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Statement by Mr. Tao Zhang, IMF Executive Director, at the Conclusion of the 2012 Article IV Consultation with People’s Republic of China, July 20, 2012

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International Monetary Fund
Published Date:
July 2012
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I thank staff for the constructive discussions held with my authorities. My authorities appreciated the staff’s candid advice and continue to attach great value to this annual engagement with the Fund.

Since the global financial crisis, the Chinese economy has maintained strong growth and provided crucial support to the global recovery. At the same time, the economy is undergoing structural changes, reflected in part by the substantial decline of the current account surplus, which has, in turn, contributed to a narrowing of global imbalances. Recent economic data on the Chinese economy point to a slower but still robust pace of growth, reflecting weaker external demand as a result of the soft global recovery, as well as my authorities’ efforts to rebalance the economy toward domestic demand. The pace of growth remains consistent with my authorities’ target of 7.5 percent for 2012 and the economic fundamentals remain sound.

My authorities will continue to consolidate the achievements made in transforming the pattern of economic development and set the stage for further progress under the Twelfth Five-Year Plan. Efforts are being made to maintain steady and strong growth while accelerating structural adjustments and managing inflation expectations. However, the external environment, including a weak global recovery, the heightened stress in the Euro Area, volatile commodity prices, and rising trade protectionism continue to pose significant challenges.

Recent economic developments

China’s GDP grew 7.8 percent year-on-year in the first half of 2012. While retail sales continued to grow at a robust rate of 14.4 percent, the growth of fixed asset investment has moderated to 20.4 percent, or 5.2 percentage points lower than the same period of 2011. Growth in property investment has further decelerated to a rate of 16.6 percent. The per capita disposable income of urban residents and the per capita net income of rural residents rose in nominal terms by 13.3 percent and 16.1 percent, respectively, with higher growth for rural residents. Exports and imports grew 9.2 percent and 6.7 percent, respectively, in the first half of 2012, further narrowing the trade balance as a share of GDP to 1.9 percent.

Inflation continued on its downward trajectory, following the adoption of an appropriate policy mix. In the first half of 2012, CPI inflation was 3.3 percent year-on-year, or 2.1 percentage points lower than the same period of 2011. The key challenges to maintaining price stability point to high and volatile commodity prices, rising domestic factor costs, and frequent shortage of a few categories of agricultural products. As the 2012 Report on the Work of the Government stated, price stability is a key objective of government policies, which included using monetary policy tools to regulate the supply of money and credit, increasing production to ensure the supply of major agricultural products, improving the distribution network, and strengthening the supervision of market operations. My authorities’ projection of CPI inflation for 2012 is around 4 percent, which has taken into account the aggregate domestic demand as well as the impact of international commodity prices, and the effect of reforming the regulated prices.

Fiscal policy

My authorities continued to implement a proactive fiscal policy. The 2012 budget projected a deficit of 800 billion yuan, or 1.5 percent of GDP. Fiscal revenues for the first half of the year grew 12.2 percent year-on-year to about 6.4 trillion yuan, with tax revenues growing 9.8 percent year-on-year to 5.5 trillion yuan. The deceleration in the growth of fiscal revenues can be mainly attributed to the weaker economic growth, lower inflation, the declining profits of enterprises, and tax reduction. Budgetary expenditure totaled 5.39 trillion yuan in the first half, up 21.3 percent from a year ago. The expenditure structure continued to give priority to education, culture, medical and health care, employment, social security, low-income housing projects, while further reducing administrative costs. Outstanding government debt to GDP is lower than 20 percent, supported by the low level of fiscal deficit in the past years. This provides the government with ample room for the implementation of proactive fiscal policy should downside risks materialize.

Monetary policy

My authorities’ monetary policy continued to aim to promote steady and robust economic development, maintain stable prices, and guard against financial risks. As of end-June 2012, broad money supply increased by 13.6 percent and credit expansion stood at 15.9 percent, in line with my authorities’ expectations at the beginning of the year. The People’s Bank of China (PBC) announced an asymmetric cut in the one-year benchmark lending and deposit rates, reducing the lending rate by 31 basis points to 6 percent and the deposit rate by 25 basis points to 3 percent, effective from July 6. In addition, the PBC has allowed banks more flexibility to set interest rates, with the ceiling on deposit rates increased to 110 percent of the benchmark rate and the floor on lending rates reduced to 70 percent of the benchmark rate. The adjustment of the band represents an incremental yet significant step in the direction of further developing a market-oriented interest rate system. The PBC also cut the reserve requirement ratio three times since last November in response to the liquidity condition in the banking system and moderating economic growth. The monetary stance will continue to rein in inflation expectations, enhance the flow of credit to support the real economy, and strengthen services to boost demand and the development of small enterprises.

Financial sector

My authorities continue to attach great importance to guarding against latent risks which exist in the banking and public finance sectors. The banking sector remains healthy, with strong asset quality and capital adequacy. The result of stress tests conducted by the CBRC (China Banking Regulatory Commission) on 17 large commercial banks confirmed the banks’ adequate capital position in dealing with macroeconomic shocks and their capacity to operate under market stress. Risks in off-balance sheet exposures are relatively small and nonbank financial intermediation is under close surveillance. The Central Government also strengthened its supervision of local government debts. Local governments are prohibited from providing guarantees for financing companies. The repayment of the debts and the provision of additional funding for ongoing projects are being actively but prudently addressed, while new local government debts are strictly limited. Overall, local government debts in China are now at a controllable and secure level.

Strengthening domestic demand

The rebalancing toward domestic demand is in progress, in line with the implementation of the Twelfth Five-Year Plan. The contribution of consumption to GDP growth has increased to 50.8 percent in 2011 from 43.1 percent in 2010. The expansion of private consumption and the lowering of the household savings rate is an adjustment process that has to be accomplished over time. My authorities are committed to accelerate improvements to the social security system and it is planned that by the end of 2012, there will be full coverage of the new old-age pension system for rural residents and the old-age pension system for nonworking urban residents. My authorities will also promote the development and reform of medical and healthcare services. These improvements will help further boost private consumption. Meanwhile, progress has been made on the move toward a higher value-added industrial structure and on promoting regional development. In the first half of 2012, the value-added of high-technology industry grew 12.3 percent year-on-year, or 1.8 percentage points higher than the growth rate observed for total industrial value-added; and economic activity in the central-western and northeastern regions registered faster growth than the economy as a whole.

Domestic demand in China has maintained a relatively high rate of growth in the past 10 years, but the pace of investment growth has been even faster, leading to an increasing share of investment in GDP. China’s high investment has to be seen in the context of ongoing industrialization, urbanization, and technological upgrading in China and the trend is consistent with some other countries’ experiences, such as Japan and Korea, in their respective economic takeoff periods. Investment in China is very unlikely to experience a rapid deceleration, a risk highlighted by the staff as it is well supported by fundamentals, and there is also adequate room for the implementation of supportive macroeconomic policies. From a longer-term perspective, the gradual deceleration in the growth of investment in line with the rebalancing of the structure of the Chinese economy would not only benefit the sustainable development of China but the sustainable development of the global economy.

Measures undertaken by my authorities in the property market are aimed at fostering the stable development of the market in the longer term. Recent data show that the measures have resulted in the intended outcome. In the first half of 2012, speculative activity has dampened and property prices have continued on a path of decelerated growth. Meanwhile, my authorities would continue to expand the supply of subsidized housing and housing for low-income families to address the housing needs of families in need. Investment in real estate moderated to a still-robust 16.6 percent year-on-year in the first half of 2012. My authorities will seek to prevent large swings in property prices to facilitate stable and sustainable economic growth.

External sector

China’s current account surplus has declined substantially from 10.1 percent of GDP in 2007 to 2.8 percent of GDP in 2011, reflecting partly cyclical factors but primarily structural factors, including significant appreciation of the real exchange rate, substantial expansion of the social safety nets, reform of factor prices, and more stringent environmental standards. Staff’s past projections of the current account have consistently pointed to a higher current account surplus than what eventually transpired, and there is a risk that this tendency has continued in the forthcoming staff report. As China makes further progress toward raising domestic demand, my authorities view the staff’s projection of China’s current account surplus at 4-4.5 percent of GDP in the medium term as leaning on the high side. Instead, they see a high possibility for China’s current account surplus to be roughly maintained at the current level or to narrow further in the medium term. As the structural adjustment continues, the change in labor costs, the urbanization process, the demographic structure, and exchange rate movements are expected to have a lagged effect on resource allocation, subsequently bringing about a decline in the savings rate and an increase in domestic consumption. Also, it is expected that the negative impact of the Euro Area crisis will continue to weigh on China’s exports performance.

Staff’s assessment of the renminbi exchange rate is that it is moderately undervalued against a broad basket of currencies. This assessment, in my authorities’ view, is not consistent with the reality. The sharp decline in the current account surplus and the recent two-way movements in the renminbi suggest that the currency is roughly in equilibrium. Other indicators, such as the forward rates in the onshore and offshore foreign exchange markets, also point to a close-to-equilibrium exchange rate.

My authorities widened the trading band of the renminbi against the U.S. dollar in April 2012. This move further increased the two-way flexibility of the renminbi exchange rate, facilitating the move of the exchange rate toward its equilibrium. My authorities remain committed to allow market forces to play a larger role in determining movements in the renminbi, and will continue to reform its exchange rate regime in this direction.

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