China’s Ministry of Finance recently held a press briefing, revealing a surprising focus on tackling local government debt rather than delivering the widely anticipated fiscal stimulus. While Minister Lan Fo’an did mention plans to increase debt and the deficit, the emphasis remained firmly on restructuring existing financial burdens. This strategic shift has sent ripples through the market, leaving investors and analysts grappling with the implications for China’s economic growth and future policy trajectory. This article delves into the details of the announcement, analyzes the potential impact, and explores differing expert opinions on the adequacy of the government’s response to the ongoing economic slowdown.
Key Takeaways: China’s Fiscal Strategy Shift
- Focus on Debt Resolution: The Ministry of Finance prioritized addressing the mounting local government debt crisis over immediate stimulus measures.
- Gradual Approach to Stimulus: While increased debt and deficit are planned, the approach to boosting consumption and social welfare spending will likely be gradual.
- No Keynesian-style Expansion: The announced policies are aimed at structural issues, not at a broad, Keynesian-style fiscal expansion to boost aggregate demand.
- Parliamentary Approval Needed: Significant fiscal changes require approval from China’s parliament, expected by the end of October, potentially leading to further debt allowance.
- Mixed Analyst Opinions: While some analysts are optimistic about the long-term strategy, others argue that additional fiscal support exceeding 2.5 trillion yuan may be necessary to maintain growth targets.
Local Governments Drag on Domestic Demand
The Chinese government’s primary concern is the substantial debt accumulated by local governments. This debt burden has been exacerbated by the slump in the real estate market, a major source of revenue for local authorities. Even before the COVID-19 pandemic, many local governments already faced financial struggles. The current situation has intensified calls for a significant fiscal stimulus package, a call seemingly ignored in favor of debt restructuring.
The impact of constrained finances
The consequences of constrained local government finances are far-reaching. According to Rhodium Group, local governments historically shouldered over 85% of expenditure while receiving only around 60% of tax revenue. This imbalance has created a severe financial strain, further amplified by sluggish consumption and slower-than-expected overall economic growth. The International Monetary Fund (IMF) directly links these limited local government finances to “downward pressure on prices,” reflecting a dampening effect on overall economic activity.
Slowing price growth
This manifests in slow price growth. China’s core consumer price index (CPI), excluding volatile food and energy, increased by only 0.1% year-on-year in September 2024 – the lowest rate since February 2021. This stagnation underlines the urgent need for policy intervention, especially given the central government’s own 5% growth target for the full year. For Morgan Stanley, addressing local government debt is almost as crucial as stimulus in reviving the economy.
Minister Lan announced a plan to allow local governments to utilize 400 billion yuan ($56.54 billion) in bonds to sustain payroll and essential services. Furthermore, a comprehensive plan to tackle the endemic problem of hidden local government debt was promised, although a timeframe was not specified. Minister Lan asserted that levels of hidden debt at the end of 2023 were half what they were in 2018, a claim that needs further scrutiny and verifiable data to be fully accepted.
Waiting for Another Meeting: The Parliament’s Role
The upcoming meeting of China’s parliament, expected at the end of October, holds significant importance. This body must approve any changes to the national budget, and previous meetings such as that in October 2023 resulted in a rare increase in the fiscal deficit to 3.8% from 3%.
Differing views on necessary stimulus
Significant disagreement amongst analysts surrounds the extent of necessary fiscal support. While some, like Vikas Pershad of M&G Investments, believe the policy direction is “on the right path” regardless of the exact stimulus size, others, such as Julian Evans-Pritchard of Capital Economics, estimate that at least 2.5 trillion yuan in additional funding is necessary to maintain the targeted growth rates for 2024 and 2025. Evans-Pritchard highlights the ineffectiveness of previous support methods focused on real estate and credit, pushing for a more direct fiscal intervention to counter the more complex economic headwinds.
A conservative approach
China’s policymakers have traditionally maintained a conservative approach, notably refraining from direct cash handouts to consumers after the pandemic, unlike the responses seen in other nations like the U.S. or Hong Kong. This preference for gradual and structural reforms is likely to continue, even amidst growing external pressure to implement a larger and more immediate stimulus package.
The debate centers on how additional borrowing will be allocated. If a significant portion is earmarked for bank recapitalization and addressing pre-existing local government debt challenges, it might not translate into a substantial boost to immediate consumer demand – a key concern for many analysts observing the situation.
In conclusion, China’s current economic strategy prioritizes the resolution of underlying structural issues, particularly local government debt, over a large-scale stimulus package. While plans for increased debt and deficit are in place, the government is opting for a gradual and targeted implementation. The upcoming parliamentary meeting will be crucial in determining the final scope and impact of government intervention. The differing opinions of analysts highlight the uncertainty surrounding the effectiveness of this strategy in achieving the government’s ambitious growth targets and mitigating the risks of further economic slowdown.
