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17-08-2015, 08:10 AM
IMF urges China not to stimulate economy because of credit risk
THE AUSTRALIAN AUGUST 17, 2015 12:00AM
David Uren
Economics Editor
Canberra
China demand Source: TheAustralian
While Chinese authorities have been telling Treasurer Joe Hockey they will do “whatever it takes” to achieve their growth targets, the International Monetary Fund has told the government to avoid further stimulus for fear of raising the risk of a credit crunch.
The fund’s annual review of the Chinese economy says the government should accept growth falling short of its target, suggesting a figure of 6.5 per cent this year and 6 per cent in 2016 would be reasonable.
The fund says reining in the vulnerabilities generated by debt-fuelled growth, particularly since the global financial crisis, should remain the top priority.
“Slower growth, of course, is not a goal unto itself but an unavoidable by-product of reining in vulnerabilities,” the staff report says.
“Over the medium term, this unpleasant trade-off can only be improved by structural reforms that create new sources of growth. The faster the progress, the sooner the growth will bottom out in a sustainable way.”
In particular, the IMF board advised that “monetary policy should take a wait-and-see approach, especially as significant easing would risk exacerbating the credit and investment vulnerabilities”.
The IMF’s annual review, released on Friday night, followed the release last week of a dismal set of activity indicators for July, showing falls in steel, motor vehicle and cement production, lower heavy manufacturing investment, and further declines in overall construction, including both residential and infrastructure spending.
Westpac’s international economist Huw McKay said the “bleak” figures would force everyone to lower their estimate of where Chinese interest rates would wind up.
He is predicting a further 75 basis points of cuts to the one-year lending rate.
The tension between reacting to the weakening pace of growth and persisting with the reform needed to put the Chinese economy on a more sustainable footing is the result of high levels of debt and the diminishing returns from the investment that China has relied upon to fuel its growth.
Total debt is high, with household, corporate and local government debt reaching 187 per cent of GDP.
Corporate and local government debt has risen by 50 per cent of GDP since the financial crisis. Lending to state-owned enterprises has resulted in excess capacity and declining profitability.
“While the high level of domestic saving has made it easier to finance this growth model, it is not sustainable, as falling investment efficiency will eventually drag down GDP, household income, and thus savings. A decline in asset prices would also pose risks,” the IMF says.
The IMF says banks should be writing off bad debts in the state-owned enterprise sector at a faster rate. The concern is that banks saddled with bad debts they won’t write off and insolvent companies continuing to operate will result in the “zombie” companies and banks that stalled Japan’s growth for much of the past two decades.
It urges bank write-offs of 1.5 per cent of GDP each year out to 2020 (roughly $US200 billion a year) supported by public capital injections and asset management companies.
A message that the chair of China’s National Development and Reform Commission Xu Shaoshi left with Hockey following their meeting in Canberra last week was that the authorities were determined to achieve their target for job growth of 10 million positions a year, and that with 7.2 million jobs created in the first half of the year, they were confident of doing so.
The IMF says these job targets are being inflated by state-owned enterprises keeping on staff when there is no work to do, and considerable excess capacity.
“Stepped-up reform of SOEs and adjustment in overcapacity sectors would, in the near term, release excess labour and push up unemployment rate by half to three-quarters (of a) percentage point,” the fund says. “However, this would facilitate the structural transformation — including services sector expansion and new investment in productive enterprise — to a more sustainable growth path. In contrast, delays in reform implementation would further build up vulnerabilities and weaken medium term employment prospects.”
The fund notes that statistics showing unemployment rates of 5 per cent do not reflect the migrant workers thrown out of work who are returning home.
However, the fund also says employment is being generated as the Chinese economy shifts from heavy manufacturing to more labour-intensive service sector work, supported by domestic consumption. There has been progress in raising the level of domestic consumption which, over the past year, contributed fractionally more to economic growth than investment for the first time.
The fund would like to see a more aggressive reduction in public sector investment, including local government infrastructure, with the funds released used for more social spending. However, this would also result in higher unemployment in the short-term.
The slowdown has been most marked in half a dozen provinces, such as Hebei and Tianjin, which have large concentrations of heavy industry. With 15 per cent of GDP, they accounted for 80 per cent of the slowdown in the past year, the IMF estimates.
This highlights the risk for Australia, which is heavily dependent upon demand from China’s heavy industry in these provinces. An analysis of the potential spill-over from China’s slowdown to Australia by Barclays chief economist Kieran Davies shows that a 1 per cent fall in China’s economic growth rate would slow Australia’s economy by at least 0.3 per cent. However, Davies says the number is probably larger than this, as China’s demand for commodities is already much weaker than its GDP growth.
He estimates Chinese demand for Australia’s exports of goods and services is down from a record 7.1 per cent of GDP in 2013-14 to 5.8 per cent last year and is likely to fall further as commodity prices drop.
However, Austrtalia remains the western country with the greatest exposure to the Chinese economy. “The RBA is reluctant to cut further given record household leverage and strong house prices, but we see the downside risk to China underpinning the risk of another rate cut, even as our base case remains that rates are on hold for an extended period,” Davies says.
The IMF report, which was completed ahead of last week’s exchange rate moves, reveals dissension among its member countries about China’s exchange rate.
The fund notes that although China’s current account surplus has fallen sharply as a share of GDP, the country’s external accounts are still too strong.
The fund urges that China should move to a fully floating exchange rate within two or three years. With growing liberalisation of capital movement, the fund says controls on the exchange rate will compromise the effectiveness of monetary policy.
THE AUSTRALIAN AUGUST 17, 2015 12:00AM
David Uren
Economics Editor
Canberra
China demand Source: TheAustralian
While Chinese authorities have been telling Treasurer Joe Hockey they will do “whatever it takes” to achieve their growth targets, the International Monetary Fund has told the government to avoid further stimulus for fear of raising the risk of a credit crunch.
The fund’s annual review of the Chinese economy says the government should accept growth falling short of its target, suggesting a figure of 6.5 per cent this year and 6 per cent in 2016 would be reasonable.
The fund says reining in the vulnerabilities generated by debt-fuelled growth, particularly since the global financial crisis, should remain the top priority.
“Slower growth, of course, is not a goal unto itself but an unavoidable by-product of reining in vulnerabilities,” the staff report says.
“Over the medium term, this unpleasant trade-off can only be improved by structural reforms that create new sources of growth. The faster the progress, the sooner the growth will bottom out in a sustainable way.”
In particular, the IMF board advised that “monetary policy should take a wait-and-see approach, especially as significant easing would risk exacerbating the credit and investment vulnerabilities”.
The IMF’s annual review, released on Friday night, followed the release last week of a dismal set of activity indicators for July, showing falls in steel, motor vehicle and cement production, lower heavy manufacturing investment, and further declines in overall construction, including both residential and infrastructure spending.
Westpac’s international economist Huw McKay said the “bleak” figures would force everyone to lower their estimate of where Chinese interest rates would wind up.
He is predicting a further 75 basis points of cuts to the one-year lending rate.
The tension between reacting to the weakening pace of growth and persisting with the reform needed to put the Chinese economy on a more sustainable footing is the result of high levels of debt and the diminishing returns from the investment that China has relied upon to fuel its growth.
Total debt is high, with household, corporate and local government debt reaching 187 per cent of GDP.
Corporate and local government debt has risen by 50 per cent of GDP since the financial crisis. Lending to state-owned enterprises has resulted in excess capacity and declining profitability.
“While the high level of domestic saving has made it easier to finance this growth model, it is not sustainable, as falling investment efficiency will eventually drag down GDP, household income, and thus savings. A decline in asset prices would also pose risks,” the IMF says.
The IMF says banks should be writing off bad debts in the state-owned enterprise sector at a faster rate. The concern is that banks saddled with bad debts they won’t write off and insolvent companies continuing to operate will result in the “zombie” companies and banks that stalled Japan’s growth for much of the past two decades.
It urges bank write-offs of 1.5 per cent of GDP each year out to 2020 (roughly $US200 billion a year) supported by public capital injections and asset management companies.
A message that the chair of China’s National Development and Reform Commission Xu Shaoshi left with Hockey following their meeting in Canberra last week was that the authorities were determined to achieve their target for job growth of 10 million positions a year, and that with 7.2 million jobs created in the first half of the year, they were confident of doing so.
The IMF says these job targets are being inflated by state-owned enterprises keeping on staff when there is no work to do, and considerable excess capacity.
“Stepped-up reform of SOEs and adjustment in overcapacity sectors would, in the near term, release excess labour and push up unemployment rate by half to three-quarters (of a) percentage point,” the fund says. “However, this would facilitate the structural transformation — including services sector expansion and new investment in productive enterprise — to a more sustainable growth path. In contrast, delays in reform implementation would further build up vulnerabilities and weaken medium term employment prospects.”
The fund notes that statistics showing unemployment rates of 5 per cent do not reflect the migrant workers thrown out of work who are returning home.
However, the fund also says employment is being generated as the Chinese economy shifts from heavy manufacturing to more labour-intensive service sector work, supported by domestic consumption. There has been progress in raising the level of domestic consumption which, over the past year, contributed fractionally more to economic growth than investment for the first time.
The fund would like to see a more aggressive reduction in public sector investment, including local government infrastructure, with the funds released used for more social spending. However, this would also result in higher unemployment in the short-term.
The slowdown has been most marked in half a dozen provinces, such as Hebei and Tianjin, which have large concentrations of heavy industry. With 15 per cent of GDP, they accounted for 80 per cent of the slowdown in the past year, the IMF estimates.
This highlights the risk for Australia, which is heavily dependent upon demand from China’s heavy industry in these provinces. An analysis of the potential spill-over from China’s slowdown to Australia by Barclays chief economist Kieran Davies shows that a 1 per cent fall in China’s economic growth rate would slow Australia’s economy by at least 0.3 per cent. However, Davies says the number is probably larger than this, as China’s demand for commodities is already much weaker than its GDP growth.
He estimates Chinese demand for Australia’s exports of goods and services is down from a record 7.1 per cent of GDP in 2013-14 to 5.8 per cent last year and is likely to fall further as commodity prices drop.
However, Austrtalia remains the western country with the greatest exposure to the Chinese economy. “The RBA is reluctant to cut further given record household leverage and strong house prices, but we see the downside risk to China underpinning the risk of another rate cut, even as our base case remains that rates are on hold for an extended period,” Davies says.
The IMF report, which was completed ahead of last week’s exchange rate moves, reveals dissension among its member countries about China’s exchange rate.
The fund notes that although China’s current account surplus has fallen sharply as a share of GDP, the country’s external accounts are still too strong.
The fund urges that China should move to a fully floating exchange rate within two or three years. With growing liberalisation of capital movement, the fund says controls on the exchange rate will compromise the effectiveness of monetary policy.
