China’s Focus on Growth Goal Risks Reform Delay, World Bank Says

China may fail to implement changes needed to put its economy on a more sustainable path as weaker expansion pushes the government to roll out stronger supportive policies to meet its growth target, the World Bank said.

“The government should have sufficient room for those policies, but they may perpetuate China’s traditional growth model that relies on government-led investment fueled by credit expansion,” the Washington-based lender said in a report today. “A policy focus on meeting growth targets could distract from pushing through the structural reforms intended to put long-term growth on a more stable footing.”

The World Bank’s comments echo a call from the International Monetary Fund yesterday for China to refrain from implementing more stimulus and pursue changes to curb dangers from shadow banking and local government debt. Policy makers are trying to keep expansion from slipping below Premier Li Keqiang’s 2014 target of about 7.5 percent while carrying out policy shifts to restructure the economy.

“Delays in implementing coherent reforms could perpetuate resource misallocation, undermine the health of the banking system, threaten the debt sustainability of local governments, and increase the fiscal costs of reform,” the World Bank said.

“Banks and borrowers still operate under distorted prices and incentives that need to be corrected in a way that does not trigger a disorderly adjustment.”

Fiscal policy and financial sector reforms remain the immediate priority, the World Bank said.

Broaden Financing

The government should implement four key fiscal reforms, including improving the revenue base of local governments and setting up an explicit framework for local government borrowing, the World Bank said. Changes in the financial system should involve interest-rate liberalization, making banks operate on a more commercial basis, and promoting equity and bond markets to broaden financing sources for companies, it said.

China’s economy expanded 7.7 percent last year and in 2012, the weakest pace since 1999 in the aftermath of the Asian financial crisis and down from an average 10.6 percent in the previous decade. Growth may ease to 7.3 percent this year, according to the median estimate of 51 analysts in a Bloomberg News survey last month.

President Xi Jinping said last month the nation needs to adapt to a “new normal” of a slower pace of expansion. At the same time, the government has rolled out measures to support the economy after first-quarter growth fell below the 2014 target.

Adding Imbalances

Policies have included speeding up investment in public housing and infrastructure, tax cuts, faster fiscal spending by local authorities and a reduction in reserve requirements for some banks.

Fiscal policy measures announced in April should help authorities reach this year’s growth target, although most of the investments will be debt financed and likely add to imbalances and vulnerabilities, according to today’s report.

The World Bank estimates the economy will expand 7.6 percent this year and 7.5 percent in 2015.

Downside risks to this year’s growth projection include a “disorderly deleveraging” that triggers a sharp slowdown in investment growth, according to the report. Debt-servicing difficulties for local governments and companies may push up non-performing loans and affect banks’ lending capacity, and the expected rebound in net exports may not materialize if the recovery in advanced countries weakens, it said.

— With assistance by Nerys Avery

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