The International Monetary Fund's No. 2 official urged China to tamp down expectations for growth and focus instead on addressing weaknesses in the financial and real-estate sectors.

China should aspire "to what you might call medium-high growth," IMF Deputy Director David Lipton said Thursday in Beijing, where he was conducting an annual review of China's economy.

"China should not always try to have the fastest possible growth but should have the fastest sustainable growth," he said, in what would be a big change from China's long-running philosophy of developing the economy as rapidly as possible.

Specifically, Mr. Lipton urged China to reduce its target for growth to around 7%, "with a somewhat lower" floor, compared to this year's target of around 7.5%. Aiming for a more moderate pace of growth, he said, would help China take measures that sap growth but make China less vulnerable in the long run, such as reducing the pace of credit growth.

Early every year, China sets a growth target. For decades, the target was routinely exceeded by the country's double-digit annual growth rate. The last time China missed the target was 1998 during the Asian financial crisis.

But in recent years, as the economy has slowed, the margin between the targeted growth and actual growth has narrowed sharply. In 2012, China reduced its GDP target from 8% to 7.5% and barely made the lower number, registering a 7.7% GDP gain.

The targets are taken seriously, Chinese economists and officials say. They are meant as a signal to the provinces of Beijing's priorities. Reducing the target is widely seen as confirmation that China would accept lower growth in exchange for shutting down highly polluting factories and taking other difficult economic measures.

The central government also uses the target to set policies. In mid-2012, when quarterly GDP growth fell below the target, the government responded with a surge of credit to boost growth, even though it deepened the country's debt problems. In the first quarter of this year, GDP grew at 7.4%, again below the target, leading to a debate about whether the economy needed additional stimulus.

So far, the government has taken only small steps, including accelerating already planned spending on railways and information technology, targeting small businesses and farms for loans and tightening regulation on so-called shadow banking institutions such as trust companies and leasing firms.

Mr. Lipton made it clear that the IMF doesn't think broad stimulus was necessary.

"We would suggest that it's best not to return to low interest rates, [more] credit and investment," he said in an interview. "We prefer a more targeted approach to stimulus."

He said stronger stimulus measures could undermine China's efforts to bring credit growth under control. Indeed, he urged China to reduce its total local-government deficit by one percentage point a year in terms of share of GDP. With smaller deficits, local governments would need to borrow less to operate. But such a move would likely reduce economic growth because governments would have less money to pay for infrastructure and other projects.

He said China should "find ways to use fiscal levers that support household incomes and [domestic] spending." Those include having state-owned firms pay more in dividends and using that money to pay for social services. Similarly, tax reform that puts more money into the pockets of ordinary Chinese would be a plus, he said.

According to a Communist Party reform plan adopted last fall, China's state-owned enterprises are required to increase their dividend payments to 30% by 2020 from the current 5% to 15%,

"Why wait till 2020?" Mr. Lipton said.

On currency matters, Mr. Lipton said the IMF continued to view the yuan as "moderately undervalued," a level the fund generally considers to be about 5% to 10% undervalued.

While he said that the currency has depreciated recently, he added that if China is able to shift its economy so it depends more on domestic consumption, it would tend to lead to an appreciation of the currency over the medium term. In IMF lingo, "medium term" is generally three to five years.

The Wall Street Journal