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.
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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 in a report on its annual Article 4 meeting with Chinese officials.
"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 didn't change its latest forecast for 2013 growth in China of 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.
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That resolve has been tested, however, as growth slowed in the April to June quarter to 7.5 percent, 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 that for the near term, a priority 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 banks won't lend to, but which risks creating piles of hidden bad debts that become a threat to financial stability.
Banks could be vulnerable in future if asset qualities should worsen. The significant expansion of local government debt levels in recent years is another cause for concern.
The IMF 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."