China's economy is expected to make a soft landing, though global headwinds are increasing, said the International Monetary Fund (IMF) in a recent report. The report was issued in Washington, D.C., on July 24 after the IMF concluded the 2012 Article IV Consultation with China. The report said China's GDP growth is expected to moderate to about 8 percent this year and then rise slightly to 8.5 percent in 2013. Compared with other economies, China's growth rate remains "formidable," said Markus Rodlauer, Deputy Director of the IMF's Asia and Pacific Department.

Lifting global demand

Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team led by Rodlauer visited China from May 29 to June 8, during which team members discussed macroeconomic management with the Chinese Government. On return to the IMF headquarters, the team prepared a report, which formed the basis for discussion by the IMF Executive Board. Such reports are considered "health checks" for member economies.

Inflation pressures in China have been eased because of decreasing food prices. Barring further shocks to agricultural supply, inflation should remain in the 3-3.5 percent range this year and fall to 2.5-3 percent in 2013, the IMF said.

The Chinese Government's macroeconomic policies are geared to slowing growth to a more sustainable pace, it said, adding that the escalating crisis in the euro zone poses grave risks to China's economic prospects.

After discussions, the IMF Executive Board considered China's current fiscal stance as appropriate. It considered the current stance of monetary policy to be consistent with the Chinese Government's economic objectives. Executive directors commended China for its robust growth that has provided an important lift to world demand during the global financial crisis. They agreed that the key challenge for China's policymakers in the period ahead will be to achieve a soft landing for the economy while pushing ahead with reforms for a more balanced and sustainable expansion.

Cooling real estate market

In an interview with the IMF Survey online magazine, Rodlauer said, "We are seeing growth in China slowing down, but we don't see it slowing down too much." China has reoriented its economic policy toward supporting growth and is on track to achieve a soft landing, he said. China's GDP growth in the second quarter of 2012 came in at 7.6 percent, which was slightly better than expected. "On current trends, we expect growth of around 8 percent this year which, of course, is still formidable compared with other countries in the world," he said.

IMF executive directors welcomed the progress in financial sector reforms in China. They stressed, nonetheless, that a large agenda remains, including strengthening the crisis management framework, adopting a formal deposit insurance scheme, and promoting the commercial orientation of banks. They also welcomed the Chinese Government's efforts to cool the real estate market and noted that eliminating the potential for property bubbles requires reforms to channel household savings away from housing and toward other financial assets.

The IMF report said China's external imbalances have been reduced significantly. The current account surplus declined from a peak 10.1 percent of GDP in 2007 to 2.8 percent of GDP last year. IMF executive directors welcomed the decline in China's external imbalances evidenced by the lower current account surplus. The renminbi remains moderately undervalued against a broad basket of currencies, the report said. China, however, disagreed. Zhang Tao, IMF Executive Director representing China, pointed out this assessment was not consistent with reality. The considerable decline in China's current account surplus and the recent two-way fluctuations of the renminbi's exchange rate show the renminbi's exchange rate has almost reached equilibrium, he said.

Driving growth with domestic consumption

The decline in external imbalances has been accompanied by rising domestic imbalances, reflected in a further rise in China's already elevated level of investment, the IMF said. While acknowledging China's large investment needs, most IMF executive directors expressed concerns about the sustainability of such a high level of investment in the context of weak external demand and excess capacity. They underscored the urgency of reforms to rebalance the economy toward more consumption-led growth. They considered that the agenda should include further financial sector liberalization, expanding the services sector, strengthening the social safety net, raising factor prices, and exchange rate flexibility. Together, this reform package will raise living standards, achieve the desired rebalancing of growth, and distribute its benefits more widely.

Rodlauer was not only confident about an economic soft landing, but also optimistic about the long-term development of the Chinese economy. "We believe that growth at around 7-8 percent a year is sustainable for China and is very doable," he said.

Rodlauer, nevertheless, reminded China of the daunting challenges it faces. Over the past few years, growth in China has relied very much on high and rising rates of investment. Over the next few years, there needs to be a smooth handover from investment to domestic consumption as the main source of growth in China. Also, savings in China are extremely high compared to international levels. Generally, in most developing and developed countries one tends to spend about 70-80 percent of income and save 20-30 percent. China, however, saves over 50 percent of its income, which means there is room to consume more.

China has devised concrete plans to change its economic development model, and it should now focus on rapidly and forcefully putting these plans into practice, he said.