The fiscal plans unveiled by China’s leadership today are as expansive as those in 2009 but credit growth will remain far more constrained. The focus again is overwhelmingly on measures to boost investment, primarily infrastructure. We expect stimulus to succeed in lifting growth in the near-term – China should emerge from the coronavirus downturn faster than other major economies. But another wave of state-mandated investment will only cement China’s structural economic problems more firmly in place.
- The fiscal plans unveiled by China’s leadership today are as expansive as those in 2009 but credit growth will remain far more constrained. The focus again is overwhelmingly on measures to boost investment, primarily infrastructure. We expect stimulus to succeed in lifting growth in the near-term – China should emerge from the coronavirus downturn faster than other major economies. But another wave of state-mandated investment will only cement China’s structural economic problems more firmly in place.
- China’s apparent lack of policy action over the past few months had surprised many. But the announcements at the National People’s Congress confirm what the ramp-up in local government bond issuance in recent weeks had suggested: that substantial fiscal loosening is underway.
- One reason for the relatively slow start is that fiscal policy in China is always concerned mainly with investment, rather than welfare spending or transfers to households or firms. The fiscal response had to wait until workers had returned and construction sites were able to open.
- The details released today suggest that fiscal support will be reasonably large. The official budget deficit will exceed 3% of GDP for the first time. The augmented deficit, which is a better measure of the true fiscal position, is likely to widen by around 4.5% of GDP. That’s the same as the increase in 2009.
- An important difference with the response to the Global Financial Crisis is that borrowing by firms will not be allowed to soar. Only about a third of the surge in economic growth in 2009 can be attributed to measures taken directly by the central or local governments. The rest was mostly driven by a colossal boom in corporate credit that ultimately led to the worries about debt and overcapacity that cast a shadow today.
- Those worries about debt have been put on the back burner – they are barely mentioned in the government’s Work Report published today. But they haven’t gone away.
- Another difference with 2009 is that property construction will apparently not be a major target of investment. Instead, the focus will be infrastructure. There is some talk of boosting spending on “new infrastructure” – a 5G network, electric car charging facilities, data centres and so on. But given the scale of investment planned, the bulk will have to go to “old” sectors, such as highways, metro systems and power transmission.
- Officials appear to have been disappointed by the slow speed of the economic recovery since lockdown restrictions ended. Conservative targets for job creation that were released today suggest they remain cautious. We think that’s sensible: the lockdown has left a legacy of unemployment and firm closures that will take time to address. But we are less sceptical than some about the capacity of stimulus to generate a sizeable pick-up in demand. While credit growth has often failed to boost the economy in recent years, an important distinction now is that the economy is operating well below capacity. Unemployment is high.
- But this success in mobilising resources in response to a crisis will come with a cost: another wave of state-mandated investment to boost demand will worsen the structural misallocation of resources across the economy and contribute to a further decline in long-run potential growth
China’s stimulus plans and the implications for growth
Today’s announcements at the National People’s Congress in Beijing fill in some important gaps in our knowledge of the leadership’s economic plans for the next year, particularly with regards to fiscal policy. In this Focus, we detail the key announcements, provide context for the decisions that have been made, and outline the likely implications for the economy. The analysis is divided into sections asking:
What was announced today?
Let’s start with what wasn’t announced – a target for annual GDP growth. This is a historic shift. China has reliably set (and reliably met) annual growth targets for over two decades. (See Chart 1.) The scrapping of the target isn’t too surprising (we flagged it as a possibility last month): any politically-palatable target would have been difficult to achieve amid the COVID-19 disruption. Still, it shows that China’s leadership is willing to adapt its ambitions to the reality on the ground and is not pursuing rapid growth at any cost. And if this is a permanent shift away from growth targets then it would be a welcome one. Efforts to hit GDP targets are partly to blame for the over-investment and rapid rises in debt during the past decade.
Chart 1: Official GDP (%y/y)
Sources: CEIC, Capital Economics
The government has retained annual targets for employment, which has long appeared even more important to the leadership than GDP. Officials have long defended high GDP growth targets as necessary to keep the labour market healthy. But the 2020 employment targets look quite conservative and suggest that officials are anticipating an extended period of labour market weakness.
The government is aiming to keep the surveyed urban unemployment rate at around 6%, broadly the current level and up from around 5% last year. The true level of unemployment is likely much higher given that the surveys are failing to capture the 10% (at least) of the migrant workforce that have not returned to the cities due to a lack of jobs.
The government is aiming to create nine million new urban jobs in 2020, presumably to help absorb a portion of these unemployed migrant workers. But by comparison, 13.5 million jobs were created in 2019 against a target of 11 million. The jobs target, however, is a gross figure, and therefore not very insightful in isolation. In recent years, the number of jobs created has continued to increase. But the change in total urban employment – the net increase in urban jobs – has slowed down. (See Chart 2.)
Chart 2: Urban Job Creation (millions)
Sources: CEIC, Capital Economics
Official figures show that 2.3 million urban jobs were created in Q1 on a gross basis. But we estimate that the COVID-19 outbreak has resulted in 20-25 million net job losses. So even if the jobs target is met it will only reverse a portion of the job losses since the start of the year.
Table 1: Government Targets [published outcome in brackets]
Official budget balance
(% of GDP)
Quota for issuance of “special” bonds
(% of GDP)
Shantytown flat starts (units mn)
Urban job creation
“about 7.5” [7.8]
“about 7.5” [7.3]
“about 7.0” [6.9]
“about 6.5” [6.9]
“about 6.5” [6.6]
Sources: State Council, CEIC, Capital Economics
Perhaps as a result of their relatively downbeat assessment of the prospects for the labour market, the leadership used the NPC to lay out plans for a ramp-up in stimulus.
The biggest announcements were on fiscal policy, where clarity on the full year stance was lacking until now. The full budget document has not been made public, but some key figures are known.
As usual, much of the focus is on the official budget deficit target, which was raised from 2.8% of GDP in 2019 to 3.6% “or higher” this year. This is the first time the target has been set above 3% which was previously seen as the upper limit (even, as we discuss below, in 2009).
The breaching of the ceiling for the deficit is a clear sign that officials believe an unusually-proactive fiscal stance is needed this year.
That said, by itself, the official deficit understates the scale of fiscal support. It is distorted by year-end injections from reserve funds, which are used to massage the figures (see in Table 1 how the published outcome almost always meets on beats the target set early in the year.) And the official deficit excludes anything that takes place outside the general budget, including the issuance of special bonds which have become increasingly important in recent years.
Local government special bond issuance went from zero in 2015 to RMB2.15trn (2.2% of GDP) last year. The NPC revealed that the quota for this year will be raised to RMB3.75trn.
In addition, another RMB1trn of new central government special bonds (referred to as “anti-virus bonds”) will be issued. This is only the third occasion in recent decades on which the central government has issued special bonds, which are treated as sovereign debt but set apart from the general budget. In 1998, special bonds were issued to recapitalise the insolvent state banks and in 2007 they were used to inject capital into CIC, China’s sovereign wealth fund.
Taken together, the increase in special bond issuance planned this year will be around 2.4% of GDP, representing more than half of the fiscal stimulus announced at the NPC.
Finally, policymakers are leaning on the social security budget as a further source of support. Although the detailed annual budget figures have yet to be published, the Finance Ministry has previously revealed that contribution waivers during the first half of the year will total 0.5% of GDP and the annual figure is expected to be around double this.
Altogether, that brings the budgeted increase in this year’s deficit to 4.2% of GDP. Assuming that there is a modest rise in off-budget borrowing too, then the augmented fiscal deficit – the best guide to the overall stance – is likely to widen by around 4.5% of GDP this year, slightly more than the 4% of GDP that we had previously anticipated. (See Chart 3.)
Chart 3: Augmented Fiscal Balance (% of GDP)
Sources: CEIC, Capital Economics
The NPC also made clear that additional monetary easing is in the pipeline. Premier Li called for a further decline in interest rates and pledged that credit growth and money supply growth would accelerate this year. The government also extended its loan support scheme for SMEs until March 2021 and called on large banks to expand lending to SMEs by more than 40% this year.
There are fewer clues than with fiscal policy as to the scale of the coming monetary stimulus. But it is clear that concerns about debt are taking a back seat for now given that they were barely mentioned in this year’s Work Report.
How does this compare with the response to previous downturns?
There have been several rounds of policy loosening over the past decade. Loosening in 2015/16 reversed the slowdown that contributed, alongside a collapsing equity bubble and botched exchange rate reform, to global panic about a China hard landing. (See here.) Less well-remembered now is the slowdown in early 2012 that appeared to catch the leadership off-guard, triggering an abrupt reversal on monetary and fiscal policy. (See here.)
But comparisons recently are mostly being drawn with the response to the Global Financial Crisis. China’s announcement of a RMB4 trillion stimulus in November 2008 (equivalent to 13% of that year’s GDP) was a key moment in the crisis, helping to stabilise some financial markets and ultimately trigger a strong recovery domestically and among producers of industrial commodities.
The easing in 2008/09 is usually described as fiscal stimulus. However, as Chart 3 shows, the fiscal element was a similar size to those in 2012 and 2015/16: sizeable, but not huge, and certainly not worth 13% of GDP.
In fact, the target for the 2009 budget deficit, set in March that year when the full details of the stimulus package had been worked out, was just 3% of GDP. As noted above, the official budget often doesn’t reflect the true fiscal position. We estimate that China’s augmented deficit, the best gauge of the fiscal position, widened by 4.4% of GDP in 2009 to 5.2%. This year, we project an increase of 4.5% of GDP.
In other words, the plans unveiled today are consistent with fiscal loosening on a similar scale to that seen in 2009.
But policy support during the Global Financial Crisis mainly worked through a huge surge in credit, rather than through the fiscal channel. (See Chart 4.) Credit growth exceeded 30% y/y throughout 2009.
Chart 4: Outstanding Credit & GDP in China (% y/y)
Sources: CEIC, Capital Economics
Credit growth and fiscal policy can’t be separated entirely: about a third of the credit surge in 2009 was due to borrowing by the central and local governments and by the off-balance sheet activities of local government financing vehicles (LGFVs) which were quasi-fiscal.
But the bulk of the surge in credit was driven by corporate borrowing in an environment in which state-owned banks were instructed to expand lending as much as they could. (See Chart 5.)
Chart 5: Contributions to Credit Growth (% pt y/y)
Sources: CEIC, Capital Economics
Credit growth has accelerated in response to the recent downturn. But so far this shift has been restrained. Indeed, in stark contrast with what happened during the Global Financial Crisis, the pick-up in lending growth in China has been dwarfed by those in some other major economies, where governments have introduced schemes guaranteeing loans to companies. (See Chart 6.)
Chart 6: Bank Lending to Corporates (% y/y)
Sources: Refinitiv, CEIC, Capital Economics
China’s fiscal response this time is unexceptional by international comparison too. Many governments have introduced larger stimulus package. With revenues collapsing and automatic stabilisers lifting spending, deficits for some (for example in the euro-zone) are likely to expand by more than 10% of GDP.
Why is stimulus restrained this time?
As noted above, the relatively downbeat projections for the labour market suggest that China’s leadership does not expect a strong economic rebound. Its stimulus plans are fairly big, but still well short of 2008. So why is it not doing more? There are two main constraints on China’s policy response: a narrow concern about debt and excess investment, and a broader one about the appropriate role of government.
In China, the primary purpose of fiscal policy is to direct investment. Outsiders like the IMF and World Bank have argued for the past two decades that social spending should be increased both to boost welfare and to deliver long-run economic dividends by supporting consumption and thereby rebalancing the economy. But social spending remains low relative both to richer economies and to those at a similar income level. By this point, that has to be seen as a choice by the leadership. For example, funding for the dibao (低保) Minimum Livelihood Guarantee scheme of transfers for the poorest households has never exceeded 0.1% of GDP. Unemployment support is so limited that in March only two million people were claiming it. Even on the official figures, thirty-five million were out of work. Actual unemployment was probably at least twice as high. There is no sign in today’s budget or Work Report or in recent comments from the leadership that this is about to change.
In 2009, according to the IMF, 90% of China’s discretionary fiscal measures were directed at boosting investment, compared with a quarter in Germany, around 10% in Japan, the UK and US and none in Brazil, Russia and India.
That constraint explains in part why the fiscal response got off to a slow start this year: concrete couldn’t be poured until construction sites reopened and workers returned. The sorts of steps taken rapidly by governments elsewhere, such as large-scale transfers to firms or workers, were not on the agenda.
But as restrictions on movement have been lifted, there have been signs in recent weeks that local government activity was ramping up. Government spending fell 5.7% y/y in the first quarter. In April it rose 7.5% y/y. Bond issuance by local governments has surged. (See here.) And local governments have started running down fiscal deposits.
The second constraint is the already high level of debt. As early as the loosening cycle of 2012, policymakers in Beijing had concluded that the unrestrained credit boom of 2009 was a mistake. The problems of excess capacity, poor resource misallocation and bad debt that now cast a shadow over the long-run outlook have their roots in that stimulus.
And the problem is more acute today. The financial system has not improved its ability to allocate credit efficiently. Over recent years, the share of credit going to state-owned firms has risen. And the capacity of the economy to absorb large volumes of investment has diminished. China’s physical infrastructure has expanded hugely since 2009. The network of paved roads has almost doubled in size and the freeway network has more than doubled. China has built a high-speed rail network and expanded the regular network by a third. Ninety airports have been built. And developers have built 75 million urban homes. Productive investments are harder to find.
Policymakers won’t be able to stimulate investment this year without tolerating some acceleration in credit. But it will be far more restrained than in 2008.
Today’s budget gives us the framework of the fiscal portion of stimulus. As outlined above, support is mostly coming in the form of larger deficits on the general and social security budgets, alongside a marked ramp up in special bond issuance.
The former appears to be mostly due to planned tax cuts. The Finance Ministry plans on reducing the tax and fee burden on firms, mostly SMEs, by RMB2.5trn (2.5% of GDP) this year. This probably overstates the scale of tax cuts somewhat: officials claim to have carried out RMB2.36trn in cuts last year but in practice the decline in tax revenue was only around 1% of GDP. (See Chart 7.) Nonetheless, it continues the trend of the past couple of years in which tax cuts have played a role in fiscal policy. The RMB2.5trn figure includes the temporary waivers of social security payments and explains much of the increase in the planned general and social security deficits.
Chart 7: Tax Revenue (4Q sum, % of GDP)
Sources: CEIC, Capital Economics
In contrast, there appears to be very little planned in terms of increasing direct transfers to households, consistent with the traditional investment focus noted above. Some local government have rolled out consumption vouchers to encourage people to shop. But their scale is tiny – only RMB18bn in total according to the government, equivalent to 0.02% of GDP.
Meanwhile, the key focus of the special bond issuance will remain investment rather than consumption. Indeed, the reason these bonds are not included in the general budget is that it is expected that they will be repaid using the revenue from the projects in which they invest.
One key difference with the investment-led stimulus of previous years is that property will play a reduced role. Although the Work Report clearly signals a reduced emphasis on deleveraging and financial risks, the language on property continues to be that “homes are for living in, not for speculation”. This suggests that major loosening of property controls probably isn’t on the cards.
Meanwhile, for the first time in recent years the shantytown redevelopment scheme – a key driver of property investment – was not mentioned at all in the Work Report, reinforcing broader signs that the scheme is being pared back.
Late last year regulations were introduced to prevent local governments from using special bonds proceeds to replenish their land reserves or fund shantytown projects. Those rules were relaxed earlier this month but only to meet funding shortfalls for existing projects. As a result, there will be a sharp reduction in the share of special bond proceeds flowing to property investment and a sharp increase in the share being used for infrastructure spending. (See Chart 8.)
There has been some talk of a shift in the type of infrastructure projects being funded. The new buzzword is “new infrastructure”, which Premier Li referred to today in the context of building out a 5G network, “next generation information networks” and charging facilities for electric cars.
This could prove important in time, but seems unlikely to be a core element of increased investment over the next 12 months. The data we have on infrastructure investment so far this year suggest that most is on old infrastructure: highways, metro systems and power transmission.
Chart 8: Net Special Bond Issuance by Intended Use (RMBbn)
Sources: CEIC, Capital Economics
There is less clarity on how the new “anti-virus” special central government bonds will be used. But reports suggest that the bulk will also flow into infrastructure, with a tilt towards healthcare-related projects.
The broad picture, therefore, is this: fiscal stimulus this time is about the same size as that in 2009 but the increase in private sector credit will be far smaller. The 2009 stimulus was split between spending on infrastructure and property. This time, tax cuts will play a part, but the vast bulk will be investment in infrastructure. Property is not a focus.
Today’s policy announcements were slightly more aggressive than we had been anticipating, but not enough to change our forecasts for economic growth.
We expect government efforts to stimulate demand to succeed and over the coming year for the economy gradually to return to near the path it was on before the coronavirus outbreak.
Our impression is that the government, and most domestic analysts, have been disappointed at the speed at which the economy has bounced back so far. The underperformance is partly due to the rapid spread of economic lockdowns beyond China’s borders. But it also reflects an initial failure to appreciate the scale of the impact on domestic demand or the shutdown in China and how long it would last. Many jobs have been lost and firms closed.
However, there is also a view now in some quarters that policymakers will not be able to stimulate growth since the surge in debt over the past decade has left few in China still willing to borrow. Investment-led stimulus in China is credit-fuelled.
We are not so pessimistic. Local governments have few constraints on their capacity to borrow if the central government lets them. State firms only face soft budget constraints, and most will implement policy instructions if instructed. In China’s state-led economic system, policymakers are able to mobilise resources more easily than their counterparts can elsewhere.
A key difference with the situation in recent years when credit growth has often failed to boost output is that the economy today is clearly operating well below capacity. Unemployment is extremely high.
We expect the economy to contract 5% this year but to bounce back with a 15% expansion in 2021. If we’re right, China will be the first major economy to return to near its pre-crisis path. But this success in mobilising resources in response to a crisis comes with a cost: another wave of state-mandated investment to boost demand will worsen the structural misallocation of resources across the economy and contribute to a further decline in long-run potential growth.