Reining in the runaway budget deficit

PUBLISHED : Monday, 29 March, 2004, 12:00am
UPDATED : Monday, 29 March, 2004, 12:00am

If anyone doubts that Premier Wen Jiabao is going to run China's economy very differently from his predecessor, Zhu Rongji, just look at the budget.

One of Mr Zhu's less helpful legacies was a huge government budget deficit, financed by a rapid run-up in government debt. Another was a fiscal system that forces local governments to pick up two-thirds of all public expenditure, while giving them less than half of all public revenue. This system has bankrupted local governments and forced them into frantic property speculation, and the imposition of illegal taxes and fees on farmers, to make ends meet.

Mr Wen has already announced a firm resolve to cut the deficit, and in this he will almost certainly succeed. Bailing out bankrupt local governments, however, will be a tougher task.

In the five years before Mr Zhu became premier, (1993-97), China's budget deficit averaged 1.8 per cent of gross domestic product. During the five years of his premiership, it averaged nearly double that, 3.4 per cent of GDP, and government debt soared from 7 per cent to 24 per cent of GDP.

This was not mere profligacy. Mr Zhu had a lot of difficult problems to deal with - a costly restructuring of state enterprises, a sick financial system and an economy left reeling after the 1997-98 Asian financial crisis. Lots of money had to be spent to solve them.

Moreover, the system Mr Zhu inherited disguised much public revenue and expenditure by funnelling it through state enterprises and 'off-budget' accounts. Much of the increase in the budget deficit during his tenure was simply a matter of bringing these hidden costs into the light. By forcing the government to recognise these costs and financing them with explicit debt, on which interest must be paid, Mr Zhu made Beijing's fiscal system much more accountable.

But he also made it much more vulnerable. The debt explosion was harmless because inflation stayed around zero and the government enjoyed very low interest rates, often less then 3 per cent. An increase in inflation and interest rates, however, could quickly impose crippling debt-service costs on the government. Inflation is rising, so the risk is real.

In his work report this month, Mr Wen made clear that reining in the budget deficit is a top priority. After years of expansion, this year's deficit will be 320 billion yuan, the same as last year. He also indicated that the deficit would stay at about this level in future years.

Maintaining a large budget deficit at a constant level may not sound like progress, but in a country with a rapidly growing economy and revenue base, it is.

Conservatively assuming annual GDP growth of 7 per cent, inflation of 3 per cent, and annual revenue growth of 10 per cent, a constant-deficit policy would have a big impact.

By 2008, the deficit would be just 1.7 per cent of GDP, compared to 2.7 per cent last year. As a proportion of government revenue, the deficit would fall from 15 per cent last year to 9 per cent in 2008. The debt load would first stabilise, then begin to fall in 2006. The government would be able to spend less on interest payments and more on badly needed social services, support for which Mr Wen has vowed to boost.

The premier made another move to improve the quality of expenditure and decrease the amount of unnecessary debt. He pledged to reduce the amount of 'special infrastructure bonds' issued by the government to 110 billion yuan this year, from 140 billion in each of the previous six years. Those bonds, introduced in 1998 to stimulate a weak economy, have in recent years been turned into useless roads, bridges and property development.

All this bodes well for the central government budget. But a time bomb is ticking in the accounts of local governments, on which, more next week.

Research by the China Economic Quarterly