LIMA: China confronts a monumental and risk-fraught task as it moves toward a more market- and consumption-based economic model, the International Monetary Fund said on Wednesday.

As the most important emerging-market economy, China’s rebalancing and deleveraging will “require great care,” the Fund said in its new review of global financial risks.

“The Chinese authorities face an unprecedented policy challenge in carrying out their objectives to make the transition to a new growth model and a more market-based financial system,” the IMF said.

“Achieving this outcome will require careful pacing of reforms and policy consistency.” The focus on China came in the IMF’s new Global Financial Stability Report which stresses the increased dangers across the emerging markets from slow growth and global market turbulence, to very high levels of corporate borrowing.

The report was released on the eve of the IMF-World Bank annual meetings, being held in Lima, at which global policy makers review the state of the global economy and hash over important issues.

If not handled well from a policy viewpoint, the IMF warned, the cost to the world economy of the emerging market downturn could be a huge three percent of global output, said IMF Financial Counsellor Jose Vinals.

“The recommendation is for an urgent upgrade in policies, so as to avoid downside risks,” he said.

In the worst scenario, corporate default rates could rise, particularly in China, “raising financial system strains, with implications for growth,” the report said.

A particular risk is that emerging markets’ state-owned enterprises like those in the energy sector, which have raised huge amounts of funding by issuing bonds, could find themselves falling back on governments to service their debt.

That could raise the risk of governments seeing their credit grades lowered to non-investment grade or junk status, as happened to Brazil one month ago, the IMF warned.

The slowdown in China, the world’s number-two economy, is both a cause and a part of the malaise hitting emerging markets.

The IMF said China will have challenges dealing with the legacies of its old centrally-planned system as it moves to a more market-driven economic structure.

For one, the IMF said, Chinese banks have only just begun to deal with growing problems on their loan books due to the difficulties many Chinese companies are having. On Tuesday the IMF cut its global growth forecast for this year to 3.1 per cent and to 3.6pc in 2016, both numbers 0.2 percentage point lower than forecasts just three months ago.

Published in Dawn, October 8th , 2015

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