China must prioritise financial stability over rapid economic growth: IMF

China's credit-to-GDP ratio is very high by global standards and consistent with a high probability of financial distress, the IMF said

China should prioritise financial stability above development goals, as pursuit of regional growth targets and helping firms avoid heavy job losses had led to a surge in debt, particularly at local government level, the International Monetary Fund said.

Noting a lack of coordination and inadequate systemic risk analysis in a report released on Wednesday, the IMF also recommended the formation of a financial stability sub-committee comprising the central bank and three financial regulatory agencies, and an increase in staff for the banking watchdog.

Since the IMF's last assessment of the Chinese financial sector's resilience to shocks and contagion in 2011, two concerns remain - credit growth remains high and the expansion of wealth management products, said Ratna Sahay, deputy director of the IMF's Monetary and Capital Markets Department.

"Risks are large," Sahay told reporters during an online briefing. "Having said that, the authorities are really aware of risks and they are working proactively to contain these risks."

The IMF report said that while China has been taking steps to address its debt risks, reining in excessive credit growth will require a de-emphasis on high GDP projections in national plans that have spurred local governments to set high growth targets.

But the near-term prioritisation of social stability seems to depend on credit growth to sustain financing to firms even when they are non-viable, it said.

"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," the report said.

"Regulators should reinforce the primacy of financial stability over development objectives," the fund said.

China's credit-to-gross domestic product (GDP) ratio is very high by global standards and consistent with a high probability of financial distress, the IMF said, citing an estimate from the Bank for International Settlements.

NEW PRODUCTS, NEW RISKS

The IMF specifically warned that the rapid development of financial products for investors could pose grave risks.

"We are also concerned that in a very innovative financial system such as China's, new products can emerge very quickly and very rapidly become large and popular, and potentially a systemic risk," said James Walsh, deputy division chief of the Monetary and Capital Markets Department.

"Better coordination among supervisors is therefore essential to make sure that these risks are contained, and that everyone understands what the risks to these products are," he said.

The China Banking Regulatory Commission (CBRC) was well-positioned to manage emerging risks, the IMF said, while adding that there was room for improvement.

"CBRC should be able to take decisions independently, and its budgetary autonomy should be preserved," said Alvaro Piris, deputy division chief of the IMF's Monetary and Capital Markets Department.

"In terms of resources, the CBRC as with the other supervisory agencies under (PBOC) have been working with a headcount that hasn't changed in 10 years, a period in which the Chinese financial sector has more than doubled in size," Piris told reporters.

The report said Chinese banks, while meeting Basel requirements, should hold more liquid assets and gradually increase their capital to create buffers to absorb potential losses that can be expected during China's economic transition as credit is tightened and assumed guarantees for investors are removed.

The People's Bank of China (PBOC) reacted swiftly to the report's release, saying that while the report is objective and pertinent, the assessment "does not the whole picture."

China has relatively strong ability to fend off any financial risk, the central bank said in a statement on its website.

Sources have told Reuters that China is likely to keep this year's GDP growth target of "around 6.5 percent" in 2018 even as Beijing steps up a campaign, now in its second year, to control systemic financial risks.