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BEIJING/WASHINGTON (Reuters) - China needs another round of "decisive measures" to make sure it continues its successful economic growth as its margins of safety are falling amid growing domestic problems, the International Monetary Fund said in its latest report.
The world's second-largest economy has been underpinned by a mix of investment, credit and fiscal stimulus, but such a pattern of growth is unsustainable, the fund said on Wednesday in a report on its annual review of China's economy.
"To secure more balanced and sustainable growth, a package of reforms is needed to contain the growing risks while transitioning the economy to a more consumer-based, inclusive, and environmentally friendly growth path," the report said.
"While China still has significant buffers to weather shocks, the margins of safety are diminishing."
The IMF did not change its latest forecast for 2013 Chinese growth at 7.75 percent, though it noted downside risks to the forecast. Its figure is above the Chinese government's target of 7.5 percent and also above most private economists' forecasts of between 7 and 7.5 percent.
China's new leaders have repeatedly indicated that they are prepared to tolerate slower growth to push through reforms and deregulation to wean the economy off a reliance on exports and investment and encourage more consumption.
That resolve has been tested, however, as growth slowed to 7.5 percent in the April to June quarter, the ninth quarter in the last 10 that expansion has weakened, and exports fell in June for the first time in 17 months.
Analysts have suggested that the government may step in if growth falls to 7 percent or below in any quarter, though it is unclear where the government's bottom line would lie.
The IMF said it was less worried about specific growth figures, as there were few signs of a sharp slowdown or "hard landing."
"We think another (government) stimulus would be warranted only if growth were to slow considerably more," Markus Rodlauer, the IMF's mission chief for China, told reporters.
The IMF also welcomed the government's move to shift more jobs into the services sector, which must take up a growing pool of labor. Services jobs generally have higher wages, helping China's transition to a consumption-led economy. China must continue the process of de-regulating the sector, the fund said.
Steven Barnett, the IMF's division chief for China, said the share of employment in the services sector remains below other countries' at comparable income levels - although it has been increasing.
But Barnett agreed with China's government that labor conditions remain stable, with a steady unemployment rate and wage growth, according to official statistics.
China's leaders have been at pains to say employment remains stable, even as the economy slows, citing a growing services sector and a demographic shift that reduces surplus rural workers. They are worried that if the slowdown leads to high unemployment, there could be social unrest.
The IMF said that for the near term, a priority for China is to rein in broader credit growth and prevent a further build-up of risks in the financial sector.
It noted the rise of China's shadow banking system, where credit is available outside regular channels to companies that cannot borrow from banks, but which risks creating hidden bad debts that become a threat to financial stability.
Banks could be vulnerable in the future if asset qualities should worsen. The IMF's Rodlauer said the fund was not yet concerned about the problem's systemic risks.
"We're not there yet in terms of size, or ... any sort of crisis proportions," he said, adding that it was important to address the issue in the long-run and remove incentives to go around formal banking rules.
The significant expansion of local government debt levels in recent years is another cause for concern. The IMF for the first time estimated that local government debt was 45 percent of GDP last year, including funds not counted in the official budget, but without taking into account the debt of state-owned firms.
The fund said China's agenda should include accelerated financial sector reforms, a revamp of local government finances, a more market-based currency exchange rate with less intervention, opening more markets to competition and liberalizing the capital account.
"With a successful transition, China will grow at a healthy pace for years to come," the report said. "Activity may be somewhat slower, a trade off worth making for the benefit of much higher income in the medium to long run -- a growth trajectory that will also be good for the global economy."
Reporting by Jonathan Standing in Beijing, additional reporting by Anna Yukhananov in Washington; Editing by Simon Cameron-Moore and Dan Grebler