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China Risks Making ‘Big Mistakes' With Widespread Crackdown, Says Ex-IMF Chief Economist

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  • China risks making "big mistakes" as it cracks down on large swathes of its economy, said Raghuram Rajan, who was IMF's chief economist from 2003 to 2006.
  • The biggest area China is seeking to reform is the housing market, said Rajan, now a finance professor at The University of Chicago Booth School of Business.
  • Real estate sector reforms are "perfect in the larger scheme of things" but "extremely precarious" in the short term, he said.
  • Rising inflation is one major challenge for the global economy, Rajan warned.

China risks making "big mistakes" as it cracks down on large swathes of its economy from technology, to private tutoring and real estate, said a former chief economist of the International Monetary Fund.

"I worry a lot about China because to some extent they're attacking the basis of their growth so far," Raghuram Rajan told CNBC's "Squawk Box Asia" on Friday.  

"At some point they have to abandon that method of growth and go to a new one. The question is: Are they trying to do it too quickly, and in the process, leaving less to support growth," he said.

China has relied on cheap labor and cheap finance to grow its economy, said Rajan, who was IMF's chief economist from 2003 to 2006. Moving away from that growth model creates "an enormous amount" of uncertainties, even though it's necessary, he added.

The biggest area China is seeking to reform is the housing market, said Rajan, now a finance professor at The University of Chicago Booth School of Business.

Chinese authorities have in recent months implemented measures to tame soaring property prices, including through tightening funding for highly indebted developers.  

Such a move is "perfect in the larger scheme of things" — but "extremely precarious" in the short term, said Rajan. Chinese real estate developer Evergrande is already struggling to repay its massive debt, and more developers could face similar troubles, he explained.

If property prices fall as a result of government measures, homeowners will feel poorer and local governments may lose revenue from lower land sales, he said, and pointed out that local governments are an important source of funding for local firms.

"So essentially, you're tackling a lot of things at the same time. When you do that, there's a risk of big mistakes," said the professor.

Economic challenges facing China have led major banks to downgrade their 2021 growth forecasts for the world's second-largest economy.

'Higher for longer' inflation

Rising inflation is one major challenge for the global economy, Rajan warned.

Inflationary pressures are looking to be less transitory than what central bankers had thought, said Rajan, who served as the governor of the Reserve Bank of India from September 2013 to September 2016.

Major central banks such as the Federal Reserve and the European Central Bank have suggested that spikes in inflation are temporary and would eventually subside.

But Rajan said there are signs that higher prices could last longer than expected.

Supply constraints — a source of accelerating inflation — have spread across sectors and countries, he explained. And rising energy prices have caused power constraints, which impose "yet more damage" on global supply chains that are already struggling with major bottlenecks, he added.

In the U.S., higher housing prices have caused rents to increase and would take time to translate into higher consumer prices, said the professor.

"So when you put all these together, it suggests that inflation would be higher for longer," said Rajan.

The IMF said in a Tuesday report that central banks should be prepared to tighten policy in case inflation gets out of control. The fund said it largely concurs with assessments that current price increases will eventually ease, but noted there is "high uncertainty" around those forecasts.

Some Asian central banks have tightened monetary policy in recent months.

The Bank of Korea raised interest rates in August, while the Monetary Authority of Singapore on Thursday tightened policy by slightly raising the slope of its exchange rate band.

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