China’s fiscal ambition to increase debt risks

China is pinning its hopes on fiscal stimulus to bolster growth, which analysts say could increase the government’s debt risk

PUBLISHED : Sunday, 21 August, 2016, 10:01pm
UPDATED : Sunday, 21 August, 2016, 10:01pm

As monetary easing is becoming less and less effective to drive China’s sluggish economy, the country is pins its hopes on sweeping fiscal stimulus to bolster growth, which analysts say could increase the government’s debt risk.

As the economy slows, aggressive monetary easing has so far failed to translate into faster growth, merely inflating asset prices, said Jacqueline Rong, the China economist at BNP Paribas, in a research note.

That tallies with what Sheng Songcheng, an official from the People’s Bank of China, said earlier this year. He warned that China risked falling into a “liquidity trap”, where companies prefer to hoard cash rather than invest it despite the large amount of liquidity in the market.

As the effectiveness of monetary easing is diminishing, China has no choice but to set its sights on fiscal stimulus to drive the economy.

If China continues to pursue such expansionary fiscal policy to bolster economic growth, it will take just a few years for government debt to become a bigger problem
Jacqueline Rong, BNP Paribas

According to the ministry of finance, central and local government debt amounted to just 50 per cent of gross domestic product as of the end of last year, far less than the average level seen in most developed countries.

Therefore “there is still scope for fiscal stimulus”, Rong said.

China said its official budget deficit is set to increase by 560 billion yuan from 2015 to an estimated 2.18 trillion yuan in 2016, or from 2.4 per cent of GDP to 3 per cent of GDP. The increase is equivalent to about 500 billion yuan of cuts in taxes and surcharges, according to the BNP Paribas report.

However, China aims to go far beyond the official budget. The government has permitted the issuance of a further 400 billion yuan of special local-government bonds at the provincial-government level. Meanwhile, China also relaxed the restriction on local-government financing vehicles late last year, which were barred from raising money for local governments in October 2014.

In total, China’s on- and off-budget deficits amount to about 5.98 trillion yuan, which is about 8 per cent of its GDP, well above the 3 per cent official deficit ratio target, Rong said.

The overall government debt levels are manageable so far, but “the rapid accumulation of off-budget local-government debt – usually off the radar of central government and the market – is a growing concern”, she said.

Despite myriad measures to curb local-government debt, their borrowings actually increased over the past two years and no solid progress had been made on shutting down China’s the funding vehicles, said Lv Zhushan, deputy director of the financial and economic committee of the National People’s Congress, the country’s chief legislator.

“If China continues to pursue such expansionary fiscal policy to bolster economic growth, it will take just a few years for government debt to become a bigger problem,” Rong said.

The situation in China is similar to events in Japan two decades ago.

“Japan’s experience should be a good lesson for China in this regard,” said Rong. In the 1990s, Japan undertook massive fiscal stimulus in the form of infrastructure and public works, which failed to put the economy back on its feet and merely added to government debt.