It became a place where it was a hubbub of activity. It was the one place where it was private family time. Now a look at chinas economy and the challenges china faces in trying to maintain their rate of economic growth. The International Monetary fund China Mission team was part of a Brookings Institution discussion on the repeat imf report outlining chinas local debt, it financial sector, and real estate market. Its an hour and a half. [inaudible conversations] [inaudible conversations] interest and some extend mystery second largest economy in the world and the largest contributor in the world growth. The enormous interest about what is happening in china not just within the country but around the world. This morning we have an extremely distinguished panel to help us sort through the issue. On my left is marcus. Hes the Deputy Director at the imf and the mission chief to china. Marcus, actually has studied not just economic but also law and International Relations which makes him perfectly suited to have him figure out not what is happening in chinas economy but the broader implications for the world might by. On my right we have steve roach. Who spend a long and distinguished career at morgan stanley. He jumped to my side of the fence. In the Global Economy. And before that the World Bank Office in china. So of all people who know china intimately. What we start off is with a presentation by markus. Tell us about the Main Findings of this years annual report that the imf writes on china. That will give us a basis for discussion and bring in the panelists and leave some time at the end for questions and answers. To begin with, markus. Good morning and thiewng brookings for fighting us here. Thank you to eswar for agreeing to be on the panel. Before i start, i would like to acknowledge what they have done china and china, of course, is a team effort. All you see or hear today you see our report published on the website. Steve is the head of the china division, and [inaudible] the main message of report this year. A lot of concern early in the year potentially in china. Remain confident that the growth has been moderate. We dont see a major risk of a sharp imminent decline of growth. Hard landing in china. At the same time; however, vulnerabilitieses have been growing for years. They have continued to grow over the past year. If you compare it to last years imf report you will defect some heightening of concerns about the growing vulnerabilities in the chinese economy and greater urgency to financial structure reforms that has been that put the economy on more Sustainable Growth path. Growth in china is typical much more policy dependent than it is for many other large economies. And the actual growth protection in china always very closely linked to what thinks about the governments policy reaction. How strongly will they counter act any decline or risk to growth. And so far quite positively i would say the government has signaled the tolerance for growth in line with its own target. Which is around 7. 5 . In contrast to the past, whenever there was a final slow down, the economy would move strongly investment this year. The response has been significantly more moderate, and the chinese has not appeared to want to prop up activity above the target. So coming out of china now at the High Frequency and many of them over 100 the Third Quarter in to a first few days of this show that the second half of the year. There has been a little bit of slowing retail sales well in the double double digit. We donl dont see any decline. Also the trade data recently has come back somewhat. We have confidence that assessment of growth of 7. 5 is about right. As i emphasized since the global crisis. Sustainable because the sign of risk might be growing. Significant buffers to whether are not an imminent crisis mode. The margin of safety are clearly diminishing. These three risks sort of which jump out and look at the finance of the economy. They sort of reflect deeper vulnerable underlying problems in the economy along the current growth path. Which remains based largely on capital accumulation and Credit Finance investment. In a nutshell, these three risk you see on top they reflect a process where by capacity is being accumulated well ahead of final consumer demand, its financed by credit expansion. And this has lead to wide spread access catch, pressure on corporate profitability, diminishing return to investment, and rising corporate and local government debts. In order to sustain growth the economy need to be transformed away from the pattern of growth based on capital accumulation to one more based on total factor productivity. Let look a bit closer at the financial sector. Chinas stock of credit on the lefthand scale is among the highest in the world at the level of income. You see the red dot china and the domestic banking credits close to 150 percent is clearly an outlier. But on the right you see its growing extremely fast especially in the nonbank segment not included in the left. On the righthand side you see total social financing calling china bank credit and credit given outside the banking channel. That financing has increased by 60 of gdp in four years. And by the predominant source of the funding still remains in the Banking Sector traditionally and increasingly larger has come through other channels such as high yielding Wealth Management product and other nonbanking source of financial and its very positive in many ways because it moves the financial closer to the market. It carries tremendous risks and a problem because first of all better regulated Banking Sector. Its an area of weaker surmings. Supervisorrers have a hard time catching up what is the socalled and the speed of some of the progress is nearly overwhelming. The consequence what you see here is nearly explosion of secret a steady buildup of leverage which is eroding the strength of the financial sector. So this questioning of rising leverage means that the corporate burden has always risen. If you look at the leverage in the corporate sector they are manageable. A growing share at least in out of the firm data available. A growing share of the firm are showing interest coverage below one. And, you know, its its not again a crisis proportion continue this recent trend would suggest constrain on the corporate sector and marc macroeconomically. Second point local government debt. The buildup in credit has been accompanied bay large increase in local government debt. Infrastructure spending by local government is an important tool in china. A lot of fiscal spending comes from the local Government Social and investment. It has become so since the Global Financial crisis. And a large part of this local Government Spending investment spending is being done off budget. Its not recorded as part of general Government Spending. Now to better assess the microeconomic scale. To be at the front tried to construct what we call an augmented fiscal balance. The recorded official general Government Data together with the off budget fiscal transaction. Looking at it together shows us that the actual debt of the Public Sector augmented Public Sector is much higher than the official 22 official. But augmented debt including the off budget spending comes to somewhere around 50 of gdp. We have 45 because we dont include something. If you look on the right side the market estimate and the government estimate which has been around for the last two or three years of the side of the government debt. Its somewhere between 50 and 60 including what you saw on the liability side. And of course, the rate of that is official debt is much higher means also that the public deficit, if you include the augmented part is higher than measured on the order of one, two, or 3 . Around 8 to 10 of gdp. Real estate on the lefthand side you see relgt accounts for a very significant share of gdp already. Its 12. 5 of output and about 14 and remain now a key engine of growth; however, one has to realize that existing distortion s make this market acceptable to large political swings boom and bust cycle. On the supply side we have local government. Which rely on land sales for financing and Real Estate Development for gout. Which often leads to push surprise to the market. On the demand side, the market is prone to bubbles because housing representatives a uniquely appealing Investment Opportunity for the private sector given that the Interest Rates are close to zero. Given the restriction that can put their money abroad. Theres a history of robust capital gains. And also favor tax treatment. On the demand side theres a huge incentive. So this is a risky situation and clearly over the medium term Real Estate Development will have to slow down a more sustainable pace. The challenge is to do it in a way not just by restricting price growth of trying to control it from the top but removing the underlying distorts that create the incentive to the risk. As we said the three risk. They sit on top of the underlining deeper vulnerable related to chinas growth model which remains on capital accumulation. Investment, which is being implemented through quasi stateowned enterprise investment. That investment has been used to support domestic activity, and to offset the impact of external shops. By this of course had spillover effects for the Global Economy. It has tremendous the domestic imbalance between investment and consumption. There are signs in last years that the imbalance is no longer worsening. But the shift toward consumer based economy has yet to occur. For the last Year Investment as a part of gdp remain flat of a share of gdp. And antiurban Household Savings rate increased which mean more consumption. On the lefthand side you see China Remains an outlier with investment and share of gdp much higher than consumption lower than other countries. On the righthand side you see from the supply side. What is the composition of chinas growth. Secondary sector remains the main driver of growth not forget about the other challenge. Of rebalancing and of challenge which is, for example, while there has been a major reduction of pot in china over the past years, inequality at the same time has increased tremendously over the past two decades. You look at the staff report that it shows how much has increased in the past two decades which is the largest increase of the market economies. And last but not least, the environmental challenges, of course, of adding factors of production and investment and resources tremendous and not sustainable. So clearly the time is running out on the current growth model. We have growth accounting exercise that the south over the past two or three decade its mainly factor accumulation. Putting labor and new factories together, and producing for exports. Clearly this growth can no longer continue. It it continues, you see the orange line here on the bottom is china, if it continues it can go on for a few more years. It will run out of steam eventually you will create too much capacity of enterprises for profitability [inaudible] at some point in time there will be a crisis or sharp slow down. Chinas convergence process which measures the ratio of chinas gdp to the u. S. Which has proceeded steadily over the past two decades. The visk that convert [inaudible] might stall which has done for many others stage of development. The choice for china is to either change the growth model and sustain the conner have jensen process. If theres a it can actually continue to con jeering closer toward advanced income levels. What the key policies explaining details in our report. Successful transition in china will require a decisive new round of reforms that will define to unleash these new sources of growth. Which are based on productivity growth. At the same time need to address the risk in the various spot of the economy. And at the same time make growth more inclusive and environmentally sustainable. And not diminish the challenge all of this caused in an external environment which likely will remain difficult at least for some years. The challenge is tremendous. It may entail over the next few years somewhat Slower Growth in china. Not in the 8, 9, so 10 range. What is strategy at the strategic level. I think it highlight three points. An increasingly greater role to market forces. Through continued liberalization and government. Stronger qof mans. Thats important we mention it. As we increase the role of market forces, we need to see stronger govern mans at the lower level of government and economic units. And statement shifting income toward household and increasing consumption. These are strategic in term of Economic Policy the agenda include a broad set of fiscal financial sector, Exchange Rate and other structure measures that need to be taken over the next three or four years. Many of these reform directions and policy objectives have actually indeed outlined in the governments recent announcements. So we are confident with the authorities we see a great recognition of the challenge and clear understanding of the policy area that need to be addressed, and the direction that policy needs to take. And you have seen it in a various announcements that come out over the last six month. What is needed is clear and specific policy measures and timely and focused implementation. Let me sum up again. Ernear term look in china 7. 5 percent but the vulnerable are growing along the current path. While margins are still there, theyre diminishing. And financial structure reform must be accelerated to contain the risk and form the gross model. Thank you. Thank you. Do you agree with marcus assessment of the short term and medium term. Specifically, do you think what he laid out in term of what the right one. Do you have anything to add or subtract . Thank you. I like the imf report a lot. The bottom line growth of seven and a half percent this year. Risks building up and the need to transform the growth model. I like to agree with this as an opening remarking. What i want to do is briefly emphasis the risk are really quite serious. The risk that are built up are quite serious. Add a couple of additional issues to the structure reform agenda. I agree with the issues markus touched on. I want to broaden the agenda a bit. First, on the risk. I like his figure that shows chinas private consumption and investment as a share of gdp compared to other countries. China is extraordinary. It has investment and low private consumption. We havent seen it before. On the investment side. If you invest 50 of gdp at the stage you double the Capital Stock in six years. During the inviement push. The Capital Stock has been doubled. It will be doubled again in six years. Theres evidence that the return to investment is dropping, and so im pretty convinced if you double Capital Stock looking forward the next six years, theres not going to be demand to use that Capital Stock. You run in to some kind of financial or physical problem in the imf report brings that out. I want to emphasize thats serious. I agree with the reform agenda touched on. I would add two areas that i also think are important. The first is, reforming household registration system. If you look at china, theres been obviously been some rural urban migration. Its rather limited if you compare to the historical experience of other country. If you include the migrant its about 52 for the emigration rate. When south korea was at the same level it reached 68 . The household system obviously restricts mobility. One result china has very large rural urban income difference. By restricting the ability of vie grant to move to the city. You restrict the ability of many rural people to move and find higher income. Its particularly difficult for people to bring their family, children, old people, and if they move to cities, you know, that would provide quite a bit of additional demand for social services. The government would have to find the resources for those. There would be challenges. If you think about shifting from an vestmentdriven knowledge more consumptiondriven model, i think easing up on the system and encouraging more real migration of families from the country side to to the city consume more greater provision of government surfaces. The other area i would briefly mention is state enterprise reform. The official statistic it takes more than 40 of the recent years has been in the stateowned sector. There are a lot of enterprise with mixed ownership. Thats probably the lowest. And state enterprise they operate in quite a few sectors, but i see them as being especially visible in modern Services Like financial is services, media, telecom, logistics, airline. These are sectors theres a small number of stateowned incumbent, chinese often refer to these as monopolistic sectors. Monopoly sectors. They are a lot of profit or perhaps we would call economists calm it rent. They pay very little dividend to the government. Nice thing in the imf report the statistic in recent years centrally own state enterprise have paid 0. 4 dividend to the Central Government budget. Basically you have a system in which protected uses earn profit and they reinvest it. If took more of the Government Income to the simple reform and expand the social services, that would be shifting some resources from investment to consumption. My general point is there are important institutional features of the china chinese system that encourage investment and discourage consumption. It makes sense to target some of