The need for a neutral monetary policy

In the coming years, China's government will have to confront significant challenges to achieve stable, inclusive and sustainable economic growth. Policymakers must act quickly to design and implement prudent, forward-looking fiscal and financial policies.

The most significant medium- and long-term threat to China's fiscal position lies in the system of implicit guarantees that the central government has established for local government debt. In the wake of the global financial crisis, local governments borrowed heavily from banks to support China's massive stimulus program, accumulating 10.7 trillion yuan ($1.7 trillion) worth of debt by 2011.

China's leaders hope to control potential risks stemming from local-government investment vehicles (LGIVs) by limiting bank lending. The balance of bank loans to LGIVs increased only slightly in 2012, to 9.3 trillion yuan from 9.1 trillion yuan in 2011. The China Banking Regulatory Commission has called on banks to retain last year's LGIV loan quotas for 2013, and to ensure that the overall balance of loans to LGIVs does not exceed the 2011 year-end total.