The International Monetary Fund said China's slowing economy faces significant downside risks and relies too much on investment, urging leaders to boost consumption and channel citizens' savings away from housing.

The IMF repeated an assessment that the yuan is “moderately” undervalued, which China disputed, the Washington-based lender said in an annual review. The fund omitted an estimated range for the currency's undervaluation that was included in an earlier draft, according to two officials at the fund who had seen the previous language and spoke on condition of anonymity.

The call to support consumer spending echoes priorities set by Premier Wen Jiabao's government, which is seeking to stem a six-quarter slowdown in economic growth. Leaders have cut interest rates and stepped up investment as the ruling Communist Party prepares for a once-a-decade leadership handover starting later this year.

“The authorities have taken the foot off the brakes, but they have not yet stepped on the accelerator in a major way,” Markus Rodlauer, head of the IMF's China team, said on a conference call with reporters. The IMF statement followed a July 20 directors' meeting to discuss the annual staff assessment of China's policies.

While the economy “seems to be undergoing a soft landing,” achieving it is a key challenge, the IMF said. “China is well placed to respond forcefully, if needed, to a deterioration of the external environment, in particular through fiscal policy.”

With a slowdown in export growth, China has allowed the yuan to weaken this year. The currency has dropped about 1.4 percent against the dollar in 2012 after a 4.7 percent gain in 2011. The yuan fell less than 0.1 percent against the dollar to 6.3887 as of 11:23 a.m. in Shanghai.

The yuan “is assessed to be moderately undervalued against a broad basket of currencies,” the IMF staff wrote, reiterating an assessment last month by David Lipton, the IMF's first deputy managing director. That was a change from the previous stance that the currency was “substantially” undervalued.

China disputed the new assessment and said the yuan was “now close to equilibrium or, at most, slightly undervalued,” according to the report.

Estimates Omitted

The IMF refrained in this year's report from giving an estimate of how much the yuan may be undervalued, compared with last year's assessment, which gave a range of 3 percent to 23 percent. Rodlauer, asked why figures were left out this year, said on the call that “numbers tend to get a life of their own,” though some estimates will appear in a separate exchange-rate report to be issued “shortly.”

Bill Murray, an IMF spokesman, declined to comment on the omission of the yuan's estimated undervaluation that was in an earlier draft.

China in April widened the yuan's daily trading band for the first time since 2007, allowing the currency to move 1 percent around a rate set daily by the central bank, up from 0.5 percent.

China's economy is bottoming out now and likely to have a “slight improvement” this quarter, Rodlauer said in a Bloomberg Television interview. Separately today, China's Ministry of Industry and Information Technology said growth may stabilize and rebound in the second half as policies gradually take effect.

Chinese officials agreed that in case of a worsening of Europe's debt crisis, they would try for a “balanced approach between fiscal and monetary measures,” the IMF staff report said.

IMF directors “noted that the pace of activity has slowed and downside risks are significant,” the fund said. Options to support the economy while avoiding the side effects of a credit-fueled stimulus include subsidies for consumption, incentives to reduce pollution and greater spending on a social safety net, the IMF staff wrote.

China's economy is cooling as Europe's debt crisis limits exports and Wen's past tightening to curb inflation and prolonged efforts to subdue property prices restrain domestic demand. Gross domestic product expanded 7.6 percent in the second quarter from a year earlier, the least in three years. The expansion may cool to 7.4 percent this quarter, Song Guoqing, a central bank adviser, said July 21.

Labor Situation

Wen warned this month of a “severe” labor outlook and said economic difficulties may persist for a while as downward pressure on the economy remains “relatively large.”

The IMF repeated its forecast from last week that China's gross domestic product will expand 8 percent in 2012, compared with 8.2 percent seen in April, and accelerate to 8.5 percent growth in 2013, compared with 8.8 percent predicted three months ago. Inflation will range from 3 percent to 3.5 percent for the year and slow to 2.5 percent to 3 percent in 2013, “barring further shocks to agricultural supply,” the IMF said.

Chinese authorities are “confident” they can reach growth of at least 7.5 percent this year, according to the IMF staff report.

The IMF forecast a current-account surplus of 2.3 percent of GDP this year, rising over the next five years to 4.3 percent in 2017. That longer-term prediction is “well below the 7 to 8 percent of GDP previously expected,” the IMF report said.

China is accelerating capital spending in response to the slowdown, and the IMF said its directors expressed concern about the sustainability of “such a high level of investment in the context of weak external demand and excess capacity.” The IMF sees gross domestic investment little changed this year at 48.5 percent of GDP.

IMF officials “underscored the urgency of reforms to rebalance the economy toward more consumption-led growth,” the lender said. Wen said this month that “growth-stabilizing policies include boosting consumption and diversifying exports, but currently, what is important is to promote a reasonable growth in investment.”

Gome Electrical Appliances Holding Ltd., China's second-biggest electronics retailer, warned yesterday it may post a first-half loss as revenue declined and its e-commerce unit was unprofitable. Gome and Suning Appliance Co., a larger rival, last year benefited from government subsidies on home-appliance purchases.

The IMF said China still has a “large agenda” to pursue on improving its financial system including strengthening the framework for crisis management, adopting deposit insurance and regulating risk from loan growth and off-balance-sheet transactions.

IMF officials welcomed China's efforts to cool the property market while saying that “eliminating the potential for property bubbles requires reforms to channel household savings away from housing and toward other financial assets.”

Wen has vowed to “unswervingly” maintain property controls even as he tolerates some piecemeal measures to support the market.

Bloomberg News

Instant Insights /

IMF Cites China Downside Risks

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