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BEIJING, Aug 12 (Reuters) - The International Monetary Fund on Friday said China's policymakers should shift away from economic growth targets for it to improve the quality of its stimulus.
The fund also projected the world's second-largest economy would grow 6.6 percent in 2016, which compares with China's own targets of 6.5 to 7 percent growth.
"The practice of setting annual growth targets (rather than projections) has fostered an undesirable focus on short-term, low-quality stimulus measures," the IMF said in its annual review on China.
If China continues to set annual targets, they should be set flexibly using wider ranges and at sustainable rates, the report said. As an example, it suggested China could set a target of around 6 percent for 2017, adding GDP targets should receive less policymaking attention compared with other more specific indicators such as household income growth.
The IMF predicted GDP growth would gradually slow in the coming years to around 5.8 percent in 2021.
Interest rates have been cut beyond what is necessary and if inflation picks up, as projected, rates should rise towards less accommodative levels, the report noted.
The report also included views from Chinese government officials the IMF met during the review process: In contrast to the IMF, Chinese authorities see "the level of interest rates as appropriate from a cyclical perspective".
Authorities also disagreed with the IMF's view that policy support was adding to vulnerabilities, with higher infrastructure investment in less developed parts of China actually helping lift long-term growth prospects.
The IMF said almost four million premature deaths by 2030 could be prevented if China substantially raised taxes on fossil fuels and pollution. In regards to China's finances, the IMF said it was difficult to monitor China's fiscal stance as "much spending and most of the deficit and financing occurs off budget with little transparency."
The fund expects inflation to remain around 2-2.5 percent this year and next and rise to around 3 percent over the medium-term, as commodity prices pick up and wage pressures rise.
Capital outflows in 2015 and early 2016 were in excess of the current account surplus leading to a substantial fall in FX reserves, with the IMF attributing this to investor concerns about slowing growth and concerns about yuan depreciation. The volume of capital outflows as a percentage of GDP is expected to be similar this year.
A more flexible, market-determined exchange rate is required so the market can play a more decisive role in the economy, the report said, and achieving an effective float by 2018 remains a key goal.
In general, China had made impressive but uneven progress on reforms with a growing chance of a sharp slowdown if meaningful reforms remain absent, James Daniel, IMF Mission Chief for China, said.
China had made slower progress in strengthening corporate governance, preventing weak state-owned firms from further borrowing, tackling excessive corporate debt and opening up state-dominated service sectors, Daniel said. (Reporting by Sue-Lin Wong; Editing by Sam Holmes)