The Chinese authorities would like to thank the mission team for the candid and constructive policy discussions and professional analysis in the staff report. To avoid repeating the authorities’ views that have already been reflected in the staff report, we would like to offer the following additional comments.
The Chinese economy has maintained a steady growth momentum, while facing some internal and external challenges, including trade friction. The authorities have focused on the quality of growth and have made notable progress in rebalancing. Following a 6.9 percent growth rate in 2017, GDP grew by 6.8 percent in the first half of 2018 and is projected to grow at around 6.5 percent for the year as a whole. Inflation has remained stable, with CPI increasing by 2.0 percent y-o-y in the first half of this year. Employment has continued to improve with the surveyed urban unemployment rate at 4.8 percent in June. Supported by successful policy adjustments in recent years, domestic demand has become the most important driving force for growth. Consumption contributed to 58.8 percent of growth in 2017, and further reached 78.5 percent in the first half of 2018.
In the first half of this year, in dollar terms, China’s trade in goods went up 16 percent to about 2.2 trillion U.S. dollars, with exports rising by 12.8 percent and imports by 19.9 percent. The trade surplus was narrowed by 24.5 percent and FDI rose by 4.1 percent. In the first five months of 2018, profits of industrial enterprises grew by 16.5 percent. With the support of strong economic fundamentals and a versatile policy toolkit, the authorities are confident that the economy can withstand external shocks and avoid systemic risks. The authorities will continue to carry out prudent macroeconomic and financial policies in a consistent and forward-looking manner, and stay firm on the course of deepening reforms and further opening-up.
The monetary policy remains prudent and neutral. Recently, to neutralize the tightening effect of the financial regulation, the People’s Bank of China (PBC) cut the reserve requirement ratio (RRR) by 50 basis points for banks with the aim of further promoting legal and market-based debt-for-equity swaps and enhancing the support to SMEs.
China continues to adopt a proactive fiscal policy. Following the across-the-board implementation of the business tax as part of the VAT reform since last year, and new measures were announced to lower the VAT rate from 17 to 16 percent for the manufacturing sector and from 11 to 10 percent for the transportation sector. Combined with other measures, this will reduce taxes for businesses and individuals by more than 120 billion U.S. dollars this year.
Local government debt
The authorities welcome staff’s recognition of the country’s strong public assets and positive net financial worth held by the government. Staff should be able to make a more objective and accurate assessment of the government’s fiscal position by looking at both assets and liabilities of the balance sheets, rather than sticking to the so-called “augmented debt” that only focuses on the liability side of the government. The assets of the sampled LGFVs far exceed their liabilities, suggesting that staff might have over-estimated the current public debt risks and under-estimated future growth potential. In his work, The Wealth of Nations, Adam Smith emphasized that infrastructure and resource flows could reduce inequality, and government should take responsibility of building and maintaining infrastructure and public works. As the provider of public goods, the government has channeled most of its debts to infrastructure investments to promote convergence of regional developments, reduce transaction costs, and boost potential growth in the medium and long term. Many assets are either profitable by themselves or being able to generate externalities to the economy. The rapid development of Fintech, mobile payment and e-commerce, the formation of a highly integrated domestic market, the great reduction of travel time, and the increased supply of effective working hours have all benefited from the improvement of telecommunication and transportation networks.
Financial regulation and deleveraging
The authorities attach great importance to safeguarding the financial system. The Financial Stability and Development Committee (FSDC) has become fully operational with its first meeting in early July, announcing its leadership structure and composition of its members from key institutions. This will further enhance coordination and push forward regulatory reforms as well as the implementation of the work programs to prevent systemic risks.
The deleveraging efforts have delivered positive results. China’s overall leverage ratio was 250.3 percent in 2017 and tended to stabilize. Credit to the nonfinancial corporate sector saw a decline of a 0.7 percentage point to 159 percent for the first time since 2011, reflecting a rapid increase of corporate profits and fiscal revenue. The leverage ratio of the government sector was 36.2 percent, down by 0.5 percentage point. Meanwhile, the leverage ratio of the household sector increased by 4 percentage points to 55.1 percent, slightly below the average growth rate between 2012 and 2016. In addition, the average debt-to-asset ratio for central SOEs stood at 66 percent as of end June, down 0.3 percentage point since this year.
The rebalancing progress should be assessed by its long-term trend. China’s current account surplus has declined from its peak of about 10 percent of GDP in 2007 to 1.3 percent in 2017. In the first quarter of this year, the current account registered a deficit of 34.1 billion U.S. dollars. The government has also made arduous efforts to strengthen environmental protection, and various environmental indicators have been steadily improved. In the first quarter of 2018, the consumption of energy per unit GDP declined by 3.2 percent y-o-y.
Significant progress has been made in SOE reforms, particularly in tackling zombie firms while transferring their social responsibilities to the government. Measures taken by the authorities include M&A, restructuring, strengthening corporate governance, and allowing non-viable zombie firms to exit from the market by the end of this year. By the end of 2017, the authorities have dealt with 1,200 zombie firms through these measures, cutting losses by 25.1 billion U.S. dollars equivalent. This year, the authorities will tackle another 800 zombie firms. With improved efficiency, the combined profits of central SOEs went up by 23 percent in the first half of this year. Meanwhile, the share of SOEs in total employment fell to 15 percent. In the highly competitive export sector, the privately-owned firms have outperformed that of the SOEs’ since 2007. The share of both privately-owned and foreign-owned firms in total export is almost 90 percent.
China firmly supports free trade and the multilateral trade system. After President Xi announced a package of opening-up policies in April this year, China has taken an array of significant steps to further open-up its financial sector by removing most of the limits on foreign ownership and substantially expanding the business scope for foreign banks. China has accelerated its opening-up by lowering import tariffs in automobile and agriculture products as well as in various consumer goods. Foreign investors are also allowed to set up wholly-owned automobile companies. Recently, China further shortened the negative list on foreign investment from 63 to 48 items. In particular, the negative list that applies to China’s free trade zones has been shortened to 45 items.
Like many other countries, China has also experienced difficulties and challenges associated with globalization, such as increased unemployment, income inequality and regional disparity. We have done our homework by deepening reforms and strengthening international cooperation. In China’s response to WTO accession, thousands of SOEs were restructured and bankrupted, more than 30 million employees lost their jobs and got re-employed. China has fulfilled its commitment to the WTO by cutting its overall nominal tariff rate from 15 percent to 9.8 percent. In practice, China has even gone beyond its WTO commitment by lowering its effective tariff rate to 2.4 percent, which is lower than that of EMDCs, and close to the level of AEs.
Thanks to the government’s efforts to protect intellectual property rights, China’s indigenous innovation has mushroomed and is now ranked number one in total patent applications, and number two in international patent applications, according to the WIPO. In 2017, China paid US$28.6 billion for intellectual property rights. Technology is a tradeable commodity, and a foreign company has the freedom to choose whether or not to enter into a contract that can fairly compensate the technology transfer. In case there is any dispute on technology transfer, it should be resolved through legal procedures under the WTO framework. In science and technology, China still has a long way to go to catch up with AEs. The visible progress up to date can mainly be attributed to a deep-rooted culture of respecting education and acquiring of knowledge, steady increase in R&D, as well as a large pool of educated labor force (8.2 million new graduates in 2018 alone).
Very recently, China and the European Union have agreed to jointly improve the rules-based international trade system, promoting multilateralism and support free trade. This is highly consistent with China’s road map and timetable on reform and opening-up. Regardless of the outcome of China’s bilateral trade disputes, China’s economy is resilient enough to absorb shocks associated with the trade dispute. China will continue to firmly support free trade and the multilateral trade system and fully commit to deepening reforms, further opening-up, protecting intellectual property rights, and developing an open and competitive business environment for both domestic and foreign firms.
The authorities have made tremendous efforts in poverty alleviation. In the past five years alone, more than 68 million people have been lifted out of poverty, more than 8 million have been relocated from inhospitable areas. National pension schemes have been significantly expanded to cover more than 900 million people, and the basic health insurance plans have covered 1.35 billion people. Due to the large-scale infrastructure development sponsored by the government, 99 percent of the villages are now accessible to modern paved roads. Over 26 million housing units have been rebuilt in the rundown urban areas, and more than 17 million dilapidated houses have been renovated in rural areas, and more than one hundred million ordinary people have benefited from these efforts. The Gini Coefficient has declined from 0.491 in 2008 to 0.469 in 2017.
Many EDs have shown their interest in the Belt and Road Initiative and kindly reminded the authorities of the need to manage various risks. We appreciate the wide recognition of the great potential benefits of the initiative, and in China we are willing to listen to constructive advices and feedback. Also, we welcome broad participation and a joint sharing of risks and benefits. In his recent meeting with the World Bank President, Jim Yong Kim, President Xi made it very clear that China will promote the Belt and Road Initiative based on relevant international standards and rules.
Last but not least, we will continue to make serious efforts to fill data gaps.