By Vivienne Russell | 31 July 2014

Fiscal reforms should be implemented in China to strengthen the country’s public finances and foster more inclusive growth, the International Monetary Fund has said.

In its annual review of China’s economy, the IMF noted that growth was continuing to slacken off and is expected to be 7.4% this year, down from a high of 10.4% in 2010, and was predicted to further fall to 7.1% in 2015.

China’s rapid economic growth had been sustained by heavy reliance on capital spending and credit, the IMF said. ‘However, declining efficiency of investment, a significant build up of debt, income inequality and environmental costs are threatening growth prospects,’ it warned, noting that general government debt was now close to 40% of gross domestic product.

‘The challenge is to shift gears, reduce the vulnerabilities that have built up, and transition to a more sustainable growth path,’ the Article 4 consultation said.

Fiscal and social security reforms would help to deliver more inclusive growth as well as boosting consumption and strengthening the public finances, it argued.

Among the necessary changes is an overhaul of China’s local government finances to better align local revenues with expenditure and strengthen the management of public borrowing at local level.

‘To ensure the sustainability of public finances, this should be combined with reforms to the social security system, shifting the legacy and welfare parts of pensions to the budget, improvements in the tax system, and cuts to lower-priority spending,’ the fund added.

Economic vulnerabilities in China had now reached the point that a fiscal stimulus might become necessary if growth risks slowing significantly below the authorities’ target.

‘If such as stimulus becomes necessary, it should be applied through fiscal policy, on-budget, with measures aimed at protecting the vulnerable and advancing reforms.’