Beijing's fiscal firepower not as fearsome as many think
with Tom Holland
Later this month, the mainland government is expected to announce a major spending package to help support Chinese growth through the coming global slowdown. Unfortunately, Beijing's fiscal firepower is not as fearsome as many believe.
With the outlook for the export- and investment-dependent mainland economy darkening rapidly as global growth slows, Beijing is casting around for policy measures to keep growth ticking over at the 8 per cent annual rate it needs to prevent a sharp rise in unemployment.
Other countries would either cut interest rates to ease business conditions or reduce personal taxes to encourage consumer demand. In China, neither looks workable.
Cutting interest rates would merely direct lending to the kind of over-invested highly polluting capital-intensive industries that Beijing is attempting to rein in.
At the same time, giving money back to ordinary people is unlikely to encourage a significant spending surge. With little state provision for health or education, Chinese consumers remain deeply cautious. Overcoming that wariness will take years of structural reform. It cannot be achieved with a simple handout.
As a result, the only way to achieve a counter-cyclical growth spurt is by ramping up government spending, in much the same way that former premier Zhu Rongji did in 1998 to overcome the effects of the Asian crisis.
Arguing that China's fiscal position is relatively healthy - Beijing ran a budget surplus last year after 20 years of deficits - many observers expect a hefty package of new spending measures worth hundreds of billions of yuan. They could be disappointed.
As the first of the two charts below shows, both government revenues and spending have increased sharply in recent years. Beijing did indeed run a surplus in 2007, but only because revenue growth fractionally outstripped the rise in expenditure at the very peak of the cycle.
Unfortunately for finance ministry officials, history tells us that when the economic cycle turns down, revenues tend to fall rapidly, while spending proves a lot more 'sticky'. As a result, fiscal positions quickly deteriorate and budget surpluses soon turn into deficits.
There are ominous signs that this is happening in China. As the second chart shows, government revenue in August was just 10 per cent higher than in the same month in 2007. That compares with a rise of 32 per cent for 2007 as a whole.
And there are signals China's fiscal position will get a great deal worse before it gets better. Tax reform earlier this year has already damped corporate tax revenue from domestic companies. Now with profit growth slowing abruptly - the country's biggest listed aluminium producer warned yesterday that third-quarter profits would be down 50 per cent from last year - revenue from corporate taxes is set to fall steeply.
That's not all. The property market is cooling. Home sales in Beijing and Shanghai were down around 80 per cent in September compared with the previous year. As a result, government revenues from property taxes and land sales are also likely to head south.
The other side of the fiscal equation is looking scary, too. As the economy slows, the proportion of non-performing loans in the state-controlled banking sector is certain to rise, bumping up the government's contingent liabilities.
That's important, because although the official ratio of bad loans at the end of June was just 5.6 per cent of banks' total loan books, the absolute amount was more than 17 times the government's budget surplus for the whole of last year. Clearly it wouldn't take much of an increase to knock a big hole in banks' capital and, ultimately, in the government's own finances.
With these considerations weighing on officials' deliberations, don't expect a big boost from their stimulus measures. Oh sure, they will still come up with an impressive headline number, but given the budget constraints, it is highly unlikely any package will contain much in the way of real new spending.