Coronavirus: China’s central bank, finance ministry at odds over funding for economic recovery

China’s top economic policymakers have been engaged in heated debate over whether the country’s central bank should directly buy special bonds issued by the finance ministry to help the government’s economic support measures. The discord reflects the differing schools of thought in China over how best to help the world’s second largest economy recover from the coronavirus. The National People’s Congress (NPC), which is due to meet in less than three weeks, is expected to provide clearer signals on Beijing’s economic policy. Liu Shangxi, president of the Chinese Academy of Fiscal Sciences, a finance ministry-affiliated think tank, kicked off the debate after he recently proposed issuing 5 trillion yuan (US$700.5 billion) in special Treasury bonds to help stabilise the economy. He called on the People’s Bank of China (PBOC) to buy them in tranches at an interest rate of zero. Such purchases of bonds are technically taboo in China as central bank law forbids it from directly bankrolling government spending. The “monetary financing” of government fiscal plans means the central bank is creating additional money supply to buy the debt, which could lead to higher inflation. The US Federal Reserve, the European Central Bank and the Bank of Japan now purchase government bonds as part of their “quantitative easing” policies, though they make the purchases from secondary markets, not directly from the government. Still, critics are increasingly worried about inflation risks down the road. China’s central bank was banned from directly buying government bonds based on “hyperinflation fears”, said Liu, who is also a member of the Chinese People’s Political Consultative Conference, which will convene its annual meeting on May 21 alongside the NPC. But he said the likelihood of such a scenario “is now almost zero” given the weak state of China’s economy. He said the PBOC needed to think outside the box as “neither quantitative easing nor a low interest rate [environment] has led to inflation”, adding the old theory that the central bank should not be the cashier for the government was “outdated”. China has already decided it will issue special Treasury bonds to help support the economy. Budget deficits can be enlarged during times of economic crisis, but [we] must balance saving the economy with fiscal discipline Wu Xiaoling However, the way they are issued along with the size of the allocation – which could be trillions of yuan – will be announced at the NPC session starting on May 22. For defenders of central bank independence, Liu’s idea risks opening a Pandora’s Box in China. Former PBOC deputy governor Wu Xiaoling said there must be constraints on government expenditure to ensure the efficiency of fiscal spending. “Budget deficits can be enlarged during times of economic crisis, but [we] must balance saving the economy with fiscal discipline,” she said in comments posted to the website of the China Wealth Management 50 Forum on Wednesday. If economic stimulus is too big, it could bring the risk of inflation and a fast increase in the leverage [debt] ratio Yi Gang “The key question faced by the Chinese economy is whether our fiscal policies are appropriate and how efficient they are,” she said, warning that an unlimited amount of cheap funding for the government could lead to wasteful spending. Central bank governor Yi Gang has warned on several occasions about excessive economic stimulus, citing the already high risks present in China’s financial system. “If economic stimulus is too big, it could bring the risk of inflation and a fast increase in the leverage [debt] ratio. We must maintain normal monetary policy as long as possible to safeguard the strategic period for long-term development,” he wrote in an article published late last month. The current debate is not the first time that fiscal and monetary policymakers have clashed. Two years ago, the two agencies also argued over who should play the leading role in stabilising growth that had been slowed by the US-China trade war. The 25-member Politburo headed by President Xi Jinping has called for increased policy support after the Chinese economy contracted 6.8 per cent in the first quarter. Fiscal policy is widely expected to take the lead role in supporting the post-coronavirus recovery from here on, with the PBOC already having taken a series of steps since the start of the year, including injecting trillions of yuan of liquidity into the banking system, lowering funding costs for borrowing and using targeted measures to increase lending to troubled small businesses. The nation’s fiscal situation is now under stress after a 2.3 trillion yuan business tax cut last year and another 318 billion yuan tax cut on social security contributions in the first quarter. In the first three months of the year, fiscal revenues dropped 14.3 per cent from a year earlier to 4.6 trillion yuan, while expenditures fell 5.7 per cent to 5.53 trillion yuan.