(Bloomberg) -- China needs to step up government spending to support an economy that’s slowing due to coronavirus lockdowns and a property sector downturn, according to the International Monetary Fund.

The policy suggestions came after the fund cut its 2022 growth forecast for China to 4.8%, with the report noting that risks to that forecast were “predominately on the downside.” 

The economic recovery “lacks balance and momentum has slowed, reflecting the rapid withdrawal of fiscal support, lagging consumption amid recurrent Covid-19 outbreaks despite a successful vaccination campaign, and slowing real-estate investment,” the fund said in its annual report on the country’s economy. 

“The combination of more frequent outbreaks and a zero-Covid tolerance approach has forced China’s economic activity into a stop-and-go pattern” and this could “further delay the recovery in private demand,” according to the report. 

The IMF has no reason to expect that coronavirus outbreaks will become any less frequent this year, Helge Berger, head of the IMF’s China mission, said at a media briefing before the report’s release. “This is one of the big reasons we have lowered our forecast for the year,” he said. 

Even though more that 80% of China’s population is vaccinated “it remains unclear whether it will allow for lockdowns to be phased out” due to China’s zero tolerance approach to outbreaks, the IMF said in its report. However, Berger stopped short of calling on China to change its approach, instead suggesting Beijing could “continue to fine-tune lockdown measures.”

The report added that Chinese authorities had “acknowledged that the zero-Covid tolerance strategy is impacting the recovery of private consumption but saw its benefits outweighing any economic costs.”

Fiscal Support

Government spending rose at the slowest pace in nearly two decades last year, suggesting limited fiscal support for an economy that’s lost momentum sharply in recent months, with the IMF noting that fiscal policy turned “strongly contractionary” at the start of 2021. 

The fund called on Beijing to step up fiscal support for the economy by increasing spending on social services, and suggested the government prioritize spending on “targeted direct income support” instead of infrastructure investment. More spending on social services would promote the rebalancing of the economy toward consumption and the services sector, which “regressed sharply in 2020 and normalization is projected to have remained slow in 2021,” the report said. 

The directors at the fund disagreed on whether China should further ease monetary policy, the IMF said, with some supporting further monetary stimulus while others said the People’s Bank of China should maintain the current accommodative stance. 

The PBOC and commercial banks have cut rates and taken other steps this year to support lending and the economy. The central bank also indicated it would take further action, saying earlier this month it would open its tool box to spur the economy.  

The IMF highlighted China’s property sector as the other main reason for cutting its growth forecast. Activity and investment in the sector has slowed sharply as a result of Beijing’s efforts to cut debt, with home prices and sales falling for months and a number of property developers defaulting on debts. 

“We see the tensions in the property sector continuing. You have to worry about that risk becoming more intensive in the sector and impacting the rest of the economy,” the IMF’s Berger said in an interview before the report was released. 

The fund chided China for a “lack of a clear, coordinated, and well-communicated policy response to financial stress faced by large property developers.” The attempt to reduce leverage in the housing sector has led to slowing investment, the fund said, calling on Beijing to provide financial support for property developers if stress in the housing market threatens economic and financial stability. 

“A sharper-than-expected slowdown in the property sector could trigger a wide range of adverse effects on aggregate demand, with negative feedback loops to the financial sector and could generate international spillovers,” the fund said.

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