BEIJING, Dec 7 (Reuters) - China should prioritise financial stability above development goals, as pursuit of regional growth targets and helping firms avoid heavy job losses had led to a surge in debt, particularly at local government level, the International Monetary Fund said.
Noting a lack of coordination and inadequate systemic risk analysis, in a report released on Wednesday, the IMF also recommended the formation of a financial stability sub-committee comprising the central bank and three financial regulatory agencies.
Expansionary monetary and fiscal policies aimed at propping up employment and growth had led to a surge in debt among weak corporates and local government entities looking to prevent businesses from failing and their economies from floundering, the IMF said.
"The apparent primary goals of preventing large falls in local jobs and reaching regional growth targets have conflicted with other policy objectives such as financial stability," the IMF said.
"Regulators should reinforce the primacy of financial stability over development objectives," the fund said.
China's credit-to-gross domestic product (GDP) ratio is now very high by global standards and consistent with a high probability of financial distress, the IMF said, citing an estimate from the Bank for International Settlements.
While China has been taking steps to address its debt risks, reining in excessive credit growth will require a de-emphasis on high GDP projections in national plans that have spurred local governments to set high growth targets, the fund said.
But the near-term prioritisation of social stability seems to depend on credit growth to sustain financing to firms even when they are non-viable, it said.
Sources have told Reuters that China is likely to keep this year's GDP growth target of "around 6.5 percent" in 2018 even as Beijing steps up a campaign, now in its second year, to control systemic financial risks.
The IMF said the sub-committee it has recommended should report to Beijing's new Financial Stability and Development Committee.
Chinese banks, while meeting Basel requirements, should gradually increase their capital to create buffers to absorb potential losses that can be expected during China's economic transition as credit is tightened and implicit guarantees are removed, the IMF said.
There are widespread perceptions of implicit guarantees, the fund said, with banks often compensating retail investors for losses and lenders assuming that loss-making state-owned enterprises or financial intermediaries will be bailed out.
Banks also need to hold more liquid assets, the fund said.
The IMF's assessment was based on findings by a mission that visited China several times this year, as well as earlier visits in 2015 and 2016. The mission met with senior Chinese leaders and officials from regulatory and government bodies including the central bank.
The IMF report is part of the fund's Financial Sector Assessment Program, established in 1999, that assesses the resilience of a country's financial sector to shocks and contagion. The first such assessment for China was published in 2011. (Reporting by Ryan Woo; Editing by Simon Cameron-moore)