One of the central jobs of the IMF is to regularly check up on all its members. They’re called “Article IV consultations” for reasons the link will explain. Today, the Fund published its take on China’s economy.
As usual, it is a tortuously-constructed document — designed not to piss off one of the Fund’s biggest and most sensitive shareholders, while still providing some valuable insight into one of the most important pillars of the global economy.
(Underscoring the sensitivity, the process for China’s Article IV actually started back in early Novembe. The projections weren’t finalised until mid-December, weren’t presented to the IMF’s executive board until mid-January, and although the forecasts were incorporated into its January World Economic Outlook update, the full report wasn’t released until this morning).
The headline is that the IMF now forecasts that growth will rebound from just 2.6 per cent last year to 4.2 per cent this year thanks to the post-Covid reopening. Here’s the Fund’s summary:
Following an impressive recovery from the initial impact of the pandemic, China’s growth has slowed significantly in 2022. It remains under pressure as more transmissible variants have led to recurring outbreaks that have dampened mobility, the real estate crisis remains unresolved, and global demand has slowed. Macroeconomic policies have been eased appropriately, but their effectiveness has been diminished by a focus on enterprises and increasingly less effective traditional infrastructure investment rather than support to households. The pandemic and its impacts have also been a setback to economic rebalancing toward private consumption and to reducing greenhouse gas emissions. A slowdown in growth-enhancing reforms against the backdrop of increasing geoeconomic fragmentation pressures stand in the way of a much-needed lift to productivity growth, weighing on China’s medium-term growth potential.
As ever though, the interesting bits are elsewhere, such as the details of the forecasts. For example, the growth of overall “social financing” — a broad measure of debt in the Chinese financial system — is slowing, but will climb to 305 per cent in 2023.
Elsewhere, the IMF notes that capital outflows have increased (though remain smaller than what was seen back in 2015-16) and the renminbi is under pressure. But the IMF’s main worry still seems to China’s messy real estate market.
It flagged the slowness of restructuring the vast tangled web of property developers — bond prices indicate that 38 per cent of them have or will default — and seems unconvinced by Beijing’s insistence that everything is now fine.
Here is what China told the IMF:
The authorities were of the view that the problems in the real estate sector remained broadly contained and they were taking strong action. They noted that excessive leverage and weak governance of several large real estate firms had strong spillover effects on the broader property market since the second half of 2021, which were exacerbated by other factors such as the impact of COVID. They expected successive rounds of policy support led by local governments, which have a key role in China’s system of regionally differentiated real estate regulation, to have a gradual but cumulative effect on the market, with signs of stabilization already emerging in the third quarter of 2022.
The authorities assessed the banking sector to be generally healthy. They emphasized that banking sector exposures to property developers were limited and that mortgage risk was low due to high prudential requirements and the lack of financial leverage. The overall capital level of the banking system is relatively high. They noted that they continuously monitor and pay close attention to the potential impact of pressure on the profitability of real estate enterprises. On leverage, the authorities emphasized that the private sector debt-to-GDP ratio had been on a downtrend in recent quarters, despite temporary increases due to slower growth.
And here is what the IMF itself wrote:
Despite the broadening policy response, the crisis has continued and the need for large-scale restructuring remains. Demand-side easing measures have had limited traction in boosting sales amid widening financial turmoil among private developers. The new housing completion funding mechanism will partially address the backlog of unfinished housing, but its scope appears small relative to the potential scale of construction needs should demand remain weak (see Box 1), and formalized forbearance policies are likely to limit creditor incentives to pursue restructuring. Adding to local government difficulties, while the scheme is funded by the central government, local governments must still backstop housing completion loans, and several highly-indebted regions also have large stocks of unfinished housing.
The real estate crisis and the growth slowdown reinforce vulnerabilities from high debt in the non-financial sector and add to financial sector strains. Balance sheet pressures are rising at financial institutions, particularly at smaller banks and some non-bank lenders as asset quality has deteriorated. Moratoria on inclusive and pandemic-related loans continue to grow and banks are allowed easing in NPL classification rules for loans to sectors affected by the real estate crisis and the pandemic. Developer bond price declines and some households’ efforts to suspend mortgage repayments imply worsening credit quality in many smaller banks and some non-bank financial institutions from their real estate-related exposures, raising financial stability risks given their limited capital buffers and interconnectedness to the broader banking sector. Funding conditions for some smaller banks have tightened notably, despite ample aggregate liquidity in the system, reflecting in part governance concerns, lower profitability, and slow progress in their recapitalization efforts, although profitability pressures and resulting declines in capital adequacy ratios have also emerged in the banking system more broadly.
The IMF wants China to set up “more robust mechanisms” to restructure distressed real estate developers, curtail off-balance-sheet borrowing by local governments and state-owned enterprises, and strengthen the banking system to contain the financial stability risks.
The tl;dr is that China reopening will naturally boost growth, but there are a lot of gremlins still lurking in the system that could cause problems in 2023.
