IMF: China On Sustained Growth Path But Momentum To Ease In 2H

--IMF Stresses Need for China to Enhance Exchange Rate Flexibility

--IMF Welcomes Reforms, But Still Much to Do On State-Owned Enterprises

     BEIJING (MNI) - China is on a "more sustainable growth path," with

regulatory reforms have underpinned growth, although growth momentum is likely

to wane over the rest of the year, the International Monetary Fund (IMF) said in

its annual Article IV consultation on China published Tuesday 

     "Important supervisory and regulatory action is being taken against

financial sector risks, and corporate debt is growing more slowly, reflecting

restructuring initiatives and overcapacity reduction," the IMF said in its

report.

     The IMF projected Chinese growth to 6.7% this year, higher than Chinese

government's targeted economic growth rate of around 6.5% this year. 

     Growth is likely to slow over the course of 2017 as  recent regulatory

measures have tightened financial conditions and contributed to a declining

credit impulse, the IMF said. For 2018, the IMF sees Chinese growth slowing to

6.4%. 

     IMF directors supported a gradual tightening of monetary policy if core

inflation continued to pick up. 

     The IMF predicted the benchmark 7-day reserve repo rate, a key policy

instrument for the new interest rate corridor,  will rise to 3.0%, at the top

end of the range of 2.75-3.0% that the People's Bank of China announced in its

second-quarter monetary policy report released last Friday. 

     The IMF suggested reforms need to accelerate to secure medium-term

stability and address the risk that the current economic track could eventually

lead to a sharp adjustment.

     The IMF noted that the yuan exchange rate "remains broadly in line with

fundamentals" and that China's strong growth "has provided critical support to

global demand." 

     The IMF directors "stressed the importance of continued progress toward

greater exchange rate flexibility, and welcomed the authorities' commitment to

deepen reforms and rely more on market forces to determine the exchange rate,"

the IMF said. 

     But pressure on the exchange rate could resume because of a

faster-than-expected normalization of U.S. interest rates, weaker growth in

China, or some other shock to confidence, the IMF warned. However, these risks

are likely small in the short run due to the stronger enforcement of capital

flow management, the prominence of state-owned banks in the foreign exchange

market, and ample foreign exchange reserves.

     The directors noted that recent steps to curb capital flows were broadly

consistent with the Fund's institutional view, but emphasized the need to ensure

consistent and transparent implementation. Directors stressed the importance of

carefully sequenced reforms to support the ongoing capital account

liberalization. 

     The recent firming of Chinese growth had given authorities an opportunity

"to accelerate needed reforms and focus more on the quality and sustainability

of growth," the IMF said. 

     "Directors welcomed the improvements in the performance of state-owned

enterprises and urged further reforms, including hardening budget constraints,

accelerating restructuring of under-performing debt, and allowing the exit of

non-viable firms," the report said.

     Despite several high-level announcements, there has been little effective

progress in exposing SOEs to greater competition due to the limited breath of

the reforms and their slow implementation, the IMF argued. 

     "Directors also highlighted the importance of a broader improvement in the

investment climate, including reducing barriers to entry, ensuring a level

playing field, and reducing trade barriers," it added.

     In the IMF's eyes, greater opportunities and a level playing field for the

private sector, including foreign firms, would increase via reducing barriers to

entry and a greater focus on giving the private sector equal access to resources

and ensuring equal treatment in regulations, taxation, government procurement

and administrative approvals. 

     China also has scope to gain from trade by reducing barriers, including

tariffs which are still considerably higher than those of its main trading

partners. Progress in these areas could help reduce trade tensions, foster

positive outcomes, rather than negative ones, and encourage greater openness

amongst trading partners by demonstrating China's commitment to an open

rules-based trading system, the IMF suggested. 

     "The immediate priority for fiscal policy should be to adjust the

composition of the budget to support faster rebalancing and ease the costs of

transition from an investment and credit led model," the directors said.

     Ongoing fiscal framework reforms should be deepened to support consumption,

reduce inequality, and ensure medium-term debt sustainability, the IMF added. 

     Directors agreed that having some fiscal space allows the pace of

consolidation to balance concerns about growth and sustainability. They also

underscored the importance of monitoring debt, noting that further efforts to

reform central-local fiscal relations can help reduce risks arising from off

budget spending. 

     Monetary policy effectiveness would be considerably improved if price

stability was formally identified as its primary objective. In addition, the

PBOC should have clear accountability around the target and the necessary

operational independence to achieve it, the IMF said. 

     All in all, the IMF thought ahead of the fall Communist Party Congress, the

economy is well-positioned to meet the 2017 growth target amid continuing

stability in the balance of payments.

--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

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