IMF Notes China Authorities See Interest-Rate Level Appropriate

(Bloomberg) -- China’s leaders plan to underpin demand with fiscal support and view interest rates as being at "appropriate" levels, according to glimpses of their thinking seen in the International Monetary Fund’s yearly review of the economy.

"The authorities emphasized that monetary and fiscal policies would provide a supportive environment for supply-side restructuring," IMF staff wrote in the report on its Article IV consultations. "They viewed the level of interest rates as appropriate from a cyclical perspective. They expected credit growth to normalize in the remainder of the year."

Flagged as "authorities’ views," the IMF report contains rare insight into how China’s communist leaders view the pace of reform, the economic environment, and currency policy.

"Exchange market pressures had eased considerably in recent months and the move to a more market-based exchange rate was progressing," authorities noted according to the IMF report. "The approach was to continue maintaining broad stability against a currency basket while allowing market forces a greater role in determining the level. FX intervention had decreased in recent months and was used largely to smooth adjustments and curb overshooting."

The IMF report -- which calls for improved policy communication -- comes a year after China’s surprise yuan devaluation shook global markets and undermined confidence in the nation’s economic prospects. After its recent declines, the yuan "remains broadly in line with fundamentals," the IMF said.

Those fundamentals tarnished slightly Friday, when data showed the latest readings on factory output, retail sales, investment and new credit missed economist forecasts.

Industrial production rose 6 percent from a year earlier in July, the National Bureau of Statistics said Friday. Retail sales climbed 10.2 percent last month, while fixed-asset investment increased 8.1 percent in the first seven months of the year. Aggregate financing was 487.9 billion yuan ($73.4 billion) in July, compared with a median estimate of 1 trillion yuan in a Bloomberg survey of economists.

All four readings missed economists estimates. Bloomberg’s monthly gross domestic product tracker slipped to 6.94 percent in July, from 7.13 percent a month earlier.

The IMF forecast gross domestic product will rise 6.6 percent in 2016 and 6.2 percent in 2017, while it sees inflation picking up to around 2 percent this year. China’s leaders are targeting GDP growth of 6.5 percent to 7 percent in 2016.

"The near-term growth outlook has improved due to recent policy support," the IMF wrote in its analysis. "But the medium-term outlook is clouded by continued resource misallocation, high and rising corporate debt, structural excess capacity, and the increasingly large, opaque, and interconnected financial sector. The apparent challenges in implementing a clear and decisive reform path add to concerns that China may exhaust its still-sizable buffers before the economy changes course sufficiently."

The IMF expressed concern over the pace of reform in areas such as state-owned enterprises and deleveraging, and praised it elsewhere, noting progress on the interest-rate liberalization front. It also called for additional policy changes.

The People’s Bank of China "should declare the seven-day repo rate its new intermediate policy target for monetary policy purposes and publish a new market rate (seven-day repo) representative of lending conditions for Tier 1 banks," the IMF said. "The clearer the policy framework, the easier it will be for the market to establish a yield curve. Standing facilities should act as a backstop with unlimited access for banks against appropriate collateral."

The PBOC has kept its traditional benchmark interest rates unchanged since October, instead adding liquidity through money market channels as it moves toward an interest-rate corridor.

The IMF called for macro policies aimed at lowering vulnerabilities, even if that means slower economic growth in the near term. The fund’s directors highlighted the urgency of addressing the corporate debt problem and urged further improvements in data quality and policy communication.

China’s debt has swelled to about two and a half times the size of its economy. That’s high by global standards given its development level.

Authorities disagreed with IMF’s view that policy support was adding to China’s vulnerabilities. They noted higher infrastructure investment in less-developed areas of the country would help boost long-term growth prospects, the IMF report showed. The quality of growth was improving, as shown by stable employment, robust wages and the rising contribution of private consumption to overall demand.

To contact the reporter on this story: Malcolm Scott in Hong Kong at mscott23@bloomberg.net. To contact the editors responsible for this story: Malcolm Scott at mscott23@bloomberg.net, Enda Curran