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IMF remains sanguine on China despite doomsday fears

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Doomsday scenarios of a hard-landing in China may have transfixed market watchers, but the International Monetary Fund (IMF) remains relatively sanguine on the economic outlook.

A nearly 40 percent selloff in mainland stock markets over the past few months exacerbated concerns over the mainland economy, especially after China's regulators took a series of dramatic measures to boost the stock market, including large-scale share purchases, that had the unintended effect of denting confidence in the government and spurring criticism that the incident was badly mishandled. A devaluation of the yuan against the U.S. dollar also fanned speculation that China was trying to goose its exports sector again as the economy slows.

The IMF takes a different view.

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"The Chinese economy is undergoing a major transition from export-led growth to a model increasingly driven by consumption and services," the IMF said in a blog post Monday. "So far, developments in the real economy provide some comfort that the transition can be managed."

"China has adequate policy space should further policy stimulus become necessary to prevent growth from falling excessively," the IMF said, although it urged that any measures target demand and rebalancing, such as supporting consumption for the "more vulnerable" members of mainland society.

While the transition is "essential," it's also caused a slowdown in imports and increased financial market volatility, the fund noted.

But the IMF added that the slowdown is in line with the fund's forecast for economic growth to fall to 6.8 percent this year, compared with the government's target of 7 percent, and down from 7.4 percent last year.

For the second quarter, China reported gross domestic product (GDP) growth of 7 percent on year, renewing concerns that the mainland's economic data may be unreliable. However, there are signs of the transition in China's purchasing managers' index (PMI) data. The official manufacturing PMI for September remained in contraction territory, while the official services PMI continued to show growth.

"The slower growth in property investment and the deceleration of growth in other related sectors already reflects the faster-than-expected rebalancing of China's economy," Nomura said in a note Monday. "Economic growth is now being driven more by consumption and the service sector, rather than investment and related manufacturing sectors. However, an inevitable result during such a rebalancing process is that the speed of growth will be much lower than before."

Read More A tale of two China PMIs: Manufacturing still in contraction mode

Nomura expects the government will lower its 2016 GDP growth target to 6.5 percent from 2015's around 7 percent.

To be sure, even the IMF noted that "downside risks have increased," particularly increasing levels of debt.

"Since the Global Financial Crisis, growth in China has relied heavily on investment and credit, with the biggest buildup of leverage going to state-owned enterprises, the real estate and construction sectors, and weaker corporates," it said. "This created growing vulnerabilities which—while still manageable—cannot continue to accumulate."

For example, the IMF noted the recent China stock market rout, with shares surging on credit growth before crashing over the past couple months.

"The bottom line is: vigilance must remain the watchword," the IMF said. "For China, that means focusing on the downside risks, and for the rest of the world, guarding against potential spillovers."