

Tier I

Tier II

NBS: Floor space selling price

Tier III or IV

Sources: Fangguanju; and IMF staff estimates.

…although the Capital Account has Proven more

Porous than Expected

12

-250

-150

-50

50

150

2011Q1 2011Q4 2012Q3 2013Q2 2014Q1 2014Q4 2015Q3 2016Q2

Non-reserve flows Errors and Omissions

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

Progress Toward more Flexible Exchange Rate

Regime Will Help

13

6

6.2

6.4

6.6

6.880

90

100

110

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

RMB Exchange Rates vs. the US Dollar and CFETS Index

RMB/USD daily central parity fixing (RHS)

CFETS Index (Dec 31, 2014)

Oct-16

Outlook—Upside Risk to Near-term Growth…

14

47.5

48.0

48.5

49.0

49.5

49

49.5

50

50.5

51

51.5

Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16

PMI: Manufacturing(SA, 50+=Expansion, 3MMA)


PMI: Manufaturing

Employment (RHS)

PMI: Manufaturing

Aug-16

-7

-6

-5

-4

-3

-2

-1

0


Producer Prices Index(In percent, year-on-year growth)

Aug-16


-10

-5

0

5

10

15

20


Real Exports(In percent, year-on-year growth, 3MMA)


Aug-16-5

0

5

10

15

20

25


Real Estate Investment(In percent, year-on-year growth, 3MMA)

Aug-16


… but Increasingly Weak Medium-term Without

Reform

15

2

3

4

5

6

7

8

2012 2015 2018 2021

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


Projection range

ProactiveNo-reform

Baseline

140

170

200

230

2014 2015 2016 2017 2018 2019 2020 2021

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

Sources: CEIC Data Company Ltd.; World Economic Outlook (WEO) 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.

No-reform

Proactive

Baseline

Policy Advice and Key Takeaways

16

• 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

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

• 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

THANK YOU

17

Policies – (1) Tackle Corporate Debt Problem

18

0

5000

10000

15000

20000

25000

30000

USA Germany England & Wales China

Insolvency Little Used(Number of cases, 2014)

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

Insolvency Service.

• High level – political – decision to let

weak firms go

• Harden budget constraints

• Triage: good, bad and the ugly

• Recognize losses

• Share the burden

• Out of court debt restructuring /

distressed debt market

• Social costs

• Facilitate market entry

Policies – (2) Accept the Slowdown

19

-20

-10

0

10

20

30

2003 2004 2005 2007 2008 2009 2011 2012 2013 2015

Tig

hte

r

Lo

ose

r

Monetary Policy Looser than Implied 1/

Policy stance index

Taylor-rule implied

policy index

Mar-2016


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.

-15

-10

-5

0

5

-15

-10

-5

0

5

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

Proj.

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

Consolidated general

government balance

Augmented

balance

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

• Move away from growth targets

• Slow credit growth—tackle at source

• Interest rates—eventually/gradually rise

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

budget pro-rebalancing, introduce substantial carbon/coal tax

20

Policies – (3) Fiscal and External Space

43

31

65

0

10

20

30

40

50

60

70

0

10

20

30

40

50

60

70

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

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

Sources: World Economic Outlook (WEO); and IMF staff estimates.

1/ Including all explicit government (central and local) liabilities and part of the contingent

liabilities that the government might be responsible for.

182

75

113

94

0

40

80

120

160

200

0

40

80

120

160

200

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

Sources: Assessing Reserve Adequacy; IMF Policy Papers; February 14, 2011.

2016Q1 EM Average

(ex China)

2016Q1 EM Average

(ex China)

Fixed With Capital Controls Fixed Without Capital Controls

Policies – (4) Guard against Financial Risks

21

Current Regulatory Structure

State Council

CBRC CSRC CIRC

PBOC

SAFE

• Commercial

banks

•Financial asset

management

companies

•Trusts

•Other

depository FI

• Securities

• Futures

• Insurance

• Monetary

policy

• Financial

stability

• Other financial

regulations

• Foreign

exchange

management

• Cross border

payments and

capital flows

• FX reserve

• Banks: proactive recognition of losses; build

capital; improve funding quality

• Shadow products: holistic/aggressive

approach to supervision

• Capital markets: orderly functioning, not

intervention

• Property: restrict demand in Tier I; restrict

supply in lower tiers

• Crisis preparedness: prepare for potential

idiosyncratic and systemic stress

• Regulatory structure: no best practice, but

major upgrade in effectiveness needed

Policies – (5) Move to Effective Float

22

• Transition difficult but should continue—

effective float ideally by 2018

• Couple with short-term management to

avoid excessive volatility

• RMB broadly in line with fundamentals,

but should respond to market conditions

• Support with move to more market-based

monetary framework

• Caution with further capital account

liberalization

0

2

4

6

8

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

Narrowing Corridor around 7-day Repo Rate

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

PBC interest on excess reserves

PBC standing lending facility

PBC 7d reverse repo (OMO)

Interbank 7d repo (fixing rate)

Aug 16

Policies – (6) Enhance Transparency

23

• Data: progress made but major gaps

• Communications: clear, authoritative, consistent

What were Beijing’s Views (1)?

24

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 recovery

AEs; rising geopolitical tension

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

and supervisors reacting)

What were Beijing’s Views (2)?

25

• 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”

• 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

progressively more role for market forces while curbing overshooting.

Capital account to be gradually liberalized.

• Transparency: data quality being upgraded, recognize importance of

communications but also constraints

Check out the Reports

26

• 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-

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

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

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

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

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

https://www.project-syndicate.org/commentary/china-corporate-debt-problem-by-david-lipton-2016-08

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

http://www.imf.org/en/News/Articles/2016/08/11/14/40/NA081216-Proactive-Reforms-Critical-to-China-Medium-Term-Growth-Prospects

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