IMF tells China of urgent need for economic change China's growth has slowed significantly in recent months. But even its current pace of expansion may be unsustainable unless the country starts making significant and systemic changes to its economy, and soon, the International Monetary Fund warned Wednesday. "Since the global crisis, a mix of investment, credit and fiscal stimulus has underpinned activity," the IMF said in a major annual assessment of the Chinese economy. This pattern of growth is not sustainable and is raising vulnerabilities. While China still has significant buffers to weather shocks, the margins of safety are diminishing. The report emphasized downside risks to the Chinese economy, touching on familiar themes, although imparting more of a sense of urgency than it has in the past. The country still has large foreign currency reserves and plenty of room for new government spending to buffer against any unexpected shocks, Markus Rodlauer, the IMF's China mission chief, said in an interview. But he added that the Chinese economy is looking more and more vulnerable, with changes only getting harder to make as time goes on. The IMF - along with a range of international economic officials, research groups, academics and financial market participants - has raised concern that money is pouring into mispriced real estate and infrastructure investments in China that are increasing growth in the short term but might do little for the Chinese economy down the road. For decades, a cheap currency, cheap labour and huge infrastructure investment fuelled enormous growth in the Asian nation. China has made "substantial" progress on rebalancing its trade deficits with the rest of the world, the IMF said, and its current account balance as a share of its total economy is less than a quarter of its pre-crisis peak. The fund described the Chinese currency as "moderately" undervalued, as it has for about a year after a long stretch of describing it as "significantly" undervalued - a policy maneouvre that helped boost China's exports but angered many foreign countries whose goods became relatively less competitive. But imbalances in China's domestic economy "remain large," the IMF warned, with Chinese consumers failing to take over for consumers from the United States, Germany and other countries who helped stoke China's growth for years. Consumption rates have barely budged from last year. But net purchases of physical assets like roads, hospitals and commercial buildings grew further as a share of the economy. "A decisive shift toward a more consumption-based growth path has yet to occur," the IMF said. Accelerating the transformation of the growth model remains the main priority. The IMF focused on a few spots of acute risk in the Chinese economy. One is the financial system. The country has seen a huge boom in lending through "less regulated" parts of its financial system, it said. The report raised concerns about the adequacy of the country's regulatory controls, and about the quality of underwriting and the pricing of risk. The formal banking sector might not be as strong as it looks, either, the IMF warned. "Based on reported data, bank balance sheets appear healthy and loan books show only a modest deterioration in asset quality," it wrote. However, banks remain vulnerable to a sharper worsening of corporate sector financial performance. Another issue is a proliferation of debt-financed spending by local governments without adequate tax bases, often through "local government financing vehicles" that have long been fingered as a weak spot in China's markets. "Further rapid growth of debts would raise the risk of a disorderly adjustment in local government spending," the IMF warned. Finally, it also cautioned about the possibility of sharp price drops in the real estate markets, which remain "prone to bubbles," the IMF said, in no small part because many Chinese savers do not earn interest on their deposits and thus push money into the housing markets. Making adjustments to the financial markets and correcting the pace of infrastructure spending might mean slower growth in the near term, the IMF has said. But it might mean more sustainable growth in the long term, with substantial benefits not just for China but for global growth as well. But that message is coming as the Chinese economy is already slowing down considerably, with growth falling to an annual pace of about 7.5 per cent, down from a peak of more than 14 per cent in 2007, before the global financial crisis. More broadly, the emerging-market economies that helped pull the world out of the global recession have cooled of late, dragging down the global growth rate with them. Growth remains sluggish in the United States, and much of Europe is mired in a recession. "Growth in emerging-market economies will remain high, much higher than in the advanced economies, but may be substantially lower than it was before the crisis," Olivier Blanchard, the IMF's chief economist, said at a news briefing this month. China is aware of the issues that the IMF and other analysts have raised, and it generally agrees with them. Chinese policy makers have in part engineered the recent economic slowdown and have shown a willingness to make changes. But there are few details now about how the new Chinese government might move to revamp the nation's economy, with more elaboration expected after a major Communist Party meeting this fall. The fact that China's population is aging - and its labour force gradually shrinking - adds to the pressure for structural overhauls. Authorities are now aiming to raise domestic consumption and productivity, reduce China's reliance on exports and construction investment, and rein in financial risks flagged in the IMF's report. In recent weeks, Beijing has made it increasingly clear that it is prepared to tolerate a slower pace of growth as it pursues those goals and that there will be no repeat of an aggressive stimulus that followed the global financial crisis. Premier Li Keqiang reiterated that message in comments reported by the official Xinhua news agency Wednesday. Although he acknowledged that the economy faced risks and challenges, he said, it remained "generally stable," according to Xinhua. And while authorities must work to "keep economic growth within a reasonable range," they would aim to deploy "targeted" policies and "not change the direction of policies based only on temporary changes in economic barometers," Xinhua quoted Mr. Li as saying. "Beijing is trying to boost public confidence and emphasize the seriousness of its intention by reiterating the need to stabilize growth," Qu Hongbin, chief China economist at HSBC in Hong Kong, wrote in a note Wednesday, referring to Mr. Li's comments. We expect further modest fiscal stimulus to put a floor on growth.