Shen Jianguang on Five Major Misunderstandings of China’s Fiscal Stimulus Package
Investors may have underestimated the importance of addressing hidden debt and overlooked the potential impact of a fundamental change on China’s fiscal policy, the well-known economist says.
Dr. Shen Jianguang, a well-known Chinese economist now employed by a major tech giant in China, doubles as a columnist for FTChinese, a terrific service of the Financial Times that produces high-quality financial news and analysis in Chinese. This week, he wrote about what he believes are 低估财政增量政策的五大误区 Five Major Misunderstandings of China’s Fiscal Stimulus Package in FTChinese.
Before entering the private sector, Dr. Shen was Senior Economist at the European Central Bank (ECB) in Frankfurt, where he took the position of monitoring and analyzing the Chinese and Asian economies. Dr. Shen also held economist and senior economist positions at the IMF, OECD, CICC, and Central Bank of Finland, in addition to being a visiting scholar at the People’s Bank of China and the Department of Economics at the Massachusetts Institute of Technology.
Below is an English translation by Shen via FTChinese.
低估财政增量政策的五大误区
Five Major Misunderstandings of China’s Fiscal Stimulus Package
On November 8, the Standing Committee of the National People's Congress held a press conference, revealing its latest fiscal stimulus package: from 2024 to 2026, an additional 2 trillion yuan of local government special bond will be issued annually, directly replacing local governments' hidden debts. The Ministry of Finance also announced that starting in 2024, 800 billion yuan will be allocated annually from the new local government special bonds over the next five years to repay debts. Furthermore, it was made clear that the hidden debts related to shantytown renovation, totaling 2 trillion yuan, will not need to be repaid before 2028. Finance Minister Lan Fo’an also stated that other incremental fiscal policies are in preparation.
However, the capital markets didn’t seem to believe that such fiscal stimulus package is enough to revive the Chinese economy. below expectations. During the press conference, A50 futures and the RMB exchange rate saw significant declines; in the following trading days, the Hang Seng Index also plummeted. In my opinion, the market has five major misunderstandings regarding China's fiscal stimulus package. Investors may have underestimated the importance of addressing hidden debt and overlooked the potential impact of a fundamental change on China’s fiscal policy. Of course, if the central government later starts to address the housing market difficulties and further stimulate consumption, China's economic recovery will indeed be on a more solid footing.
Misunderstanding 1: Insufficient Scale of the Fiscal Package
The market's primary misconception about the policy is that the scale of incremental policy is insufficient: the new local government debt quotas allocated for replacing hidden debts amount to only 6 trillion yuan; the 800 billion yuan allocated annually for replacing hidden debts will be deducted from the government’s annual budget, while the 2 trillion yuan of debt related to shantytown renovations is only deferred according to contract, with repayment postponed until after 2029.
However, I believe this view fails to fully grasp the comprehensive picture of the entire set of incremental fiscal tools. Regarding debt replacement, Finance Minister Lan Fo’an has clearly stated that the issuance of special bonds will be expanded in 2025. I believe this could offset the 800 billion yuan allocated for debt replacement each year. Additionally, the 2 trillion yuan of deferred debts could be understood as the issuance of replacement bonds over four years, worth about 2 trillion yuan. From this perspective, the total debt replacement reached a total of 12 trillion yuan, or 10% of GDP. This is just one of the measures, definitely not small.
In addition to debt replacement, Minister Lan Fo’an also mentioned that fiscal and tax support for the real estate market, capital injections into large state-owned banks, and special bonds for land and housing reserves are currently in process. Next year, the fiscal deficit space may also be expanded to support equipment investment and consumer goods "trade-ins" subsidies, as well as increasing transfer payments to support technological innovation and social welfare expenditures.
When considering all of these policy measures, China’s latest fiscal stimulus package may reached 20% of GDP, undoubtedly should be described as bold and large-scale.
Misunderstanding 2: Debt Replacement is Merely Debt Exchange Without Spending Effects
Another major misunderstanding in the market regarding the fiscal package is the belief that debt replacement measures are primarily asset-liability management tools. While debt replacement helps alleviate fiscal and financial risks, it is seen as lacking spending effects. The impact on the broad fiscal deficit or surplus is the most direct indicator of whether a fiscal policy is expansionary or contractionary. In my view, the debt replacement deal has significantly reduced the fiscal surpluses that local governments would otherwise have been forced to generate in order to repay hidden debts, which has a clear expansionary effect.
Based on the Ministry of Finance’s disclosure that the implicit debt balance at the end of 2023 was 14.3 trillion yuan, and the previous statement that "the implicit debt recorded on the government debt information platform at the end of 2023 was 50% lower than the baseline in 2018," it can be inferred that the scale of implicit debt at the end of 2018 was approximately 29 trillion yuan. According to the original plan, the implicit debts were to be eliminated over ten years, meaning that local governments needed to repay 3 trillion yuan of implicit debt annually. In fact, from 2019 to 2023, approximately 14-15 trillion yuan of implicit debt was repaid.
From 2019 to 2023, China carried out three rounds of debt replacement: the 818.6 billion yuan debt replacement in pilot counties, the 504.2 billion yuan debt replacement for clearing implicit debts in Beijing, Shanghai, and Guangzhou, and the 2.2 trillion yuan debt replacement arranged after the Politburo meeting in 2023, which called for a "comprehensive debt resolution plan."
This means that even though there are still some methods of debt management—such as allowing local state-owned enterprises to help repay the implicit debts in various ways—between 2019 and 2023, local governments directly repaid a significant portion of the remaining 10-11 trillion yuan debt. I estimate that local governments may have been forced to generate fiscal surpluses of 1-1.5 trillion yuan per year to repay the implicit debt. Moreover, in order to manage and shift these debts, local governments also had to consume substantial time, effort, and resources.
Once the implicit debts are converted into explicit debt, generally only interest payments are required each year, and the focus shifts to balance management. According to calculations presented by the Ministry of Finance during a press conference, the annual debt repayment scale for the next five years will be only 460 billion yuan. This means that, compared to the past five years, local governments will be able to increase fiscal expenditure by approximately 0.6-1% of GDP per year, which will provide a clear support to aggregate demand. Additionally, debt replacement can reduce interest expenditures by a total of 600 billion yuan over the next five years. The time and resources previously consumed by debt management are also saved.
In my view, this is the true meaning behind Finance Minister Lan Fo'an’s statement at the press conference, where he said, "Resources that were originally used for debt repayment can now be redirected to promote development and improve people's livelihoods; ... and the time and effort previously spent on debt and risk management can now be better invested in planning and driving high-quality development."
Misunderstanding 3: Supporting the Government but Not Enterprises and Households
Another criticism of government debt swaps—the key focus of incremental fiscal policies—is that while the policy addresses the government's urgent needs, it does not take into account the needs of businesses and households. This view fails to understand the widespread effects on businesses and residents due to the fiscal stress faced by local governments, which is compounded by the pandemic’s impact, a deep adjustment in the real estate market, and efforts to resolve implicit debts.
First, local governments have been forced to reduce public investment, spending on public services such as education and healthcare, as well as procurement and transfer payments, which could directly affect the income of many businesses and households. Second, the government’s delays in paying for project costs have had a significant impact on the upstream and downstream enterprises in many industries. Third, due to cash flow pressures, some local governments have delayed payments to civil servants, teachers, and other government employees, and in some cases, have even collected funds from civil servants to repay debts. Finally, considering the multiplier effect, the impact on both households and businesses is even more significant.
As of September 2024, fiscal spending on education had increased by only 1.1% year-on-year, the lowest level for the same period in recent history, aside from the 2020 pandemic year. The low government expenditure has also affected social consumption, with retail sales of consumer goods growing significantly slower than household consumption expenditure. Not only private enterprises have faced difficulties, but state-owned and central enterprises have also experienced layoffs and wage cuts due to unpaid debts, and some have been sued as "dishonest identity " for failing to pay their downstream suppliers. Some enterprises have even been driven to bankruptcy. The collapse of large construction firms, which have a broad impact, could trigger a chain reaction in the entire industrial chain.
According to data from the National Bureau of Statistics, government consumption accounts for about 30% of total final consumption. It is estimated that fiscal funds also directly influence about 30% of infrastructure investment. Large-scale debt swaps have alleviated local governments’ cash flow pressures, which is beneficial for restoring general government spending, addressing payment arrears to businesses and civil servants, and can further stimulate income recovery for both enterprises and households through the multiplier effect.
Misunderstanding 4: Supporting Investment but Not Consumption
Another concern regarding the fiscal package is that while the government’s repayment of project debts benefits the firms, it does little to stimulate consumption. In the author's view, some policy measures also indirectly support consumption.
First, as mentioned earlier, the improvement in local government spending has a significant impact on boosting government consumption in areas like healthcare, education, and procurement, which in turn benefits the retail sales of consumer goods. Second, resolving issues related to enterprise debts and the non-payment of civil servants' salaries will also contribute to the growth of household incomes, thereby supporting consumer spending. Third, next year, the expansion of the fiscal deficit will provide greater space for further consumption support, such as the "trade-in" incentives for household appliances and automobiles, which is expected to help sustain consumption growth in these sectors. Finally, larger transfer payments and better guarantees for public welfare spending in 2025 will reduce the need for precautionary savings among residents, thus further stimulating consumption.
Misunderstanding 5: There is No Incremental Fiscal Funding in 2024
Some investors are concerned that the fiscal package mainly "focuses on the long-term" and lacks effective measures to achieve the economic growth target for 2024. A detailed analysis of China’s fiscal data and relevant policy details reveals that there is considerable room for expansion in the fiscal deficit in the fourth quarter, which can play an important role in expanding domestic demand.
Currently, there are four main channels through which the broad fiscal deficit is expected to expand within this year:
Firstly, as of September, government expenditures exceeded revenues by 2.96 trillion yuan, a difference of about 2 trillion yuan compared to the initial deficit target of 4.9392 trillion yuan. This is primarily due to factors such as insufficient high-quality project reserves and delays in project approvals. With project approvals gradually moving, it is expected that government expenditures may accelerate in November and December, supporting infrastructure investment. The Ministry of Finance previously stated that there is still 2.3 trillion yuan in special bond quotas and unutilized funds available for expenditure in the last three months of the year.
Secondly, in a press release on October 12, the Ministry of Finance revealed that an additional 400 billion yuan of local government bonds would be issued to resolve outstanding government investment project debts and clear government arrears to businesses. Payments to settle arrears with businesses will also significantly increase the broad fiscal deficit.
Thirdly, a direct debt swap of 6 trillion yuan, approved for 2024, is expected to see 2 trillion yuan used this year. A significant portion of that money may be directly allocated to expenditures. For example, local governments could use the funds to settle arrears to businesses, pay overdue salaries to government employees, or directly fund public investment and social welfare expenditures. This will also contribute to the increase in the broad fiscal deficit.
Fourthly, the Finance Minister Lan Fo’an emphasized that although fiscal revenue has fallen short of expectations, the government is confident about achieving fiscal balance. He also mentioned additional tools for supplementing fiscal revenue, including "SOEs contributing part of their special earnings," "activating government-owned assets," and drawing on the "local budget stabilization fund." The central bank's profits, proceeds from the disposal of state-owned assets, and budget stabilization fund income all represent fiscal reserves, and their utilization will further support overall demand expansion.
Policy Recommendations
In my view, within China's existing political and economic framework, a fiscal package centered around helping local governments reduce debt is both realistic and essential. Combined with the gradual rollout of other incremental policies, China’s economy is expected to rebound from its low point in the fourth quarter of this year.
Looking ahead, if the central government can establish a Housing and Land Reserve Bank to drive large-scale land acquisitions and improve the supply-demand dynamics in the real estate market, and adopt more direct consumption-driven measures, such as issuing special government bonds to provide larger subsidies for low-income groups or restoring civil servant salaries to their levels in 2021, China’s economic recovery could be in a more solid foundation.