IMF Warns China Against Aggressive Economic Stimulus

China must resist taking aggressive stimulus steps as it navigates troubled economic waters as they could add to excessive debt levels leading to an "abrupt adjustment", the International Monetary Fund said Friday.

The IMF warning, contained in a policy report, comes after Chinese leaders earlier this week signaled a shift toward looser fiscal policy to help barricade the world's second-largest economy against global economic turbulence, AFP reported.

After more than a year of aggressively cracking down on dangerously high debt levels, China's cabinet on Monday said it would be more "active" in stimulating the economy, citing "external uncertainties".

But the IMF said "a reversion to credit-driven stimulus would further increase vulnerabilities that could eventually lead to an abrupt adjustment".

It urged policymakers to "stay the course" in its longer-term drive to wean China's economy off a dependence on fast growth fuelled by exports and investment, and toward higher-quality, sustainable growth with domestic demand as a key driver.

Growth Remains Solid

The IMF also lauded Beijing's stewardship of the economy, saying growth remained solid, all the more reason to pursue economic reform now and "fix the roof while the sun is shining".

Premier Li Keqiang said on Monday that "fiscal policy should be more active", which analysts have called a clear signal that Beijing would ease up on its credit crackdown to keep economic growth steady.

The government said it also would accelerate plans to reduce taxes by more than 1.1 trillion yuan ($160 billion) and to issue 1.35 trillion yuan in local government special bonds for infrastructure projects.

The apparent policy shift had been widely anticipated due to the mounting need to support growth in the face of fears that the trade war with the US could wreak havoc on China.

The IMF, however, expressed confidence that China could balance the competing imperatives and reiterated a 2018 full-year economic growth forecast of 6.6%, down from the 6.9% recorded in 2017.

While the IMF praised China’s progress on reducing financial sector risks and in further opening its economy, it said credit growth was still unsustainably high as some aspects of the country’s rebalancing had slowed, Reuters said.

Beijing has over the last two years sought to rein in rapid credit growth, which economists and analysts say will result in slower growth in the near term but is needed to avoid a sharp slowdown and the risk of a financial crisis longer term.

The IMF said China needs to stick to its deleveraging agenda while implementing much-needed fiscal reforms and economic rebalancing.

“China is at an historic juncture. After decades of high-speed growth, the authorities are now focusing on high-quality growth,” the report said. “Whether and how this shift is carried through will determine China’s development path for decades to come.”

Yuan Fairly Valued

The Chinese yuan is still "fairly valued" despite recent declines against the dollar, the IMF said. "The moves haven't been that big by the standards of other emerging markets. It only takes the currency back to where it was at the beginning of the year and on the average of last year," said James Daniel, the IMF mission chief for China.

China's currency has been sliding since mid-June amid an escalating trade war between the US and China, after bumping around at higher levels from February through May. On Friday, USD/CNY was trading around 6.8.

The recent moves in the Chinese yuan are what is to be expected from a flexible exchange rate, Daniel told CNBC's "The Rundown."

"Domestically in China, there's a bit of a slowdown, somewhat of a monetary easing ... but the American economy is doing well and there is a tightening bias in America so you'd expect to see this divergent monetary condition reflected in a somewhat weaker exchange rate in China," Daniel explains.

The divergence in US and China monetary conditions contribute to the recent slide in the Chinese yuan. The IMF added that China's headline inflation is expected to rise gradually to around 2.5%, while producer price inflation would moderate.

The US is also closely watching the currency of its top trading partner. On Thursday, Treasury Secretary Steven Mnuchin told CNBC he's "closely monitoring" the weakening in the Chinese currency.