China’s Growth Ambitions Spur Credit Expansion, Undermine Financial Stability: IMF

The Chinese government’s pursuit of overambitious growth targets – especially at the regional level-  is driving excessive growth in debt and compromising the stability of the financial system according to a new report from the International Monetary Fund.

According to the report China’s use of fiscal and monetary policy to shore up employment and economic growth levels was behind the surge in debt amongst defunct companies as well as local government entities.

This in turn is undermining the stability of China’s financial system, despite the much-touted deleveraging campaign launched by Beijing earlier this year.

“The apparent primary goals of preventing large falls in local jobs and reaching regional growth targets have conflicted with other policy objectives such as financial stability,” said the IMF.

“Regulators should reinforce the primacy of financial stability over development objectives.”

According to the IMF the Chinese government’s preoccupation with social stability has compelled it to provide financing to ailing companies, leading to sharp growth in credit and attendant dubious debt.

Estimates from the Bank for International Settlements indicate that China’s credit-to-GDP ratio is now high by international standards, putting its financial system in perilous territory.

According to the IMF in order for Chinese regulators to successively achieve their goal of deleveraging the economy and curbing overly rapid credit growth, they will need to dial down their preoccupation with ambitious GDP targets that are a key component of national planning policy.

The IMF advocates the creation of a financial stability subcommittee, comprised of the People’s Bank of China, the China Banking Regulatory Commission, the China Insurance Regulatory Commission and the China Securities Regulatory Commission, in order to address shortcomings with respect to regulatory coordination and systemic risk analysis.

It also recommends that China rescind the “implicit guarantees” that characterise much of its financial system, with banks expected to compensate retail investors in the case of losses, and the government expected to bail out ailing state-owned enterprises.

In order to facilitate the process of deleveraging and implicit guarantee removal, the IMF further advises that regulators widen the capital buffers of Chinese banks, so that they are better capable of withstanding potential losses during what is likely to be a fraught transition period.

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