IMF Calls China's Excessive Reliance on Debt 'Core Challenge'

     BEIJING (MNI) - As China shifts from export-led growth toward a more

service-dominated economy, the "core challenge" remains the nation's excessive

reliance on debt to fund growth, Alfred Schipke, chief IMF representative for

China, said at a briefing in Beijing to discuss the IMF's latest World Economic

Outlook report, which was released early last month. 

     China's debt is large and continuing to grow, although it has increased at

a modestly slower pace recently due to the government's deleveraging efforts.

Still, debt accumulated in past years is likely to increase the fragility of the

economy, according to the IMF.

     The IMF'S conclusion was echoed in the warning from People's Bank of China

Governor Zhou Xiaochuan during the 19th Communist Party Congress last month.

Zhou stressed that China needs to be aware of the risk of a so-called Minsky

moment, or a sudden major collapse of asset values sparked by debt or currency

pressures, particularly local government borrowing and rising household debt.

     Schipke told MNI that "The most concerning problem at present is corporate

debt, who causes the high debt and where it comes from, and its linkage to the

financial sector."

     China's corporate debt issue has been increasingly discussed as a "gray

rhino" -- a large and neglected danger -- as returns on investment have fallen.

The need for ever-larger sums of capital to achieve better economic results is

the main reason the Chinese economy is so heavily reliant on expanding credit

for growth, Zhang Longmei, the IMF's deputy representatives for China, said

during the briefing on Tuesday. 

     In addition to concerns about corporate debt, how to calculate total

Chinese public debt is controversial, Schipke warned.

     "Public debt should include some invisible debt -- for example, the local

government funding facilities and government-leading funds -- so it is not just

37% of the total GDP," Schipke argued, using the Chinese government's official

figure for the government's debt-to-GDP ratio. 

     "If [government] regulations do not ensure that [investment] funds will not

get bailed out when they collapse, this debt actually should also be part of

public debt," he added. 

     The Chinese government has stressed repeatedly that the debt of local

government funding vehicles (LGFVs) does not constitute government debt. But it

is still doubtful whether local governments and their funding vehicles can cut

their close connections in a clean and clear way, considering that local

governments still depend on the LGFVs for funding and usually are major stock

holders in the investment companies.

     The IMF has also issued a special warning about the risks from debt owed by

state-owned enterprises (SOEs), particularly zombie firms that have no hope of

profitability. "Fifty percent of bank loans go to the SOEs in China. If the SOEs

cannot be reformed, overall investment efficiency will not improve," Schipke

said. "[China should] make sure credit goes to the most productive parts of the

economy so companies compete with each other on an equal footing."

     The IMF praised the Chinese government's efforts to deal with the nation's

debt problems through its deleveraging campaign, but it suggested that policy

makers need to further enhance reforms of the budget and tax system as part of

the deleveraging process.

     The international organization also suggested that it is good time for

China to allow a more flexible foreign-exchange rate system, given the country's

recent strong economic performance, the relatively benign global trading

environment and the strict controls China imposed on its capital account earlier

this year.

     "According to our statistics, the yuan has not been overly overvalued or

undervalued," Schipke stressed.

     Schipke also noted the importance of the yuan's inclusion last October in

the currency basket used to calculate the IMF's Special Drawing Rights (SDR),

its international reserve asset. "It is important for the IMF, for China and for

the world," Schipke said.

     The IMF's October World Economic Outlook report revised up its estimates

for Chinese growth this year and next. The IMF now sees China's economic growth

at 6.8% for 2017 and 6.5% for 2018, an increase of 0.1 percentage point for each

compared with the previous forecast in July.  

--MNI Beijing Bureau; +86 (10) 8532 5998; email: marissa.wang@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

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