"Part of the problem lies in high growth targets, which incentivize local governments to extend credit and protect failing companies", the International Monetary Fund said, adding that the government had been prioritizing "social stability" in the near-term, appearing "to rely on credit expansion to continue financing firms even when they are not viable".
Meanwhile, the worldwide financial institution warned that China's rapid credit growth, complex financial products and government's implicit guarantee posed threats to financial stability.
The IMF said the growth in credit held by companies and households had outpaced that of the wider economy and the ratio of credit to GDP was now "very high by worldwide standards and consistent with a high probability of financial distress". The credit-to-GDP ratio is now about 25% above the long-term trend, very high by global standards and consistent with a high probability of financial distress. Corporate debt was now at 165 percent of GDP, the report said, while household debt had also risen quickly over the past few years. "The buildup of credit in traditional sectors has gone hand-in-hand with a slowdown of productivity growth and pressures on asset quality". China's economic growth as a proportion of world economic growth was between 25% and 30% of global economic growth in 2016. Xi is trying to move China to a different model where growth is slower but more sustainable.
The lender noted that despite low loan-to-value ratios, the rapid growth in household debt presents concerns.
The IMF also noted developments in the Chinese financial system similar to those in the United States in the years before the financial crisis of a decade ago.
There had also been growth in increasingly complex investment vehicles while risky lending had been moving away from banks to less well-supervised parts of the financial sector. The IMF recommended China form a financial stability sub-committee comprising the central bank and regulatory agencies and provide more staff for the banking regulator. It added Beijing should adjust its economic strategy further and create a body to focus exclusively on financial stability.