Residents in Shanghai share a bike as they ride on an empty road on June 1. China’s leading financial and business hub is coming out of a two-month Covid-19 lockdown that has set back the national economy and largely confined millions of people to their homes. Photo: AP
by David Brown
by David Brown

Fiscal spending a better tool than monetary easing to boost China’s economic growth

  • Another interest rate cut could further weaken the renminbi while global inflation risks are rising and higher import costs threaten domestic price stability
  • By contrast, rolling out more fiscal stimulus is a viable option as there is precedent of a higher budget deficit, and investor demand for Chinese debt remains firm
What happens next for China’s monetary policy as the outlook for global growth continues to soften? Has Beijing reached the end of the road on monetary easing or is another interest rate cut on the cards?
While China’s economy needs as much support as possible to keep the government’s 2022 growth target of 5.5 per cent within reach, another interest rate cut may be risking too much for China’s currency when global monetary conditions are already tightening.

Beijing can’t afford to jeopardise the renminbi while global inflation risks are high and higher import costs could threaten domestic price stability in a bigger way.

The simple solution might be to keep domestic monetary conditions steady and let fiscal expansion take the full strain of reflation efforts. That means temporarily shelving plans for fiscal stabilisation and issuing more government debt to plug a bigger budget gap, but domestic growth prospects should improve.

Beijing could normally open up the policy throttles on four fronts: cutting interest rates again, flooding the markets with extra liquidity, letting the yuan weaken, and pumping in more fiscal stimulus to sustain faster growth.

It worked to Beijing’s advantage in the first Covid-19 wave two years ago, when the government stepped in with special policy measures to raise the annual growth rate from a lowly 2.2 per cent in 2020 to a vigorous 8.1 per cent in 2021.
But with global inflation risks building up and the renminbi exchange rate already losing over 5 per cent against the US dollar in the past four months, the chances for using easier monetary policy to boost growth are starting to fade.
Fortunately, China has been spared the inflation fate of other countries, such as the US, where consumer prices are currently running at 8.3 per cent higher than a year ago, or Germany, where headline inflation hit 7.9 per cent last month. In China, the annual CPI inflation rate only moved up to 2.1 per cent in May from 0.9 per cent in February, but Beijing needs to proceed with care as there are still potential inflation risks feeding through.

Import prices are currently 6.1 per cent higher than a year ago while producer price inflation was running at 8 per cent in April after reaching a peak of 13.5 per cent in October 2021 when global supply-chain pressures were most acute. Those pressures are not over yet.

China’s economy continues to show signs of vulnerability with the latest purchasing managers’ index for manufacturing at 49.6 in May, consistent with more subdued business activity and slower growth ahead. Another cut in interest rates would definitely lift morale, but it might risk more exchange rate weakness at the same time.

With global interest rates heading higher, cutting domestic rates would be counterproductive if it triggered another sell-off in the renminbi, further exacerbating inflation risks down the line.


An even weaker renminbi could also inflame US-China trade war tensions, potentially putting US export competitiveness at a greater disadvantage to China. Prioritising a stable dollar/renminbi exchange rate would rule out more interest rate cuts for the foreseeable future.

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To achieve faster growth, Beijing should focus on much bigger fiscal stimulus. Despite calls for fiscal stabilisation and reducing the budget deficit as a percentage of gross domestic product, a temporary overshoot will be necessary beyond official indications of a 2.8 per cent budget deficit target this year.

Beijing has subsequently suggested that the extra spending measures needed to support the economy could increase this year’s deficit target by an extra 1 percentage point, but the government should have scope to go even further. As recently as 2018, before the Covid-19 crisis, the budget deficit/GDP ratio had jumped to as high as 4.2 per cent. The precedent is there.

The extra government debt issuance needed to cover the budget shortfall should not be a problem while investor demand for high-grade government paper remains reasonably firm, reflecting global uncertainties. The trade-off for a higher budget deficit would be a better outlook for the economy.

The value-added of extra government spending on the economy will be invaluable for employment prospects, stronger consumer confidence and ultimately for faster growth in 2022.

David Brown is the chief executive of New View Economics