China’s economic policymakers are using stimulative fiscal and monetary policy for two purposes. First, they seek to cushion the economy’s long-term transition to an economy driven by consumption, services, and higher value-added manufacturing. Second, they are also fighting headwinds largely caused by external factors – a slowing world economy and trade disputes.
The steady decline in top-line GDP growth – from 6.4 percent in the first quarter to 6.2 percent in the second quarter to 6.0 percent in the third quarter, as per the data released on Oct 18 – is exactly what is expected and needed.
The nation is moving from raw GDP growth toward an emphasis on improving the quality of citizens’ lives. The National Bureau of Statistics’ summary of the third-quarter data said: “Solid efforts were made to advance the ‘three critical battles’ of preventing and defusing financial risks, conducting targeted poverty eradication and controlling pollution.”
And, the transition away from manufacturing to services (which are officially called the tertiary industry) continues. “The economic structure was optimized. In the first three quarters, the value added of the tertiary industry accounted for 54.0 percent of GDP, 0.6 percentage point higher than that of the same period last year,” the NBS said in its summary.
However, this transition causes economic pain as old industries and jobs shrink and resources are redirected. One goal of macroeconomic policy is to reduce this pain.
“We are seeing a deceleration in domestic demand and the challenging global environment, so we expect some monetary loosening and continued strong fiscal spending, including some fiscal support through infrastructure investment,” said Dominik Peschel, an economist at the Asian Development Bank representative mission in Beijing.
Policymakers are emphasizing the role of fiscal stimulus – cutting taxes and increasing government spending. Of course, the large, more than 2 trillion yuan ($282.6 billion) cut in taxes and fees has limited government revenue, which rose by 3.2 percent, well below the 9.4 percent growth in the same period last year.
According to Ministry of Finance estimates, the government budget deficit will rise to 2.8 percent of GDP in 2019, up from 2.64 percent in 2018, but slightly less than the 2.9 percent seen in 2017. Government new debt issuance has risen sharply since 2015, but total outstanding debt remains very low by international standards. So, China has a good deal of room for further fiscal stimulus.
Finance Minister Liu Kun, in a September press conference, acknowledged the pressure in maintaining fiscal balance as on the one hand the tax and fee reduction policy is more aggressive; on the other hand, government spending needs to be strong so as to support key reforms.
Attempts to use fiscal policy, especially boosts in infrastructure spending, may not be as effective as previously. At an earlier stage of growth, China was very short of hard infrastructure – transportation, energy, water, and so forth – so almost any infrastructure spending would be economically useful.
However, now the country has world-class, even world-leading, infrastructure in many areas, so the marginal value of additional hard infrastructure is likely to be lower. It is especially important that new infrastructure spending be targeted to the most productive uses.
“One of the issues is the need to shift more toward soft infrastructure – health and education. A lot of the stimulation has traditionally been done by construction investment, but in order to unlock part of the savings in the Chinese economy, especially household savings, it is important to provide good health and education so the households don’t have the necessity of such high savings rates. This would help rebalance the economy,” explained Peschel.
One difficulty with using fiscal stimulus is that most infrastructure spending needs to be implemented by local governments, but the tax cuts have limited their budgets.
Peschel said: “The challenge to local governments, which are responsible for the bulk of expenditures on health and education, is that they don’t have the ability to generate additional revenue on their own and their debt issuance is controlled by the central government. It’s a structural issue about how revenue is raised and spent by the central and local governments.
“The tax cuts, especially the cut in the value-added tax rates, have reduced local government revenue. Earlier this year, there were changes in the way the revenue raised from certain local government special bonds issuance can be used, thus giving them more leeway to spend on infrastructure.”
Responding to this problem, the State Council, China’s Cabinet, announced in October that the tax income redistribution between the central and local governments has been rebalanced so that local governments will receive 50 percent of VAT revenues, instead of the 25 percent they had been receiving.
Policymakers are also seeking to use monetary policy, cuts in interest rates and increases in loan availability, to stimulate additional corporate investment and consumer spending. However, these sectors are reluctant to increase debt.
In an October report, the IMF stressed the conflict between stimulating growth and reducing corporate debt. “In China, the effects of escalating tariffs and weakening external demand have exacerbated the slowdown associated with needed regulatory strengthening to rein in the accumulation of debt.”
Moreover, the China Beige Book, a financial data company, reported a surge in shadow banking loans in the first half of 2019, reversing the drop in 2018 that was caused by a regulatory crackdown.
However, despite recent increases, debt levels still remain low by international standards.
“Government debt and consumer debt are still at reasonable levels. Corporate debt was addressed by the government in 2018, requesting State-owned enterprises to reduce their leverage, but of course in the current situation it is difficult for the companies not to incur a bit more debt if they are asked to help stabilize the economy,” said Peschel of the ADB.
“If you look at the bond market, market participants usually perceive local government debt as safe and they therefore require only a small spread over the interest rate on central government bonds.”
The traditional danger of expansionary monetary policy is that inflation will go up. However, China’s core inflation rate remained low at about 2 percent. The recent increase in the reported rate of inflation from 2 percent last year to 3 percent this year is entirely due to a huge increase in pork prices caused by the African swine fever epidemic.
At a press conference in October, Victor Gaspar, director of the IMF’s fiscal affairs department, said: “We very much welcome the contribution fiscal policy makes to the rebalancing of the economic growth model of China, especially where by increasing the purchasing power of consumers it fosters the move from exports to domestic demand and from investment to consumption, which is part of the transition of the growth model in China.”
Similarly, Roman Wojdyla, general manager of Home Credit Consumer Finance Co Ltd, said earlier: “From our point of view, the most resilient part of the Chinese economy is its vast consumer market and the macro control exercised by the Chinese government.”
Bottom line: 2019 is proving to be a challenging year for the Chinese economy. It continues its long-term reform toward higher value-added industry, a growing service sector and rising consumer demand while at the same time facing external challenges. In these circumstances, appropriate fiscal and monetary stimulus is maintaining growth and employment and facilitating reform.